Colorado Discretionary and Special Needs Trust Act

Transcription

1 Colorado Discretionary and Special Needs Trust Act 101 Legislative Declaration Government and Families Working Together To Help the Disabled Families play a multitude of roles in their relatives' lives. By retaining and improving both discretionary trusts and special needs trust, which permits families to express on-going personal concern and provide supplemental support for a person with disabilities, the State is bolstering the ability of families to help their relatives access services, maintain a better quality of life and, in some cases, remain in the community and more in the mainstream with all the attendant societal and financial benefits. Protecting the Disabled, and Helping Reduce the State Budget Deficit This act also protects first party special needs trusts from the claims of a creditor during the beneficiary s life as well as to insure that the remaining funds will be available to reimburse the state for Medicaid costs. This legislation should help facilitate future care planning efforts for disabled individuals throughout the State as well as insure that the wishes of all persons who create trusts are respected. Retaining Colorado Trust Business and Colorado Life Insurance Business This Act retains, clarifies, codifies, and strengthens Colorado trusts. By retaining and improving Colorado law, more Coloradans would be more likely to keep trusts in Colorado. As a secondary benefit, by retaining the Colorado trust business, more Coloradans would continue to fund irrevocable life insurance trusts with Colorado issued insurance products. In this way, the state of Colorado retains the income tax derived from the sale of these life insurance products, as well as the income tax revenue from many Colorado trusts. Further, Colorado s general economy is strengthened since many trusts will not leave Colorado to find a state with more favorable trust law. 102 Retention of the Common Law Distinction of a Discretionary-Support Trust The Colorado and common law distinction between a discretionary interest and a support interest shall be maintained. Also, the common law regarding protective and restrictive distribution language shall also be maintained. 103 Definitions As used in Sections 102 through 113: Beneficial interest is limited to a distribution interest or a remainder interest. A beneficial interest specifically excludes a power of appointment or a power reserved by the settlor. 1

2 (d) (e) (f) (g) (h) (i) (j) (k) "Beneficiary" means a person that has a present or future beneficial interest in a trust, vested or contingent. However, the holder of a power of appointment is not a beneficiary. Child Support Claimant means a beneficiary s child who has a judgment or court order against the beneficiary for support. In this section, child includes any person for whom an order or judgment for child support has been entered in this or another jurisdiction. 1 A current distribution interest is a distribution interest where on the date of qualification the beneficiary is an eligible distributee or permissible distributee of trust income or principal. A distribution interest is a beneficiary s right or expectancy of a distribution subject to the appropriate judicial review standard. A distribution interest is classified as a mandatory interest, a support interest, a discretionary interest, or a combination of any of the aforementioned distribution interests. 2 A distribution interest includes both current distribution interests and future distribution interests. Future distribution interest is a distribution interest other than a current distribution interest. Power of appointment means an inter-vivos or testamentary power to direct the disposition of trust property, other than a distribution decision by a trustee to a beneficiary. Powers of Appointment are held by donees, not the settlor. 3 Remainder interest means an interest where a trust beneficiary will receive the property outright at some time during the future. Reserved power means a power held by the settlor. Special Needs Trust is a discretionary interest. Without limiting the scope of a special needs trust, the settlor may limit distributions or provide guidelines for either the special needs of the beneficiary, the nonsupport needs of a beneficiary, or the supplemental needs of a beneficiary. This definition would also include any trust authorized by C.R.S. Sections to of Title 15, Article 14. Trust means for purposes of Sections 101 through 113 only an irrevocable trust. The term trust as used herein does not include trusts that are revocable by the settlor, and such revocable trusts are not affected by sections 101 through 113. Sections 101 through 113 also do not apply to any constructive or resulting trusts. 104 General Provisions Applying to Trusts Whether or not a spendthrift provision is included in a trust, the following provisions apply to all trusts discussed in Sections 101 through 112. Judicial sale of Beneficial Interests and Powers are Prohibited. 2

3 A distribution interest, 4 remainder interest, power of appointment, or a reserved power may not be judicially sold. (d) Personal Obligations of the Trustee. Trust property is not subject to personal obligations of the trustee, even if the trustee becomes insolvent or bankrupt. Sole and Exclusive Remedies Sections 101 through 112 provide for the sole and exclusive remedies that are available to any creditor or other non-beneficiary with a claim regarding a beneficiary s interest in the trust. 5 Fraudulent Conveyance Notwithstanding Section 104(d) above, Sections 101 through 113 do not affect the rights of a creditor or party to bring an action against the trustee for a fraudulent conveyance action. 105 Control and Dominion Issues Applying to All Trusts 112. The following provisions apply to all trusts discussed in Sections 101 through Removal/Replacement Power. A creditor may not attach, exercise, or otherwise reach an interest of a beneficiary or any other person who holds an unconditional or conditional removal or replacement power over a trustee. Further, such a power is personal to the power holder and may not be exercised by the power holder s creditors, nor may a court direct any person to exercise such power. Beneficiary Who is a Trustee. A creditor may not reach an interest of a beneficiary nor otherwise compel a distribution because the beneficiary is then serving as a trustee or a cotrustee. 6 The Following Factors Will Not Constitute Improper Dominion and Control. In the event that a party raises the issue of a settlor s or a beneficiary s influence over a trust as a basis for invading or invalidating a trust, the following factors, alone or in combination, shall not be considered improper dominion and control over a trust: (1) a beneficiary serving as a trustee or a co-trustee as described in above; 3

4 (2) the settlor or a beneficiary holds an unrestricted power to remove or replace a trustee; (3) the settlor or a beneficiary is a trust administrator, a general partner of a partnership, a manager of a limited liability company, an officer of a corporation, or any other managerial function of any other type of entity, and part or all of the trust property consists of an interest in said entity; (4) a person related by blood or adoption to a settlor or a beneficiary is appointed as trustee; (5) a settlor s or a beneficiary s accountant, attorney, financial advisor, business associate, or a friend is appointed as trustee; (6) any power of appointment is held by a beneficiary; or (7) any reserved power is held by the settlor other than a power to withdraw trust property for the benefit of the settlor, the settlor s creditors, the settlor s estate, or creditor s of the settlor s estate. 106 Spendthrift Provisions (d) (e) (f) Voluntary and Involuntary Spendthrift Provision Permitted. A spendthrift provision is valid only if it restrains both the voluntary or involuntary transfer of a beneficiary s interest. 7 Voluntary and Involuntary Transfers Prohibited. If a trust provides that the interest of a beneficiary is held subject to a spendthrift provision, or words of similar import, it shall restrain both the voluntary and involuntary transfer of the beneficiary s interest. Spendthrift Protection Protects All Beneficial Interests Spendthrift provisions protect all beneficial interests in trust. Application of Spendthrift Provisions to Distribution Interests. The applicability of a spendthrift provision to a classification of a distribution interest is found in sections 108 through 110. Powers of Appointment. A power of appointment in any trust is personal in nature and cannot be attached or forced to be exercised by a creditor or a court regardless of the presence of a spendthrift provision. A power of appointment is not a property interest. 8 Reserved Power. A settlor s reserved power is not protected by a spendthrift provision. If a reserved power does not constitute a power of the settlor to withdraw 4

5 income or principal, the holder of a reserved power may exercise the power in his sole and absolute discretion unencumbered by any court. 107 Classification of Distribution Interests 9 A distribution interest in a trust shall be classified as a mandatory interest, a support interest or a discretionary interest. These definitions apply for all trusts discussed in Sections 101 through 112. (d) (e) Mandatory Interest A mandatory interest is a distribution interest where the trustee has no discretion in determining whether the distribution shall be made, or the amount or timing of such distribution. Support Interest A support interest is any interest which is not a mandatory interest or a discretionary interest. A support interest must include mandatory language such as shall make distributions and be coupled with a standard capable of judicial interpretation, such as an ascertainable standard as defined in United States Internal Revenue Code Section Discretionary Interest A discretionary interest is any interest where a trustee has discretion to make or withhold a distribution. A discretionary interest includes permissive language such as may make distributions or it may include mandatory language that is inconsistent with the settlor s intent to create a discretionary trust, such as the trustee shall make distributions in the trustee s sole and absolute discretion. Different Distribution Interests Held by a Beneficiary A beneficiary may concurrently hold a mandatory interest, support interest, and/or discretionary interest. To the extent a trust contains a discretionary interest, a support interest and/or a mandatory interest such trust shall be treated as follows: the trust shall be a mandatory interest only to the extent of the mandatory language, the trust shall be a support interest only to the extent of such support language. The remaining trust property shall be held as a discretionary interest. 10 Guidelines for Classification of Distribution Language Absent clear and convincing evidence to the contrary, the following language results in the following classification of beneficial interests: (1) Mandatory Interest (i) All income shall be distributed to my spouse; or 5

6 (ii) (2) Support Interest One hundred thousand dollars a year shall be distributed to my son. The trustee shall make distributions for health, education, maintenance, and support. (3) Discretionary Interest (i) The trustee may, in the trustee s sole and absolute discretion make distributions for health, education, maintenance, and support. 11 (ii) (iii) (iv) (v) The trustee shall, in the trustee s sole and absolute discretion, make distributions for health, education, maintenance, and support; 12 The trustee may make distributions for health, education, maintenance, and support; The trustee shall make distributions for health, education, maintenance, and support. The Trustee may exclude any of the beneficiaries or may make unequal distributions among them. The trustee may make distributions for health, education, maintenance, support, comfort, and general welfare. 108 Mandatory Interests The following provisions apply only to mandatory interests. Spendthrift Provision If a trust contains a spendthrift provision, a creditor may not attach present and future mandatory distributions from the trust. A creditor must wait until a distribution is received by a beneficiary before attachment. 13 Notwithstanding the two sentences above, subject to Section 111, a child support claimant may attach present and future distributions at the trust level for child support. No Spendthrift Provision If a trust does not contain a spendthrift provision, subject to Section 111, a creditor may attach present and future mandatory distributions from the trust at the trust level. Judicial Standard of Review 6

7 A beneficiary holding a mandatory distribution interest may enforce such interest. A court may review a trustee s distribution discretion if the trustee acts beyond the bounds of reasonableness. 109 Support Interests The following provisions apply only to support interests. (d) Spendthrift Protection If a support interest is protected by a spendthrift provision, a creditor, except for a child support claimant, must wait until a distribution is received by a beneficiary before attachment. A Child Support Claimant May Only Attach Present and Future Distributions. The sole and exclusive remedy of a child support claimant, unless limited by protective or restrictive language in Section 111, is the attachment of the support interest at the trust level. The court may limit the amount subject to attachment as appropriate under the circumstances to provide for the needs of the beneficiary and the beneficiary s family. 14 No Spendthrift Provision If a trust does not contain a spendthrift provision, unless limited by protective or restrictive language in Section 111, a creditor may attach may attach present and future support distributions from the trust at the trust level. Judicial Standard of Review. The mere fact that a court would have exercised the distribution power under a support interest differently than the trustee is not sufficient reason for interfering with the exercise of the distribution power by the trustee. However, a court may review a trustee s distribution discretion if the trustee acts beyond the bounds of reasonableness Discretionary Interests The following provisions apply only to discretionary interests. Discretionary Interest Not an Enforceable Right or Property Interest A discretionary interest is neither a property interest nor an enforceable right to a distribution it is a mere expectancy. Notwithstanding the preceding sentence, a beneficiary holding a discretionary interest has an equitable interest sufficient to bring an action against the trustee subject to the judicial review standard of Section 110(e). 16 7

8 Spendthrift Provision Whether or not a trust contains a spendthrift provision, no creditor may attach a discretionary interest, require the trustee to exercise the trustee s discretion to make a distribution, or cause a court to judicially sell a discretionary interest. All creditors, including a child support claimant, must wait until a distribution is received by a beneficiary before attachment. (d) (e) Payments on Behalf of a Beneficiary. Regardless of whether a beneficiary has any outstanding creditor, a trustee may in lieu of distributions to a beneficiary make distributions on behalf of such beneficiary and may exhaust the income and principal of the trust for the benefit of such beneficiary. A trustee will not be liable to any creditor or beneficiary for making distributions for the benefit of a beneficiary. Forcing Distributions from a Trust. A creditor, including a child support claimant, of a beneficiary has no greater rights than a beneficiary, and may not compel a distribution that is subject to the trustee s discretion, nor may a court order a distribution on behalf of a creditor. Judicial Review Standard. A court may review a trustee s distribution discretion only if it is proved by clear and convincing evidence that the trustee (1) acts dishonestly; (2) acts with an improper motive; or (3) fails to act. The sole factor of a trustee s deliberate decision not to a make a specific distribution does not constitute a failure to act. There is no standard of reasonableness under the above review standard Protective or Restrictive Distribution Language 18 Original Grant of Trustee Distribution Powers A trustee may only make distributions for the purposes designated by the Settlor. No creditor, including a child support claimant, has greater rights than a beneficiary. Whether or not a trust has a spendthrift clause, no creditor, including a child support claimant, can attach present or future distributions if such creditor s claim does not come within the distribution standard. 19 Restriction Curtailing a Trustee s Distribution Powers A provision curtailing a trustee s power to make any distribution that would be an available resource is valid. 20 8

9 112 Statutory Referenced Special Needs Trusts Medicaid Exception Trusts Notwithstanding Section 113 below, no Creditor may reach the settlor s interest in a trust authorized by C.R.S. Sections to of Title 15, Article 14. This subsection shall not affect the interest of the Department of Health Care Policy & Financing in any such trust. Other Medicaid Trusts Any trust that does not constitute a countable resource under Title XIX of the Social Security Act for the benefit of a disabled person is valid in this state provided it is established in conformity with said statute and agency rules adopted by the Medical Services Board pursuant to C.R.S. Section Self-Settled Irrevocable Trusts Subject to Section 112 above, a creditor or assignee of the settlor may reach the maximum amount that can be distributed to or for settlor's benefit. If a trust has more than one settlor, the amount the creditor or assignee of a particular settlor may reach may not exceed the settlor's interest in the portion of the trust attributable to that settlor's contribution. 9

10 Memorandum of Points and Authorities Contrary to popular belief, it appears that the exception creditors proposed under the Restatement (Second) of Trusts, Section 157, have gained little universal acceptance. Even the exception for child support may have been adopted by the courts less than 50% of the time. In the [Iowa] Trust Code We Trust Some Trust Law For Iowa, 49 Drake L. Rev. 165 (2001) citing at footnote 276 regarding child support Trust Income or Assets as Subject to Claim Against Beneficiary for Alimony, Maintenance or Child Support, 91 A.L.R.2d 262 (1963). Ignoring the cases involving self-settled trusts and the cases involving only accrued income otherwise payable to a beneficiary, a majority of the cases decided without the aid of a statute rejected an exception for alimony or support of a former spouse. See Bogert & Bogert, supra note 50, 224, at 465 (2d rev. ed. 1992). The cases on child support were about evenly split. Therefore it is uncertain whether there is a strong majority opinion regarding child support let alone the other exception creditors listed by Restatement Second. This act allows an exception creditor only for child support. While the terms support trusts and discretionary trusts are widely used in the professional literature, this Code uses a more technical definition of support interest and discretionary interest, which are different types of current distribution interests. This Code follows the distinction made by the Internal Revenue Code Section 2041 that powers of appointment are held by donees, not the settlor. A power held by the settlor is a reserved power. This follows the Restatement (Second) of Trusts Section 162 rule, If the interest of the beneficiary is so indefinite or contingent that it may not be sold with fairness to both creditors and the beneficiary, it cannot be reached by creditors. A governmental entity may not necessarily be a creditor. Case law to date holds that a creditor cannot reach a beneficiary s interest by virtue of the beneficiary serving as a trustee or co-trustee. In re Coumbe, 304 B.R. 378 (9 th Cir. 2003); In re Hersloff, 147 B.R. 262 (M.D. Fla. 1992); In re Schwen, 43 Collier Bankr. Cas. 2d 255 (D. Minn. 1999). The majority rule is that a spendthrift provision must prohibit both the voluntary and involuntary alienation of a beneficial interest; however, Michigan law does not appear to require that both the voluntary and involuntary transfer be prohibited. The minority rule is that the spendthrift provision need only protect the involuntary alienation of a beneficial interest. University Bank v. Rhoadarmer, 827 P.2d 561 (Colo. 1991) (where a creditor was not allowed to attach and exercise a 5 x 5 power, and a general power of appointment was not classified as a property right that was personal to the power holder); Irwin Union Bank and Trust Company v. Long, 312 N.E.2d 908 (Colo. App. 1974); and Johnson v. Shriver, 216 P.2d 653 (Colo. 1950). Colorado follows the general common law of over 40 states that holds a general power of appointment cannot be attached and exercised by a creditor. The provision regarding the classification of a discretionary interest is similar to the Iowa Trust Code and the Missouri Uniform Trust Code after amendment. In essence, whenever a trustee is given discretion to determine the amount or timing of a distribution, a discretionary trust is created. Granting the trustee unfettered discretion is not required to create a discretionary interest. This approach follows In re Jones, 812 P.2d 1152 (Colo. 1991) and In re Marriage of Rosenblum, 602 P.2d 892 (Colo. App. 1979) that allows an estate planner to draft a discretionary trust that is limited by an ascertainable standard. For example, the distribution terms of the trust may provide that beneficiary A is to receive $10,000 a year, the trustee shall distribute income for health, education, maintenance, and support to beneficiary A, and the trustee may make discretionary distributions of principal to beneficiary A in the trustee s sole and absolute discretion. In this case, the beneficiary has a mandatory interest to the extent of $10,000, a support interest to the extent of income, and a discretionary interest to the extent of principal. 10

11 In re Marriage of Jones, 812 P.2d 1152 (Colo. 1991) noting The fact that the trustees are limited to disbursing funds to the wife for only her support, if they decide to disburse funds at all, does not deprive the trust of its discretionary character. Also see In re Marriage of Rosenblum, 602 P.2d 892 (Colo. App. 1979), where the trustees were authorized in their absolute discretion to distribute all, none or any part of the net income and principal to any of the beneficiaries, to make unequal distributions, or to withhold all income from one or more or all. However, so long as the husband is a trustee, income or principal may not be distributed to him in excess of that necessary for his health, education, support or maintenance. Seidenberg v. Weil, Case No. 95-WY-2191-WD (Dist. Colo. 1996). In addition to education and support, the distribution language in Seidenberg included care. Brasser v. Hutchison, 549 P.2d 801 (Colo. App. 1976); In re Guinn, 93 P.3d 568 (Colo. App. 2004). By not allowing a creditor to attach at the trust level, Colorado follows the majority rule. In re Shurley, 115 F.3d 333 (5 th Cir. 1997) No part of a spendthrift trust or estate can be taken on execution or garnishment by creditors of the beneficiary. Also see In re Marriage of Guinn, 93 P.3d 568 (Colo. App. 2004) where the court concluded that even a mandatory right to unrealized future discretionary allocations of income is an expectancy arising from the largess of the settlors and does not constitute property for purposes... The UTC and Restatement Third take the position that exception creditors should be allowed to attach present and future distributions at the trust level. The amended comment to Section 503 states that this is the sole remedy of the creditor. However, the specific statutory language of Section 503 does not agree with the comment that attachment of present and future distributions is the sole remedy. This act follows the intent of the UTC comment and allows a child to attach present and future distributions as at the trust level. Restatement (Second) Section 187 comment e. Restatement (Second) of Trusts Section 187(k) states The settlor cannot confer upon the trustee such an unlimited power that the court will not entertain a suit by the beneficiary to prevent the trustee from acting dishonestly. The Colorado Courts (i.e., In Re Jones, 812 P.2d 1152 (Colo. 1991) as well as many other states have added improper motive as well as failure to act as additional situations where a beneficiary may enforce his or her equitable interest in a discretionary trust. See footnote 18 below. Also see the following cases regarding a settlor s equitable interest in a discretionary trust In re Duncan s Will, 362 N.Y.S. 2d 788 (NY Surr. 1974); Dryfoos v. Dryfoos, 2000 WL (Conn. Super. 2000); Van Cott v. Prentice, 10 N.E. 257 (NY Ct. of App. 1887). Under the common law a court would only interfere with a trustee s sole and absolute discretion of a discretionary trust if the trustee (1) acts dishonestly, (2) acts with an improper motive, or (3) fails to use his or her judgment. In Re Jones, 812 P.2d 1152 (Colo. 1991); Ridgell v. Ridgell, 960 S. W. 2d 144 (Tex. App. 1997); Kansas Dept. of Social and Rehabilitation Services, 866 P.2d 1052 (KS 1994); Simpson v. State, Dept. of Social and Rehabilitation Services, 906 P.2d 174 (Kan.App. 1995); Wright v. Wright, 2002 WL (Iowa App. 2002) not cited for publication. (However this is an excellent case of a psychotic child attempting to sue the parent trustees on a discretionary trust. Had the psychotic child had an enforceable right, the result would be more than problematic); First Nat. Bank of Maryland v. Department of Health and Mental Hygiene, 399 A.2d 891 (Md. 1979); In re Tone's Estates,, 39 N.W.2d 401, (Iowa 1949); Town of Randolph v. Roberts, 195 N.E.2d 72 (Mass. 1964); Scott on Trusts, 187 p. 15; George T. Bogert, The Law of Trusts and Trustees, 2 nd Edition 1980, Supplement through Section 560 of the supplement at p. 183; Restatement (Second) Trusts, 187 (1959), p The above case law directly follows the Restatement (Second) of Trusts, Section 187 comment e and comment j. Comment e the court will not interfere unless the trustee in exercising or failing to exercise the powers acts dishonestly, or with an improper even though not dishonest motive, or fails to use his judgment, or acts beyond the bounds of a reasonable judgment. Comment j. The mere fact that the trustee is given discretion does not authorize him to act beyond the bounds of a reasonable judgment. The settlor may, may however, manifest an intention that the trustee s judgment need not be exercised reasonably, even when there is a standard by which the reasonableness of the trustee s conduct can be judged. This shall be indicated by a provision in the 11

12 trust instrument that the trustee shall have absolute or unlimited or uncontrolled discretion. These words are not interpreted literally but are ordinarily construed as merely dispensing with the standard of reasonableness. When comment e and comment j are combined, the judicial review standard for a discretionary trust becomes (1) dishonesty; (2) improper motive; or (3) failure to act. In fact, this is the classification system used by Scott on Trusts Restatement (Second) Section 154 provides that except for self-settled trusts and exception creditors, if by the terms of the trust it is provided that the trustee shall pay or apply only so much of the income and principal or either as is necessary for the education or support of the beneficiary, the beneficiary cannot transfer his interest and his creditors cannon reach it. This is a third level of asset protection. In Schierer v. Ostafin, 1999 WL (Ohio App. 1999) unreported case, when a trust was for a beneficiary s support, a debt that arose from a tort was unrelated to support and the creditor could not recover. Kryzsko v. Ramsey County Soc. Services, 607 N.W. 2d 237 (N.D. 2000), however note that the dissent correctly notes that the protection of a third party SNT rests on the classification of a trust as a discretionary trust under common law not the supplemental needs language; In re Leona Carlisle, 498 N.W. 2d 260 (Minn. App. 1993), where the court held that a trust that was discretionary and contained language to supplement was not an available resource; Carnahan v. Ohio Dept. of Human Services, 139 3d 214 (Ohio App. 2000). 12