¶ 3601
Overview
Scope of the chapter. A spendthrift provision is a term of a trust that forbids a beneficiary to transfer the beneficiary's interest and forbids the beneficiary's creditors to reach it. It is the single clause that does the most to determine whether the property a settlor leaves in trust will reach the people the settlor meant to benefit. Almost every modern trust instrument contains one, and most drafters treat it as boilerplate. This chapter examines it as a design element. It asks what the provision protects, against whom, for how long and under which law. It also identifies the creditors who can reach a beneficiary's interest whatever the instrument says. Those creditors, the exception creditors, differ sharply from state to state, and the choice of governing law for a third-party trust (see supra ch. 2) is often a choice among exception lists.
The design question. The settlor of a third-party trust decides how the property will be held for someone else. The settlor can give the beneficiary a mandatory interest, such as all net income paid quarterly, or a discretionary interest that depends on a trustee's judgment. The settlor can make the interest assignable or restrain it. The settlor can attach a forfeiture clause that ends the interest when a creditor appears. The settlor can also allow the trustee to pay the beneficiary's expenses directly instead of putting money in the beneficiary's hands. Each choice changes what a creditor can do. The spendthrift provision interacts with all of them, and the best protection usually comes from combining a well-drafted restraint with discretionary interests, a power of direct payment and governing law chosen with the exception list in mind.
Vocabulary. In this chapter a spendthrift provision means a term of a trust that restrains both voluntary and involuntary transfer of a beneficiary's interest. Unif. Trust Code §§ 103(16), 502(a). An exception creditor is a claimant against whom a spendthrift provision is unenforceable by statute or decision. A mandatory interest is an interest in distributions the trustee must make, and a discretionary interest is an interest in distributions the trustee may make or withhold. A protective trust is a trust in which a beneficiary's mandatory interest ends on an attempted alienation, a bankruptcy or a creditor's attempt to reach it, and a discretionary trust takes its place. The term settlor-beneficiary refers to a beneficiary who funded the trust; that person's position is governed by different rules (see infra ch. 37).
Sources of law. Spendthrift law in the United States rests on three layers. The first is nineteenth-century case law, which accepted restraints that English courts had rejected. The second is the Restatements, of which the Restatement (Third) of Trusts §§ 58 and 59 are the current statements, and which the Uniform Trust Code followed in most respects. The third, and now the most important, is statute: Article 5 of the Uniform Trust Code in the states that have enacted it, and freestanding statutes in Delaware, Nevada, South Dakota, California, New York and elsewhere. Federal law sits on top of all three. It decides whether a federal tax lien attaches to an interest in a trust, and whether a restraint survives in bankruptcy.
Plan of the chapter. Paragraph 3610 traces the origins of the spendthrift trust and the reasons given for it, with a full discussion of Broadway National Bank v. Adams. Paragraph 3620 examines the validity and effect of a spendthrift provision under the Uniform Trust Code. Paragraph 3630 examines the Code's exception creditors, with a full discussion of Shelley v. Shelley. Paragraph 3640 examines the debate over tort creditors, with full discussions of Sligh v. First National Bank of Holmes County and Scheffel v. Krueger. Paragraph 3650 compares the states. Paragraph 3660 examines mandatory interests, overdue distributions and property after it leaves the trust. Paragraph 3670 examines federal tax liens, criminal restitution and bankruptcy, with a full discussion of Bank One Ohio Trust Co. v. United States. Paragraph 3680 surveys protective and spendthrift trusts abroad. Paragraph 3690 sets out drafting.
Relation to other chapters. The rights of a beneficiary's creditors against a discretionary interest, and the debate over the Restatement (Third)'s treatment of discretionary trusts, are the subject of chapter 38 (see infra ch. 38). Self-settled spendthrift trusts, including the Wyoming qualified spendthrift trust, are the subject of chapter 37 (see infra ch. 37). Divorce and the claims of a beneficiary's spouse are examined in chapter 39 (see infra ch. 39). The companion volume, Lighthouse on Asset Protection, treats third-party trusts as asset protection devices at length, and this chapter refers to it as the companion volume.