Lisa M. Rico and Judith A. Saxe,
The Daily Record Newswire
A recent Appeals Court case has attorneys, fiduciaries and other advisors, both locally and nationally, considering its implications and how to advise clients to structure trusts to protect family assets.
In Pfannenstiehl v. Pfannenstiehl, 88 Mass. App. Ct. 121 (2015), the Appeals Court affirmed a lower court holding that a husband’s interest in an irrevocable spendthrift trust with ascertainable standards can be included in the marital estate for purposes of property division upon divorce.
While the holding may seem surprising to some — including the husband, who has already filed a request for further review to the Supreme Judicial Court — many attorneys, detecting a trend in the law in Massachusetts based on other recent cases with similar facts, were already sensitive to the issues presented, and drafting trusts to avoid the results of Pfannenstiehl.
Whether or not a review is granted, the case is a reminder to advisors that estate and asset protection planning is fraught with challenges and requires careful and ongoing consideration of the facts as well as the law.
At issue was whether a husband’s interest in a multi-million-dollar family trust established by his father for the benefit of the husband, the husband’s twin brother, his sister and their respective issue could be considered a marital asset for purposes of the equitable division of assets upon divorce under G.L.c. 208, §34.
The trust, which was funded with interests in family-controlled corporations operating for-profit colleges, had both a spendthrift provision, designed to protect trust assets from the beneficiaries’ creditors, and ascertainable standards.
In relevant part, the trust provided that “the Trustee shall pay to, or apply for the benefit of, a class composed of any one or more of the Donor’s then living issue such amounts of income and principal as the Trustee, in its sole discretion, may deem advisable, ..., to provide for the comfortable support, health, maintenance, welfare and education” of all the beneficiaries.
The trustees were the husband’s brother, who had leadership roles in the family business, and the father’s longtime family and business attorney, who the court noted was hands off in the administration of the trust and whose testimony was not indicative of independence.
Other compelling facts played a role in the decision. The wife had a professional job as an officer in the U.S. Army Reserves for 18 years. She left her job just two years short of the 20 years required to receive a military pension, at the urging of her husband and his family, to care for their two young children, both of whom had significant special needs. She was the primary caregiver for the children throughout the marriage.
The husband’s income, though substantial, would not have been sufficient alone to support the family in the standard of living to which they had become accustomed, made possible largely because of the income tax-free distributions they had received from the trust. The family had become dependent on the trust distributions to maintain their upper-middle class standard of living, and the distributions were “woven in the fabric of the marriage.”
The Appeals Court specifically dismissed the relevance of the spendthrift provision, stating that it was “invoked as a subterfuge to mask the husband’s income stream and thwart the division of the marital estate in the divorce.”
The facts indicate that, until just a month preceding the divorce filing, the husband received distributions, for a number of years, totaling more than $800,000. The sister and brother continued receiving regular distributions after the husband’s distributions ceased.
The change in the pattern of distributions, according to the court, “was a deliberate manipulation to erase a major component of the husband’s annual income and to silence his interest in the trust — for a convenient time while the divorce was ongoing.”
Consistent with well-settled law in Massachusetts, the Appeals Court concluded that a trust, even if it contains a spendthrift provision, may be included as a marital asset subject to division under G.L.c. 208, §34. Krokyn v. Krokyn, 378 Mass. 206, 214 (1979); Davidson v. Davidson, 19 Mass. App. Ct. 364, 371-372 (1985); and Lauricella v. Lauricella, 409 Mass. 211, 216 (1991).
While the Appeals Court, in line with existing case law, ignored the spendthrift provision for determining whether an interest in a trust was a marital asset, it is worth noting that the lower court and Appeals Court did not go so far as to order a distribution of the assets from the trust in order to effectuate the division of the marital assets.
The court then considered whether the discretionary nature of the trust and the ascertainable standards articulated therein, including the use of the word “shall,” precluded inclusion of the assets in the marital estate.
The court held that “the husband had a present enforceable right to the distributions from the 2004 trust,” that the distribution patterns prior to and up to the divorce fell within the 2004 trust’s ascertainable standards, and that it would be likely that distributions would resume for the husband’s benefit after the divorce.
Distinguishing the trust from other trusts with wholly discretionary terms, which the courts have not treated as part of the marital estate, and relying on longstanding law in Massachusetts, the court concluded that “it is clear that the 2004 trust has an ascertainable standard pursuant to which the trustees, as fiduciaries, were obligated to, and actually did, distribute the trust assets to the beneficiaries, including the husband for such things as comfortable support, health, maintenance, welfare and education.”
Accordingly, the court, in a 3-2 decision, affirmed the lower court holding that the husband’s share of the 2004 trust (calculated as one-eleventh of the total value of the 2004 trust based on the current number of beneficiaries (or $2,265,474.31)) could be considered part of the marital estate and ordered the husband to make 24 monthly payments to the wife in the amount of $48,699.77, as well as 60 percent of the remainder of the marital estate.
It is not unusual for attorneys and other family advisors to recommend clients establish discretionary trusts, rather than make outright distributions, precisely, or in part, because these types of trusts are designed to protect contributed assets from creditors’ claims, including potentially those of divorcing spouses. This is particularly true in Massachusetts, which, unlike many states, does not exclude gifts and inheritances as separate property from an asset division in a divorce. G.L.c. 208, §34.
But care is needed in determining the exact provisions of a discretionary trust. While Massachusetts courts have excluded wholly discretionary trusts as marital assets divisible under G.L.c. 208, §34 (see D.L. v. G.L., 61 Mass. App. Ct. 488 (2004)), established Massachusetts case law has consistently held that trusts subject to ascertainable standards create a judicially enforceable right in the beneficiary even if a trustee is granted broad fiduciary powers to interpret the application of the standards. See Marsman v. Nasca, 30 Mass. App. Ct. 789 (1991); Dana v. Gring, 374 Mass. 109 (1977); Woodberry v. Bunker, 359 Mass. 239 (1971); Briggs v. Crowley, 352 Mass. 194 (1967).
That was the problem with the facts in Pfannenstiehl. Although the trust gave the trustees broad fiduciary powers, the trust also included ascertainable standards. Some advisors believe such standards should serve as evidence of the intent of the grantor, not a mandate that distributions actually be made for the purposes specified or create a present enforceable right.
That view is reflective of the dissent’s argument that the husband’s interest in the trust was “too speculative and remote for inclusion in the divisible estate.” However, in Massachusetts, well known for its comprehensive trusts law, courts have consistently held that even seemingly fully discretionary ascertainable standards can create judicially enforceable rights in the beneficiary. For that reason, Massachusetts attorneys are cautious about adding such standards to trusts.
To help avoid the result in Pfannenstiehl, attorneys should consider, if they are not already doing so, revising existing irrevocable trusts and drafting new such trusts with specific provisions aimed at better insulating a trust from being included as a marital asset. These provisions could include:
• avoiding the use of ascertainable standards in favor of wholly discretionary trusts, which would allow the trustees to have full discretion over the timing and amounts of distributions to beneficiaries;
• never using the word “shall” when authorizing discretionary distributions;
• empowering under the trust an independent trustee or trust protector to modify the trust, eliminate standards or remove a beneficiary (presumably not exercised contemporaneously with a divorce);
• creating non-general powers of appointment that could divest a beneficiary’s interest in the trust;
• drafting spendthrift provisions to include language making it clear assets cannot be pledged or alienated in favor of a beneficiary’s spouse; and
• requiring at least one of the trustees be a truly independent trustee in the business of managing trusts with clear fiduciary responsibility.
Trusts could be further protected from creditors through holding assets in a family limited partnership or limited liability corporation, which can be designed to restrict the beneficiaries’ rights to transfer or alienate the property.
It is unclear in Massachusetts if any of these proposed strategies would have been effective to alter the court’s decision in Pfannenstiehl, particularly in light of the compelling facts and the pattern of and reliance by the family on the distributions.
While asset protection is given strong consideration in establishing an estate plan, it is generally not the only reason an individual would establish a trust and apparently was not the main reason why the husband’s father created the trust in Pfannenstiehl as part of a gift plan.
There are numerous other factors, including a desire to preserve assets for more than one generation; to control more easily the investment, distribution and administration of the assets; and to anticipate and respond to the changing needs of beneficiaries.
Moreover, in lieu of relying on trusts alone for asset protection, it may be preferable for grantors to encourage beneficiaries to consider executing prenuptial or potentially post-nuptial agreements to specifically address family gifts and inheritances. This is particularly true as the laws across the country in general vary, and a grantor may not be able to predict where beneficiaries will reside.
In fact, there are times and circumstances when ascertainable standards do play an important role for tax and estate planning purposes. Such standards can serve as a valuable guide to a trustee as to how assets should be distributed, particularly if a grantor’s goals are to preserve trust assets and to guide trustees, especially when a grantor is no longer capacitated or living.
These standards are often necessary for beneficiaries or others who are serving as trustees to prevent the inclusion of trust assets in a trustee’s own estate.
Rather than changing the status quo or creating hard and fast rules for estate planners, Pfannenstiehl compels attorneys and other family advisors to review documents regularly, particularly in light of changing family circumstances; to consider carefully the terms of each trust and choice of trustees; and to draft trusts flexibly to anticipate changing circumstances and needs.
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Lisa M. Rico is a partner at Rico, Murphy & Diamond, a trusts and estates and family law boutique with offices in Needham and Millis. Judith A. Saxe is a managing director and senior wealth strategist in the Boston office of Atlantic Trust, a national private wealth management firm and trust company.
