Spendthrift Clauses and Choice of Law: How to Shield a Beneficiary’s Trust Assets in Bankruptcy

In an earlier blog post, we discussed choice of law provisions (commonly referred to as forum selection clauses) which control both the place where a contract dispute would be litigated and which jurisdiction’s laws would apply to the dispute.  A similar concept applies to trusts.

A trust is essentially a contract between the settlor (the person establishing the trust) and the trustee (the person holding title to the property).  It also governs the rights of third parties to the contract.  For example, if a beneficiary of a trust is sued, certain provisions in the trust could protect that beneficiary from having his or her trust property taken away in that lawsuit.

One of those protective provisions is a spendthrift clause, which can operate to prevent a creditor from seizing the beneficiary’s property.  Many trusts provide that the trust assets cannot be seized by a creditor, and courts routinely uphold those provisions.  However, in certain limited circumstances, the spendthrift clause will not protect all of the beneficiary’s trust interest.

Another way to protect the beneficiary’s interest is by including a choice of law provision.  In In re Zukerkorn, Sally Zukerkorn established a trust for the benefit of her children.  Her trust specifically selected Hawaii as the applicable law.

Thirty years later, Sally’s son, Herbert, filed for bankruptcy in his home state of California.  Herbert attempted to shield his trust income from the bankruptcy estate.  Under California’s bankruptcy laws, Herbert would have to turn over 25% of his trust income to pay his creditors in the bankruptcy.  Under Hawaii law, he wouldn’t have to turn over any of his trust income.

Ultimately, the court decided that Hawaii law applied.  Sally’s choice of law in her trust was upheld because Hawaii had a “substantial relation” to the trust.  At the time the trust was created, Sally lived in Hawaii, the trust property was located in Hawaii, and at least one of the beneficiaries lived in Hawaii.  Also, the court noted that the trust was currently being administered by a Hawaii corporate trustee.

The Court’s decision in Zukerkorn does not mean that every trust containing a choice of law provision will be governed by that state’s law.  A “substantial relation” must exist between the trust and the chosen state, and even still, a court might disregard the provision under certain circumstances, e.g., if the trust was a self-settled trust created for the sole purpose of shielding assets, or if certain public policy exceptions apply.

However, in cases like Zukerkorn, choosing the state law which will apply to your trust and ensuring that you establish a substantial relation between that state and the trust property could provide an additional protection for your beneficiaries.

If you’d like to create a trust for your own beneficiaries, or if you’d like us to take a second look at your estate plan to evaluate whether it achieves your goals, please feel free to give us a call.

In Re Zukerkorn, BAP No. NC-11-1506-JuKiJo (2012).

Author: Amy Howse

Domestic Partnership Agreement Is Enforceable Despite Subsequent Marriage

Two same-sex partners, Wilson and Konou, began a relationship in 2005.  In 2006, they became domestic partners.  Immediately prior to registering as domestic partners, the couple executed a domestic partnership agreement, in which each of them expressly waived any rights to the property of the other in the event of death, dissolution, or legal separation.

In June 2008, when same-sex couples were permitted to marry in California, Wilson and Konou married.  Less than five months later, Wilson committed suicide.

After Wilson’s death, Konou filed a petition with the probate court, seeking to inherit a portion of Wilson’s property as a pretermitted spouse.  (See Probate Code § 21610.  Note that the statute uses the term “omitted spouse” instead.)  Konou argued that the marriage license provided him different rights than what he was entitled to under the domestic partnership.

The court decided that a domestic partnership agreement was essentially the same as a prenuptial agreement.  Couples frequently execute prenuptial agreements prior to a marriage.  The fact that the couple later married does not invalidate the prenup, or change the parties’ rights to property under the prenup.  Likewise, the court held that the domestic partnership agreement was still in force despite the couple’s later marriage.

This case highlights the importance of re-examining your estate plan on a regular basis.  It is possible that Wilson and Konou intended to provide for each other later in life, and that they believed that by getting married in 2008, they would be entitled to inherit from each other as if the domestic partnership agreement had never existed.  It is also possible that they intended for the original domestic partnership agreement to remain in effect.  Either way, a re-examination of their priorities and a discussion about it could have prevented unintended consequences.

If you haven’t re-examined your estate plan lately, it’s a good idea to take another look at it to see if it still reflects your wishes.  If you haven’t executed an estate plan at all, particularly if you have a same-sex partner or if you wish to leave your property to those not in your immediate family (nieces/nephews, cousins, friends, charities), you should strongly consider talking to an attorney about setting up an estate plan that will help you achieve your goals.  If you like, give us a call and William L. Cates or Amy Howse can assist you with your estate plan.

Estate of Wilson, 211 Cal. App. 4th 1284 (2012).

Author: Amy Howse