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Washington & Lee University School ofLaw Washington & Lee University School of Law Scholarly Commons Faculty Scholarship 1-1-2002 Rethinking the Law of Creditors' Rights in Trusts Robert T Danforth Washington and Lee University School of Law, [email protected] Follow this and additional works at: http://scholarlycommons.law.wlu.edu/wlufac Part of the Estates and Trusts Commons Recommended Citation Robert T.Danforth, Rethinking the law ofcreditors' rights in trusts, Hastings L.J. 287 (2002) This Article is brought to you for free and open access by Washington & Lee University School ofLaw Scholarly Commons. It has been accepted for inclusion in Faculty Scholarship by an authorized administrator of Washington & Lee University School of Law Scholarly Commons. For more information, please contact osburneclOwlu.edu. EFTA01116869  Articles Rethinking the Law of Creditors' Rights in Trusts by ROBERT T. DANFORTH* Whoever has the right to give, has the right to dispose of the same as he pleases. Cujus est dare ejus est disponere, is the maxim which governs in such case.' It is against public policy to permit a man to tie up his own property in such a way that he can still enjoy it but can prevent his creditors from reaching it. Introduction The last several years have witnessed the beginning of a revolutionary and controversial trend in the law of trusts in the United States: as a means of attracting business for its banks and other professional fiduciaries, several states, most notably Alaska and Delaware, have enacted legislation to facilitate the creation of so- called asset protection trusts (APTs), which allow trust settlors to shelter their assets from the claims of most creditors. This trend follows a decades-long development that has allowed the creation of such trusts offshore, and the changes in domestic law reverse a long- standing American rule under which the asset-protection features of Assistant Professor of Law, Washington and Lee University. I thank Sharon C. Wilson for her research assistance; Edward O. Henneman, Margaret Howard, Lyman P.Q. Johnson, Frederic L. Kirgis, Ronald J. Krotoszynski, Jr., David Milton, Blake D. Morant, Richard H. Seamon, Adam F. Scales, and W. Bradley Wendel for their advice, suggestions, and comments; and the Frances Lewis Law Center, Washington and Lee University, for its financial support. 1. Ashhurst v. Given, 5 Watts & Serg. 323, 330 (Pa. 1843) (declining to allow a beneficiary's creditor to reach his interest in a trust). 2. 1 Ausnm WAKEMAN SCOTT, THE LAW OF TRUSTS § 156, at 782 (1st ed. 1939) [hereinafter SCOTT ON TRUSTS (1st ed.)]. EFTA01116870 288 HASTINGS LAW JOURNAL (Vol.53 such trusts generally have been viewed as ineffective. This new development in American law also has generated a wealth of academic commentary, all of it negative? The trend appears likely to continue unabated, as other states compete for the investment funds of settlors seeking to shelter their assets from creditors. This article examines the theoretical underpinnings of the traditional American rule concerning creditors' rights in trusts established for the settlor's own benefit. Under the traditional rule, a creditor of a settlor is entitled to reach the assets of a trust for the settlor's own benefit even though, in the case of a discretionary trust: the settlor may himself or herself have no enforceable right to trust distributions, and even though allowing creditor access to the trust assets may compromise the otherwise enforceable interests of other trust beneficiaries. The article concludes that the traditional American rule is theoretically unsound. This conclusion is based on the principles of law and practical considerations that guide the behavior of trustees in determining the size and frequency of trust distributions and in determining to whom those distributions should be made. The article concludes that, as a general proposition, the rights of a creditor in an APT should be no greater than the rights of the senior, and the rights of the settlor's creditors should not be permitted to defeat the rights of other trust beneficiaries. By calling the traditional American rule into question, the article points to a provocative conclusion: APTs may and should be effective under some circumstances. But the purpose of the article is not to advocate for APT legislation. Nor is its purpose to answer all outstanding policy questions about the circumstances under which APTs should be respected. Rather, the article has some more modest goals. First, the article seeks to refocus the debate about APTs, by evaluating creditors' rights based on realistic assessments of the nature of the senior's interest in an APT and the nature of the trustee's duties to the settlor and other trust beneficiaries. Second, recognizing the perhaps inevitable tide of legislation permitting APTs, the article seeks not to stem the tide, but rather to guide it to produce a reasonable balance between the rights of creditors and the interests of trust beneficiaries. At stake are the competing objectives of property owners, whose goal is to impose limits on their own and 3. See Randall J. Gingiss, Putting a Stop to "Asset Protection" Thais, 51 BAYLOR L. REv. 987 (1999); Henry J. Lischer, Jr., Domestic Asset Protection Trusts: Pallbearers to liability?, 35 REAL. PROP. PROB. & TR. J. 479 (2000); Stewart E. Sterk, Asset Protection Trusts: Trust Law's Race to the Bottom?, 85 CORNEU. L REv. 1035 (2000); Karen E. Bon. Gray's Ghost—A Conversation About the Onshore Trust, 85 IOWA L REV. 1195 (2000). 4. A discretionary trust is one in which the trustees have discretion concerning distributions to beneficiaries. EFTA01116871 January noq RETHINKING THE LAW OF CREDITORS' RIGHTS 289 others' access to their property, and their creditors, who seek to pierce those limits by raising public policy concerns! Part I of the article provides an overview of the American law of trusts in connection with the rights of creditors of trust beneficiaries. Part I begins with an introduction to basic trust law concepts and terminology. Part I next describes the law of creditors' rights applicable to trusts of which the settlor is not a beneficiary. As Part I explains, the law generally allows the assets of such trusts to be sheltered from the claims of the beneficiaries' creditors. Part I then describes the contrary rule that has applied traditionally to so-called self-settled trusts, that is, trusts for the (exclusive or non-exclusive) benefit of the settlor. Until the recent legislative developments mentioned above, the firmly established American rule was that the assets of a self-settled trust were, with limited exceptions, fully accessible by the senior's creditors. Part I considers the historical roots of this rule, examines its theoretical basis, and concludes that the rule is theoretically unsound. Part II describes the legal developments that, beginning in the mid-1980s, led to a substantial offshore trust industry, which caters to the asset-protection objectives of Americans and others whose domestic laws fail to afford such protection. Part II then describes the legislative efforts in several American states to institute the self- settled APT as a feature of American law. Part II also considers briefly whether the creditor-protective features of these trusts will be respected by courts in United States jurisdictions that continue to follow the traditional rule. This discussion is followed by Part TEL which considers the law of fraudulent transfers and its significance in evaluating creditors' rights in self-settled trusts. Part IV of the article reexamines the law of creditors' rights in trusts by analyzing those rights from the perspective of basic fiduciary principles. Based on this reexamination, Part IV concludes that the traditional American approach to creditors' rights in self-settled trusts is based on a fundamental misunderstanding of the relationships among seniors, other trust beneficiaries, and trustees. In considering the use of APTs, Part IV also examines other creditor-protection planning tools available under present law (such as limited partnerships and tenancies by the entirety) and concludes that allowing APTs under some circumstances would serve to extend creditor protection to individuals for whom these other tools are not practicably available. Part TV then considers the policy arguments for and against the use of APTs and suggests some possible limitations that should placed on their availability and effectiveness. 5. The article's opening quotations, see supra text accompanying notes 1-2, articulate the standard supporting arguments. EFTA01116872 290 HASTINGS LAW JOURNAL [VoL 53 I. Background A. Basic Trust Law Concepts and Terminology A trust is an asset-management device that divides the burdens and benefits of ownership of property between a trustee, on the one hand, and beneficiaries, on the other. This division of ownership interests creates a fiduciary relationship between the trustee and the beneficiaries. The trustee is said to hold the "legal interests" in the trust property (i.e., the trustee holds legal title), while the beneficiaries are said to hold the "equitable interests" in the property. Thus, although the trustee is strictly speaking the "owner" of the trust assets, the trustee owns those assets not for the trustee's own benefit, but for the benefit of the beneficiaries, for whom the trustee is a fiduciary. The rights and obligations of the trustee and the beneficiaries are established by the terms of the trust instrument and through a body of law that has developed principally through decisions by courts of equity defining and enforcing the interests of trust beneficiaries. Trust law from time to time may also be modified by statute. To create a trust, a property owner transfers assets to a trustee. The transfer is usually accompanied by a written trust instrument that sets forth the terms of the trust, including both the dispositive provisions (i.e., the instructions for how the trustee is to dispose of the assets) and the administrative provisions (which specify most powers and duties of the trustee in managing the assets). The person who creates the trust is known as the "settlor."6 The trustee is usually, although need not be, someone other than the settlor. The beneficiaries of the trust may or may not include the settlor: depending on the objectives for which the trust is established. A trust will typically include "current beneficiaries," persons to whom the trustee is authorized or required to make current distributions, and "future beneficiaries," persons who will or may receive trust distributions in the future.' 6. Or, alternatively, the "grantor." This article uses the term "settlor." 7. In fact, under some circumstances, the senior will be the sole beneficiary of the trust. Note, therefore, that one person can assume any number of the roles of settlor, trustee, and beneficiary. In order to have a valid trust, however, the trustee must owe a duty to someone other than only herself. Thus, although the trustee and the beneficiary can be the same person, the sole trustee cannot also be the sole beneficiary, for under that circumstance there would be no division between the legal and equitable interests. 8. Future beneficiaries often include both persons who may or shall receive periodic distributions of income and principal, commencing at some point in the future, and remainder beneficiaries, who may or shall receive outright distributions of principal at the trust's termination. EFTA01116873 January 2002] RETHINKING THE LAW OF CREDITORS' RIGHTS 291 A trust typically establishes different dispositive schemes for trust "income" and trust "principal." For example, the trust instrument may authorize or direct the payment of income to one beneficiary or group of beneficiaries and also authorize or direct the payment of principal to the same or different beneficiaries. The concepts of "income" and "principal" are defined under applicable state law (sometimes with variations prescribed by the trust instrument). In simple terms, "principal" includes the original trust assets, proceeds from the sale of those assets, and any replacement assets purchased with the proceeds, reduced by certain charges (as prescribed by applicable law); "income" includes all trust earnings, such as rents, dividends, and interest (but excluding realized capital gains, which constitute principal), reduced by all charges not allocable to principal. B. General Rules Regarding Creditors' Rights in Trusts Except as otherwise provided by laws' or by the governing instrument, a beneficiary's interest in a trust is freely transferable. Thus, a beneficiary entitled to all income of a trust for life can transfer the income interest, either gratuitously or for consideration, to some other person, who then holds a trust income interest pur autre vie. By transferring the interest for consideration, the beneficiary is able to anticipate the interest by receiving for it funds worth approximately the present value of the income stream, as measured by the beneficiary's life expectancy. The beneficiary's income interest can also be transferred involuntarily, through attachment by a judgment creditor of the beneficiary.' Both voluntary and involuntary transfers of trust interests can disrupt a trust's dispositive plan. Consider, for example, a trust created for the benefit of the settlor's child, who lacks the requisite judgment and skill to handle outright ownership of property. If the child could anticipate her interest by selling it or using it as collateral for a loan, the trust would lose its effectiveness as a tool for managing assets on the child's behalf. Similarly, if through improvidence the child were to incur a debt which could then be satisfied from trust assets, the trust would fail to serve its purpose of protecting against such improvidence. 9. In New York interests in trusts are not transferable unless the senior expressly provides otherwise. See N.Y. Esr. POWERS & TR. LAW § 7.1-5 (McKinney 1992). 10. The judgment creditor will seek to satisfy the beneficiary's obligation in one of two ways: (i) by obtaining a court order requiring the trustee to make the income payments to the creditor, until the beneficiary's obligation is satisfied or (ii) by obtaining a court order requiring the trustee to sell the income interest and pay the proceeds to the creditor. The latter alternative is usually not available as a practical matter, due to the lack of a market for trust income interests. EFTA01116874 292 HASTINGS LAW JOURNAL (Vol. 53 To guard against such disruptions, most trusts include a so-called spendthrift provision, of which the following is typical: To the extent permitted by law, the principal and income of this trust shall not be liable for the debts of any beneficiary or subject to alienation or anticipation by a beneficiary. Almost all American jurisdictions give effect to such provisions under most circumstances, although most jurisdictions also refuse to give effect to spendthrift provisions for certain types of creditors, most significantly persons seeking delinquent child support payments and governments seeking collection of unpaid taxes." A spendthrift provision is not the only means of providing creditor protection for trust beneficiaries. Consider, for example, a so-called discretionary trust for the benefit of the settlor's child, under which the trustee is authorized to distribute income and principal in such amounts and for such purposes as the trustee deems appropriate. In the absence of a spendthrift provision (or if the spendthrift provision were for any reason ineffective), the child's interest in the trust could be attached by the child's creditors. Yet, as a practical matter, attaching the child's interest would provide creditors with little or nothing of value, because the creditors (in the child's stead) could not compel the trustee to make (and thus the trustee would be unlikely to make) any distributions. Thus, in the case of a discretionary trust, it is the nature of the beneficiary's interest rather than a provision prohibiting transfers of the interest that protects the trust assets against creditors' claims. Because the beneficiary could not compel trust distributions, neither can the beneficiary's creditors.' C. Traditional Rules Regarding Creditors' Rights in Self-Settled Trusts Until recently, in the United States the asset protection attributes of trusts described above were not available with respect to trusts for the settlor's own benefit.' The apparent origin of this rule lies in a fifteenth century English statute, which provided that "all deeds of 11. Moreover, as discussed below, virtually all jurisdictions refuse to give effect to spendthrift provisions for the benefit of the settlor. See infra notes 13.16 and accompanying text. 12. This is not to say, however, that the beneficiary of a discretionary trust can never compel distributions. Under some circumstances a trustee's refusal to make distributions under a wholly discretionary standard might be considered unreasonable and thus an abuse of discretion. See infra notes 274-276 and accompanying text. As a practical matter, however, a creditor in the beneficiary's stead would face an even greater challenge than the beneficiary in compelling a trustee to make distributions from a wholly discretionary trust. 13. For a discussion of recent domestic legislation allowing asset protection trusts, see infra notes 89.119 and accompanying text. EFTA01116875 January 2002] RETHINKING THE LAW OF CREDITORS' RIGHTS 293 gift of goods and chattels made or to be made [in] trust, to the use of that person or persons that made the same deed of gift, be void and of none effect."" This statute has been enacted in a number of American jurisdictions, though in most cases with the modification that the transfer is void only "as against creditors" of the senior!' In virtually every state in which the issue is not addressed by statute, there is judicial authority to the same effect.' Thus, the traditional rule in the United States, as reflected in section 156(1) of the Restatement (Second) of Trusts!' is that a spendthrift provision for the benefit of the settlor is not effective. For example, if a settlor were to create a trust, reserving the right to income for life and including a spendthrift provision, the settlor's creditors could reach the income interest notwithstanding the spendthrift provision. Can a settlor shelter trust assets from creditors' claims by reserving a discretionary interest in the trust? In the United States, the traditional answer to this question is "no." Although the settlor of a discretionary trust cannot compel the trustee to distribute trust income or principal to the settlor, the settlor's creditors are able to compel such distributions. The standard formulation of this rule is set forth in section 156(2) of the Restatement (Second) of Trusts as follows: Where a person creates for his own benefit a trust for support or a discretionary trust, his transferee or creditors can reach the maximum amount which the trustee under the terms of the trust could pay to him or apply for his benefit!' Applying the Restatement rule, suppose a settlor creates a trust, the terms of which authorize the trustee to distribute to the senior 14. 3 Hen. 7, c. 4 (1487); see also 2A AUSTIN 'IVAKE Scorr & WILLIAM FRANKLIN FRATCHER, THE LAW OF Tausrs § 156, at 168 n.4 (4th ed. 1987) [hereinafter SCOTT ON TRUSTS (4th ed.)]. 15. 2A SCOTT ON TRUSTS (4th ed.), supra note 14, § 156, at 169. 16. 2A SCOTT ON TRUSTS (4th ed.), supra note 14, § 156. at 165-67 n.l. 17. The Second Restatement describes the rule as follows: Where a person creates for his own benefit a trust with a provision restraining the voluntary or involuntary transfer of his interest, his transferee or creditors can reach his interest. RESTATEMENT (SECOND) OF TRUSTS § 156(1) (1959); see also RESTATEMENT (THIRD) OF TRUSTS § 58(2) (Tentative Draft No. 2, 1999) (stating that "[a] restraint on the voluntary and involuntary alienation of a beneficial interest retained by the senior is invalid"); UNIFORM TRUST CODE § 505(a) (2000) (creditors can reach senior's interest "[w]hether or not the terms of a trust contain a spendthrift provision"). 18. RESTATEMENT (SECOND) OF TRUSTS § 156(2) (1959); see also RESTATEMENT (THIRD) OF TRUSTS § 60 ant. f (Tentative Draft No. 2, 1999) (stating that the senior's creditors "can reach the maximum amount the trustee, in the proper exercise of fiduciary discretion, could pay to or apply for the benefit of the senior"); UNIFORM TRUST CODE § 505(a)(2) (2000) (stating that a "creditor... of the settlor may reach the maximum amount that can be distributed to or for the settlor's benefit"). EFTA01116876 294 HASTINGS LAW JOURNAL (Vol. 53 such amounts of income and principal as the trustee deems appropriate for any purpose. A creditor of the settlor can reach all of the trust assets, because the maximum amount that can be distributed by the trustee is the entire trust. Suppose instead the settlor creates a trust, the terms of which authorize the trustee to distribute to the settlor (or for the settlor's benefit) such amounts of income and principal of the trust as may be necessary for the senior's support. Under these circumstances, a creditor of the settlor is entitled to reach the maximum amount that could be distributed for the settlor's support, regardless of whether the creditor supplied goods or services in connection with the settlor's support19 The origin of and rationale for the Restatement rule is murky. The rule appears in the original Restatement" and also in the original edition (and all subsequent editions) of the classic treatise on the law of trusts written by the late Professor Austin Wakeman Scott;' who was also the Reporter and principal author of the First and Second Restatements. Neither Restatement nor the Restatement Reporter's Notes offer a rationale for the rule. The most recent edition of Professor Scott's treatise provides only the following: Clearly, the policy that prevents a person from creating a spendthrift trust for his own benefit also prevents him from depriving his creditors of a right to reach the trust property by creating a discretionary trust.22 Thus, to understand Professor Scott's rationale for the rule, we must also look to his discussion of the invalidity of spendthrift provisions in self-settled trusts. Unfortunately, that discussion, too, offers little elaboration or analysis. In that context, Professor Scott states simply that "[i]t is against public policy to permit a man to tie up his own property in such a way that he can still enjoy it but can prevent his creditors from reaching it."93 In discussing the distinction between self-settled trusts and trusts established for persons other than the settlor, Professor Scott states that "Mt is against public policy to permit the owner of property to create for his own benefit an interest 19. 2A Scar ON TRUSTS (4th ed.), supra note 14, § 156.2, at 176. This rule may be contrasted with the rule applicable to support trusts for the benefit of persons other than the settler, which in general may not be reached by the beneficiaries' creditors. See RESTATEMENT (SECOND) OF TRUSTS § 154 (1959). 20. RESTATEMENT OF TRUSTS § 156(2) (1935). 21. 1 SCOTT ON TRUSTS (1st ed.), supra note 2, § 156.2 at 784; 2 AUSTIN WAKEMAN SCOTT, THE LAW OF TRUSTS § 156.2 (2d ed. 1956); 2 AUSTIN WAKEMAN SCOTT, THE LAW OF TRUSTS § 156.2 (3d ed. 1967); 2A Scotr ON Thum (4th ed.), supra note 14, § 1562. 22. 2A Scan' ON TRUSTS (4th ed.), supra note 14, § 156.2, at 176. 23. 2A SCOTT ON TRUSTS (4th ed.), supra note 14, § 156, at 167; see also 1 SCOTT ON TRUSTS (1st ed.), supra note 2, § 156, at 782. EFTA01116877 January 2002j RETHINKING THE LAW OF CREDITORS' RIGHTS 295 in that property that cannot be reached by his creditors."' Most modem cases elaborate little on these rationales, simply citing the Restatement or Professor Scott's treatise. Note two essential components of the Restatement rule. First, the rule grants to creditors greater rights than those retained by the settlor himself or herself: the settlor cannot compel trust distributions, but the settlor's creditors can. Second, the rule applies notwithstanding that allowing the settlor's creditors to reach the assets of the trust may defeat not just the settlor's interests, but also the interests of other beneficiaries. In connection with the latter point in particular, consider Greenwich Trust Co. v. Tysons.' In Greenwich Trust Co., the settlor created a trust in which the trustee was authorized (but not required) to pay income to or for the benefit of the settlor, his wife, and his children for a period of 20 years, at which time the trust assets reverted to the settlor; if the settlor died before the end of the 20-year term, the trust continued for the benefit of the settlor's wife and children. Relying in part on the original Restatement, the court held that the settlor's creditor could reach the entire income interest of the trust, despite the fact that the income could be distributed currently to someone other than the settlor and despite the fact that any accumulated income (in case of the settlor's death during the 20-year term) would pass to persons other than the settlor. In responding to the trustee's concern that paying the settlor's creditor would defeat the interests of other trust beneficiaries, the court stated: The outstanding factor in the situation is that, under a trust where the trustee has absolute discretion to pay the income or expend it for the settler's benefit, the trustee could, even though he had a like discretion to expend it for others, still pay it all to the senior. Such a trust opens the way to the evasion by the settlor of his just debts, although he may still have the full enjoyment of the income from his property. To subject it to the claims of the settler's creditors does not deprive others to whom the trustee might pay the income of anything to which they are entitled of right; they could not compel the trustee to use any of the income for them. The public policy which subjects to the demands of a settler's creditors the income of a trust which the trustee in his discretion may pay to the settlor applies no less to a case where the trustee might in his discretion pay or use the income for others.% Thus, the court characterized the interests of the non-settlor beneficiaries as merely a device to permit "evasion of the settlor of 24. 2A scorr ON TRUSTS (4th ed.), supra note 14, § 156, at 168. 25. 27 A.2d 166 (Coon. 1942). 26. Id. at 173. EFTA01116878 296 HASTINGS LAW JOURNAL iVoL 53 his just debts,"" not worthy of protection in face of the right of the settlor's creditor to be paid. Two elements of the quoted passage are particularly noteworthy. First, the court observes that, under the terms of the trust, the settlor "may still have the full enjoyment of the income from his property."' Second, the court states that satisfying the claim of the settlor's creditor "does not deprive others to whom the trustee might pay the income of anything to which they are entitled of right; they could not compel the trustee to use any of the income for them." Each statement reflects a misunderstanding of basic fiduciary principles, topics on which the article elaborates in Part IV, but which bear emphasis here as well. The court's first observation—that the settlor may still have "full enjoyment" of trust income—suggests, without directly saying, that the settlor gave up no rights to income when he included his wife and children as beneficiaries, i.e., that he might be entitled to receive all the income, notwithstanding that other beneficiaries were potential income recipients. This statement ignores the fact that the trustee would be required to consider the interests of the wife and children in making income distributions and would be exposed to potential liability to the wife and children if it distributed all of the trust income to the settlor. The second statement—that the wife and children could not compel the trustee to distribute income to them—ignores the fact that a trustee, even one operating under a wholly discretionary standard, can be held liable for unreasonably withholding distributions to a beneficiary. The corollary of this proposition, of course, is that the trustee could be compelled to make distributions to the wife and children under certain circumstances. Thus, allowing the settlor's creditor to reach the income stream may very well have compromised enforceable interests of non-settlor beneficiaries. As noted earlier,70 the principal sources of the traditional rule— the Restatements and Professor Scott's treatise—offer little guidance on its rationale. Most cases that postdate the Restatement simply cite the Restatement or Professor Scott's treatise, with little or no analysis or elaboration of why the rule is being adopted.' Moreover, as observed in connection with Greenwich Trust Co., the traditional rule • may be based on misunderstandings of fiduciary principles governing the relative rights and interests of multiple trust beneficiaries. These 27. Id 28. Id. (emphasis added). 29. Id. (emphasis added). 30. See supra notes 19-24 and accompanying text. 31. See Ware v. Guide, 117 N.E.2d 137,138 (Mass. 1954); In re Robbins, 826 F2d 293, 295 (4th Qr. 1987) (applying Maryland law); In re Hertsberg Inter Vivos Trust, 578 N.W.2d 289, 291 (Mich. 1998); Hanson v. IvTuiette, 461 N.W2d 592, 596 (Iowa 1990). EFTA01116879 January 2092J RETHINKING THE LAW OF CREDITORS' RIGHTS 297 observations prompt the question whether Professor Scott, in writing his treatise and in drafting the Restatement,' properly analyzed the available precedent. The materials immediately following consider this question by reviewing the principal cases cited by Professor Scott in the first edition of his treatise? 32. The first Restatement predates the treatise by several years, but the American Law Institute did not publish Reporter's Notes for the First Restatement. See Herbert F. Goodrich, Introduction to RESTATEMENT (SECOND) OF TRUSTS viii (1959) (noting that the Second Restatement, unlike the first, includes published Reporter's Notes); see also http://www.ali.org (same) (last visited June 7, 2001). Because the first edition of the treatise postdates the Restatement by only a few years, it is likely that the same precedents served as authority for both works. 33. In support of his assertion that the creditor of a settlor can reach the maximum amount that could be distributed by the trustee, Professor Scott in the first edition of his treatise cites the following cases: De Rousse v. Williams, 164 N.W. 896 (Iowa 1917); Warner v. Rice, 8 A. 84 (Md. 1887); Bryan v. ICnickerbacker, 1 Barb. Ch. 409 (N.Y. Ch. 1846); McLean v. Button, 19 Barb. 450, 1854 WL 5847 (N.Y. 1854); Sloan v. Birdsall, 11 N.Y.S. 814 (Sup. Ct. 1890); Nolan v. Nolan, 67 A. 52 (Pa. 1907); Hay v. Price, 15 Pa. D. 144 (Ct. Com. Pl. 1906); J.S. Menken Co. v. Brinkley, 31 S.W. 92 (Tem. 1895); Petty v. Moores Brook Sanitarium, 67 S.E. 355, 356 (Va. 1910); Crane v. Illinois Merchants Trust Co., 238 EL App. 257 (1925). See 1 Scar ON TRUSTS (1st ed.), supra note 2, i§ 156.1 n.2 & 1562 n.2. Warner v. Rice, Hay v. Price, Bryan v. Knickerbocker, and J.S. Menken Co. v. Brinkley are discussed in greater detail below. See infra notes 34-52 and accompanying text. This footnote briefly considers the other cases. As this footnote suggests, most of the cases cited by Professor Scott provide, at best, marginal support for his statement of the general American rule. Consider, for example. Petty, 67 S.E. 355. In Petty, the settlor was the sole beneficiary of the trust during his lifetime, and the settlor retained a testamentary power of appointment over the trust assets. Id. Thus, any distributions made by the trustee would necessarily benefit the settlor only, and the disposition of any amounts not distributed by the trustee was subject to the settlor's control at his death. Id. at 355-56. The case therefore does not support a rule in which the rights of the settlor's creditors are allowed to defeat the interests of non-settlor beneficiaries. Similarly, in Nolan, the settlor was the sole beneficiary for life and held a testamentary power of appointment over the remainder. See 67 A. at 54. Sloan is ambiguous concerning the extent to which a senior's creditors can defeat the interests of other trust beneficiaries. 11 N.Y.S. 814. Sloan involved a trust that permitted income distributions for the support of the senior, but which also permitted distributions to the settlor's wife and daughter under certain circumstances. IS After reviewing the law concerning the rights of the settlor's creditors to reach the assets of the trust, the court stated: [T]he trust-deed given by the [senior] was valid as between the parties, and as to all the world except his creditors, and ... it was also valid as to his creditors, so far as the trusts for the benefit of his wife and daughter were concerned. The trusts that were valid did not fail because the instrument creating them also contained one that became invalid when the superior rights of creditors were involved. 11 N.Y.S. at 816-17. This portion of the opinion is confusing, because the case did not involve multiple trusts; it involved a single trust, with the settlor as principal beneficiary during his and his wife's joint lifetimes, the daughter as beneficiary with respect to periodic distributions of principal, and both the wife and the daughter as remainder EFTA01116880 298 HASTINGS LAW JOURNAL [Vol. 53 A review of the precedents on which Professor Scott relied suggests that he read them somewhat generously in support of his position. Consider, for example, Warner v. Rice, cited by Professor Scott in support of what has now become the traditional American rule. In Warner, the settlor created a trust "for the use and benefit of [the settlor] and his immediate family," the trustee being granted the authority to apply the income of the trust "to the support and maintenance of [the settlor] and his said family, during [the senior's] life.s35 The settlor also retained a testamentary power of appointment, which allowed him to direct to whom the trust assets would be distributed following his death.' The court ruled that the settlor's creditors were entitled to recover from the trust assets, beneficiaries. The above quoted passage suggests, therefore, that the settlor's creditors would not be able to defeat the interests of the wife and daughter (and thus that the creditor was not, in fact, entitled to the maximum amount that could be distributed to the settlor by the trustee). McLean involved not a discretionary trust at all, but a non-gratuitous transfer, for which the consideration was the transferee's agreement to support the transferor, his wife, and his children. 1854 WL at 5847, at *1-$2. Although the court subjected the transfer to the claims of the transferor's creditors (treating the transfer, for this purpose, as if it were a transfer in trust), the opinion nowhere supports Professor Scott's view that the transferor's creditors are entitled to receive the maximum amount that could be distributed to the transferor. DeRousse involved an ex-wife's claim for alimony against a trust for the benefit of the ex-husband. 164 N.W. at 897. The opinion principally concerns whether the ex-husband should be deemed the settlor of his interest in the trust, which he acquired in a transaction for consideration. No portion of the opinion describes the terms of the trust (it describes it simply as a "spendthrift" trust, with no elaboration); the case therefore, provides no support for Professor Scott's rule concerning the rights of creditors in self-settled discretionary trusts. Crane does generally support Professor Scott's position, although its facts suggest that the case should apply under limited circumstances. 238 III. App. 257. Crane held that the settlor's creditors could reach the assets of a self-settled discretionary trust, notwithstanding that the settlor himself could not have compelled distributions. The transfer of assets to the trust occurred after the settlor had incurred the debts, and the transfer apparently rendered the senior insolvent. See id. at 261, 267. In reaching its conclusion, the court specifically considered whether it was appropriate to grant the settlor's creditors greater rights than those held by the settlor himself. Referring to Itlite general rule that a judgment creditor in a proceeding by garnishment acquires no greater rights against the garnishee than the judgment debtor has," the court observed that this general rule "is subject to (exceptions] in cases of fraud affecting the rights of judgment creditors... and in cases where... property of a debtor has been transferred... for the purpose of defrauding creditors." Id at 268. Under these circumstances, the court allowed the senior's creditors to reach the assets of the trust. The court does not state that it would permit creditors to reach self-settled discretionary trusts only under these circumstances; nevertheless, the facts of the case and the quoted discussion suggest that less egregious circumstances might have prompted a different conclusion. 34. 8 A. 84 (Md. 1887). 35. Id at 85. 36. See id.; see also infra note 258 (explaining power of appointment terminology). EFTA01116881 January 2002J RETHINKING THE LAW OF CREDITORS' RIGHTS 299 despite the fact that the settlor's interest was a discretionary one and thus the settlor himself could not have compelled distributions to himself. In this respect the decision is consistent with the rule Professor Scott advocated. The court, however, goes to great lengths to describe the trust as being for the sole benefit of the senior— although distributions could have been made for the benefit of the senior's "immediate family," the court interpreted this as allowing distributions only for the purpose of discharging the settler's support obligations to those persons." Moreover, as the court also emphasized, the settler retained complete control over the disposition of the property following his death, through exercise of his testamentary power of appointment? In sum, therefore, the trust was established for the sole benefit of the settlor, and any amounts not distributed to the settlor during his lifetime would be subject to disposition by him at death. The case thus provides little support for Scott's rule concerning discretionary interests in trusts, under which the settlor's creditors are allowed to defeat the interests of non-settlor trust beneficiaries. Moreover, a trust in which the settlor both is the sole beneficiary and holds a testamentary power of appointment does not implicate the fiduciary duty questions raised above in connection with Greenwich Trust Co. A trustee of such a trust will be less constrained in making lifetime distributions to the settlor, because no future beneficiary has an enforceable interest that could be compromised by such distributions. Consider also J.S. Menken Co. v. Brinkley," which Professor Scott also cites in support of the traditional American rule. Like Warner, Brinkley involved a discretionary trust for the sole benefit of the settlor during his lifetime, with respect to which the settlor retained a testamentary power of appointment" In holding that the settlor's creditors could reach the assets of the trust, the court expended significant effort in distinguishing a case cited by the trustee" (in support of sheltering the trusts assets from creditors' claims), the most important distinction being that the trust in the other case was for the collective benefit of the settlor and certain family members, not solely for the benefit of the settlor.' Accordingly, Brinkley offers only weak support for Scott's position 37. See 8 A. at 87 (noting that the trust authorized distributions for the benefit of "those bearing the relation to him of dependents for support" and that no family member otherwise held an enforceable interest in the trust). 38. See id. at 86. 39. 31 S.W. 92 (Tenn. 1895). 40. See id at 93. 41. Mills v. Mills, 40 Tenn. (3 Head) 705 (1859). 42. Brinkley, 31 S.W. at 95. EFTA01116882 300 HASTINGS LAW JOURNAL (Vol. 53 and it offers no support for allowing a settlor's creditors to defeat the interests of non-settlor beneficiaries. Another case cited by Professor Scott directly contradicts his position. Bryan v. Knickerbacker involved a self-settled trust, the terms of which authorized the trustee to distribute to or for the benefit of the senior as much of the income of the trust as the trustee determined to be necessary for the settlor's support.' Any income not distributed to the settlor was to be accumulated by the trustee for eventual distribution to the remainder beneficiaries, the senior's heirs at law. Although the trustee's authority to distribute income to the settlor was phrased in discretionary terms, the Chancellor interpreted the settlor's retained interest as giving the settlor an enforceable right to receive reasonable amounts of income from the trust for his support.' Based on this interpretation, the Chancellor held that the settlor's creditors could reach the settlor's interest, i.e., the amounts that the trustee would otherwise have distributed to the settlor for his support.' The Chancellor's opinion includes an extensive discussion of Snowden v. Dales," which involved a self-settled trust in which the settlor retained a discretionary interest in the trust income, and in which the settlor expressly retained no right to compel distributions to himself. Any income not distributed to the settlor was to be accumulated by the trustee for distribution to the remainder beneficiaries. The Vice Chancellor in Snowden held that the entire income interest could be reached by the settlor's creditors." The Chancellor in Bryan indicated that it would have come to a different conclusion on the facts of Snowden.18 Because the settlor in Snowden had no right to compel trust distributions, the Chancellor reasoned, he would have ruled that the settlor's creditors "were only entitled to so much of the interest of the trust fund as the trustees should not, in their discretion, think proper to retain and accumulate for the benefit of the ultimate remaindermen."" Bryan thus directly contradicts Professor Scott's statement of the general American rule. Under Professor Scott's formulation of the rule, a settlor's creditor has greater rights than the settlor himself or herself; the creditor can compel the trustee to distribute to the creditor the maximum amount that could be distributed by the trustee, notwithstanding that the settlor could not compel such distributions. Moreover, under the traditional formulation of the 43. See I Barb. Ch. 409, 410, 426 (N.Y. Ch. 1846). 44. See id. at 428. 45. See Id. at 430-31. 46. 6 Sim. Rep. 524 (Ch. 1834). 47. Id. 48. 1Barb Ch. at 409 49. Id. at 430. EFTA01116883 January 2002) RETHINKING THE LAW OF CREDITORS' RIGHTS 301 rule, the rights of creditors are allowed to defeat the interests of non- settlor trust beneficiaries. Bryan states that a creditor should be permitted to reach only those assets with respect to which the settlor could compel distributions and with respect to which the trustee has not in its discretion decided to retain in trust for the benefit of the non-settlor beneficiaries. Another case cited by Professor Scott similarly does not fully support his position, but may offer a clue as to why Professor Scott's statement of the rule has been followed. In Hay v. Price," which involved a discretionary trust for the sole benefit of the settlor during his lifetime, the court held, as in Brinkley and Warner, that the settlor's creditor could reach the assets of the trust. Thus, as in both Brinkley and Warner, allowing the settlor's creditor to reach the trust assets did not serve to defeat the interests of other trust beneficiaries?' and the case accordingly does not support this aspect of the traditional rule. In reaching its conclusion that the assets should be subject to the creditor's claim, the court stated: It is true that the trustee, under the terms of the [trust], has a wide discretion as to the use of the property for the benefit of the [settlor]. Nevertheless, whatever use shall be made of it must be for the benefit of the [settlor] and of no one else. The mere giving of such discretion to the trustee does not, as we conceive, alter the fact that it was the settlor who attempted to put his property beyond the reach of the creditors and at the same time enjoy the benefits of it. We do not think that there is any reason for holding that the rule laid down in Mackason's Appeal and other cases jwhich held invalid spendthrift provisions in favor of trust settlors] should not be given full and controlling application to this case [involving not a spendthrift provision, but a discretionary trust for the settlor's benefit]. To hold otherwise would enable improvident persons, by adoption of the device of conferring discretion on trustees as to the disposition of property or properties, to have a secret understanding with such trustee that all the income of the trust property, or all the corpus of it, should be used for the benefit of the sailor, and thus entirely to avoid the effect of the salutaryprinciple laid down in the cases [concerning spendthrift provisions]. 50. 15 Pa. D.144 (Ct. Com. Pl. 1906). 51. The opinion does not clearly identify the remainder beneficiaries of the trust (in this case, the persons who would receive the trust assets at the settlor's death). The opinion indicates that, at the senior's death, the trust assets would pass "to such person or persons and in such proportions or shares as may be directed under [Pennsylvania law]." Id at 145. This language likely means either that the property would pass pursuant to a testamentary power of appointment held by the settlor or that the property would pass to the settlor's estate, to be distributed under the terms of his will or by intestacy. In either case, no person other than the settlor would have an enforceable interest in the trust during the settlor's lifetime. Thus, in this respect, too, the case fails to support the general rule articulated by Professor Scott. 52. Id. at 146 (emphasis added). EFTA01116884 302 HASTINGS LAW JOURNAL [VoL 53 Although this point is nowhere discussed by Professor Scott, th