Asset Protection and Spendthrift Trusts: What's the legality in Michigan?

Q: What's the legality of spendthrift trusts in Michigan?

            A spendthrift trust is a way to protect assets from creditors. Generally, a trust is established by someone – the settlor - for the benefit of someone else – a beneficiary. The trustee is the person who oversees the trust assets for the beneficiary according to the instructions in the trust by the settlor when it was made.

The “spendthrift” provision of the trust means that the beneficiary has no control over distribution, and trustee can’t make a distribution to a beneficiary unless certain conditions are met. When spendthrift trusts first began to be used, they were looked on as being necessary only for a beneficiary who had some disadvantage – like incompetence, or incapacity. However courts quickly expanded that original definition to allow the settlor’s intent to be carried out whenever possible.[1]

Spendthrift Trusts and Bankruptcy

The Bankruptcy code has been drafted as broadly as possible to include as much of the debtor’s assets as is possible in the bankruptcy estate. However, if the debtor is the beneficiary of a spendthrift trust, that changes the creditor’s ability to collect. Being a debtor who is also a beneficiary of a spendthrift trust, the assets and income of the trust are an exception from the bankruptcy estate.[2]

If the beneficiary has creditors who are waiting to seize/ attach assets once a distribution is made, the trustee can wait to make a distribution. So the assets, once distributed, will all go to the beneficiary.

Spendthrift Trusts and Michigan Law.

            Currently Michigan only allows a spendthrift trust provision when the beneficiary is someone other than the settlor. This means that if a settlor wanted to create a spendthrift trust that was used to keep the settlor’s assets shielded from creditors for the settlor’s own benefit, it would not be recognized under current Michigan law as a valid trust. So the creditors of the settlor could “pierce” a self-settled trust in a court action.

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[1] See Norton Annual Survey of Bankruptcy Law, 2011, p. 2. Available at: http://furrcohen.com/wp-content/uploads/2011/10/Norton-Annual-Survey-2011.pdf.

[2] Id. See also Restatement of Trusts, § 58 (2).