When irrevocable trusts include ex-spouses or soon to be ex-spouses as beneficiaries, family law practitioners should be aware of the options to potentially reduce or eliminate those interests.
By Sharon L. Klein, Family Wealth Strategist, Trusts & Estates Attorney
When irrevocable trusts are drafted in happier times, and then times change, is it possible to reduce or even eliminate the interest of an ex-spouse or soon to be ex-spouse? Trustees potentially have access to powerful tools that might change beneficial interests. Indeed, it might be said that there is no such thing as an “irrevocable” trust. In any event, family law practitioners should counsel clients to investigate the options.
Trust Decanting Can be a Powerful Tool to Revise Otherwise Irrevocable Trusts
“Decanting” is a technique that allows the trustee of an otherwise irrevocable trust to transfer the trust assets into a new trust with different terms. The rationale behind decanting is that a greater power should include a lesser power: If a trustee can make outright discretionary distributions to a beneficiary, then the trustee should also be permitted to do something less than an outright distribution and instead distribute trust assets into another trust for that beneficiary. Decanting can be a tremendous tool for dealing with changed circumstances, correcting mistakes, facilitating tax benefits, or optimizing a trust’s administration. In the divorce context, a trustee might be able to use the decanting technique to limit a beneficiary’s interest – or even to eliminate a beneficiary.
Ferri v. Powell-Ferri – Decanting in a Divorce Context
Ferri v. Powell-Ferri1 is a recent example of the power of decanting in the divorce context. Trust assets were successfully moved out of reach of a divorcing wife, although they were considered for alimony purposes. Husband was the beneficiary of a trust (the 1983 Trust) created by his father under which he had the right to receive the trust assets at certain ages.
The trust was valued between $69 – $98 million. The trustees, who were concerned divorcing Wife would reach trust assets, transferred the assets to a new trust (the 2011 Trust) without the knowledge or consent of Husband. At the time of the creation of the 2011 Trust, Husband had a right to request outright 75% of the 1983 Trust assets, and during the course of the legal proceedings, his right matured to 100%. The new 2011 Trust extinguished Husband’s power to request trust assets at stated ages, making distributions solely discretionary with the trustees.
Wife had filed to dissolve the marriage in Connecticut, and the trusts were settled in Massachusetts. The Connecticut Supreme Court asked the Supreme Judicial Court of Massachusetts to determine whether the trustees, one of whom was Husband’s Brother, validly exercised their powers under the 1983 Trust to distribute the trust property to the 2011 Trust. The Massachusetts Court determined that since Father, who created the 1983 Trust, intended to convey to the trustees almost unlimited discretion to act, the decanting was authorized. The Massachusetts Court did not rule on whether the trust assets must be considered in the divorce, including for alimony purposes. The Connecticut Supreme Court issued two opinions in the Ferri matters – one related to the decanting, the other related to the divorce action.
Action for Declaratory Judgment: Decanting was Authorized2
The trustees sought a judgment declaring that they were authorized to decant assets to the new trust, and that Wife had no right or interest in those assets. The Connecticut Supreme Court adopted the opinion of the Massachusetts Supreme Judicial Court, and held that the decanting was proper.
Action for Dissolution of Marriage: 2011 Trust not Marital Asset, but Could be Considered in Alimony Determination3
The court noted that the Massachusetts Supreme Judicial Court determined that the decanting was appropriate: “Consequently, the assets from the 1983 Trust cannot be considered as part of the dissolution judgment…” With regard to the 2011 trust, because that was a so-called “spendthrift trust” (protected from creditors), it was not considered an asset of the marital estate that the court could divide under Connecticut law. Wife’s status was that of a creditor and the court held that, although the court could divide the assets while they were held in the 1983 Trust, it could not reach them once they were moved into the 2011 Trust, so the decanting was successful in removing the assets from division. However, the court also noted that, although the trial court could not consider the assets decanted to the 2011 trust for equitable distribution purposes, it could and did consider Husband’s ability to earn additional income when creating its alimony orders. The trial court found that the trust funds had routinely supported Husband’s investments. Notably, the trial court ordered Husband to pay Wife $300,000 in alimony annually – despite the fact that, when the action was commenced, he had been earning only $200,000 annually.
Some Further Thoughts About Decanting
About half the jurisdictions in the U.S. provide statutory authority to decant. Most states require that notice be given to beneficiaries. It was important in the Ferri case that the decanting occurred without Husband’s permission, knowledge, or consent. Query if the same result would follow if a beneficiary was given notice of the decanting, or whether notice alone would not detract from the Connecticut Supreme Court’s holding that Husband took “no active role in planning, funding or creating the 2011 Trust” (emphasis added).
Including decanting provisions in trust instruments may maximize flexibility without having to resort to state default law. Indeed, in a recent New York case, Davidovich v. Hoppenstein4, the trustees successfully relied on their powers under a trust document to distribute a life insurance policy on the settlor’s life to a new trust that excluded an estranged daughter of the settlor and her issue. Dismissing an objection that the transfer did not satisfy the requirements of the New York decanting statute, the court held that the New York decanting statute had no bearing on the case since the trustees relied on their powers under the document to effectuate the transfer.
In Hodges v. Johnson5, however, a New Hampshire court found that trustees had violated their duty of impartiality because they did not consider the interests of beneficiaries who were removed in decantings. The court found that the decantings were void and ordered the removal of the trustees. Although the court’s decision rested on broader grounds, the facts of the case may have influenced the holding: the trial judge found that the trustees decanted the trusts to remove beneficiaries in three separate decantings at the request of the settlor and commented on the “deeply personal and harsh nature of the decantings.” The removed beneficiaries were the grantor’s second spouse, his stepchildren, and one biological child, leaving his other two children as beneficiaries. In each of the three decantings, one of the two individual co-trustees resigned; the settlor’s estate attorney was appointed as trustee to replace the trustee who resigned; the co-trustee who remained as trustee delegated his decanting power to the attorney/trustee; and the attorney/trustee executed the decanting documents. Once the decanting documents were executed, the attorney/trustee resigned as co-trustee, and the individual trustee who had resigned was re-appointed. This occurred on three successive occasions.
Perhaps this is just a reminder that trustees must be vigilant about performing their fiduciary obligations, and cannot act at the behest of the settlor or any other individual. Including specific guidance in trust agreements as to why the settlor may wish the trustee to exercise discretion unevenly may be helpful.
Collaboration Early and Often is Key
Clients benefit when matrimonial, trusts & estates, and accounting and investment professionals partner throughout the whole divorce process to integrate considerations that cross disciplines. If a family law practitioner finalizes the divorce and then refers a client to a new investment advisor and/or trusts & estates attorney, it may be too late to address a myriad of issues that should have been resolved before the divorce is concluded. Many nuanced issues require the input of a team of advisors before the divorce decree is signed.
1 Ferri v. Powell-Ferri, 476 Mass. 651, 72 N.E.3d 541 (2017)
2 Ferri v. Powell-Ferri, 326 Conn. 438, 165 A.3d 1137 (2017)
3 Powell-Ferri v. Ferri, 326 Conn. 457, 165 A.3d 1124 (2017)
4 Davidovich v. Hoppenstein,162 A.D. 3d 512,79 N.Y.S.3d 133 (2018) )
5 Hodges v. Johnson, 170 N.H. 470, 177 A.3d 86 (2017)
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Sharon L. Klein is president of Family Wealth, Eastern US Region, for Wilmington Trust. She is a Fellow of the American College of Trusts & Estates Counsel, she chairs the Domestic Relations Committee of Trusts & Estates magazine, and is a member of the New York City Bar Association’s Matrimonial Committee. Beginning her career as a trusts & estates attorney, Sharon has over 25 years’ experience in the wealth advisory arena and is a nationally recognized speaker and author. www.wilmingtontrust.com/divorce
This article is for general information only and is not intended as an offer or solicitation for the sale of any financial product, service or other professional advice. Wilmington Trust does not provide tax, legal or accounting advice. Professional advice always requires consideration of individual circumstances. Wilmington Trust is a registered service mark. Wilmington Trust Corporation is a wholly-owned subsidiary of M&T Bank Corporation (M&T). © 2019 Wilmington Trust Corporation and its affiliates. All Rights Reserved.
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