Can a Creditor or Beneficiary Challenge a Spendthrift Provision in a Trust?

A spendthrift provision in a trust restricts a beneficiary’s ability to transfer trust assets. It also prevents creditors from reaching the property of the trust to repay the beneficiary’s debts. Not surprisingly, beneficiaries and creditors often wonder whether it is possible to challenge a spendthrift clause in a trust.

Minnesota Trust Code Spendthrift Trust Provisions

The Minnesota Trust Code that took effect in 2016 includes specific sections addressing spendthrift trusts. Any challenge to a spendthrift provision is subject to those statutory provisions, which are found at Minn. Stat. §§ 501C.0502 – 501C.0506.

Spendthrift Provision Validity

The requirements for a valid spendthrift provision are in Section 501C.0502. It states that a spendthrift provision is valid if either:

• The trust includes a provision that restricts both voluntary and involuntary transfers of a beneficiary’s interest, or
• The settlor clearly manifests the intent to impose those restrictions.

The section provides that a trust using the term “spendthrift trust” or similar words is sufficient to restrict both voluntary and involuntary transfers of the beneficiary’s interest. For purposes of the validity of a spendthrift provision, neither a valid disclaimer nor exercise of a limited power of appointment constitutes a voluntary transfer.

Under this provision, if a spendthrift provision is valid, a beneficiary cannot transfer an interest that violates the spendthrift provision. In addition, a creditor (or assignee) cannot access the interest or a distribution prior to the beneficiary’s receipt.

Right To Compel Distribution

Section 501C.0504 states that whether or not a trust includes a spendthrift provision, a creditor of a beneficiary cannot compel a distribution that is within the trustee’s discretion. This restriction applies even if the discretion is stated as a standard of distribution or the trustee abused the discretion.

The limitation does not limit a beneficiary’s right to bring a court action against the trustee for abuse of discretion. In addition, if a trustee or co-trustee has discretion to make distributions for his or her own benefit, a creditor can only compel distribution to the same extent as would be allowed if the beneficiary were not acting as trustee or co-trustee.

Creditor’s Claims Against the Settlor of the Trust

Regardless of whether a trust contains a spendthrift provision, Section 501C.505 establishes the rules that apply to creditor claims against the settlor of a trust:

1. For a revocable trust, during the settlor’s life: The property of the trust is subject to claims by creditors of the settlor.
2. For a trust revocable at the settlor’s death: The property of the trust is subject to claims, costs, expenses, and allowances of the estate to the extent the probate estate is insufficient to pay those amounts.
3. For an irrevocable trust: A creditor (or assignee) of the settlor can access the maximum amount available for distribution to or for the settlor’s benefit.

Overdue Distributions

Section 501C.0506 provides that whether or not a trust contains a spendthrift provision, a creditor or assignee of a beneficiary can access a mandatory distribution of income or principal, if the trustee fails to make the distribution within a reasonable time after the set distribution date. This provision includes a distribution on termination of a trust, but does not include any distribution subject to the trustee’s discretion.

Challenges to a Spendthrift Provision in a Trust

Challenges to a spendthrift provision in a trust can arise in a number of different ways. Court actions occur as both bankruptcy litigation and probate court litigation.

In a bankruptcy case involving a debtor who is the beneficiary of a trust, a creditor (or the bankruptcy trustee) may try to access trust property to settle a claim against the debtor. If the trust contains a spendthrift provision, bankruptcy litigation may result. The court action would determine the effect of the spendthrift clause and decide whether the trust property is included in or excluded from the bankruptcy estate.

Probate litigation can take several different forms. For example, a spendthrift provision may be relevant to claims against the estate of the settlor or beneficiary. In addition, a beneficiary of a trust may also file an action to invalidate a spendthrift provision to gain access to the trust property.

The effect of a spendthrift clause also may be an issue in a probate court case relating to modification or termination of a trust. While a spendthrift provision does not prevent a court from modifying or terminating a trust, the court may consider the provision when determining whether a trust can be modified or terminated.

In a 2006 case, the Minnesota Court of Appeals considered whether consenting beneficiaries could compel early termination of a trust that included a spendthrift provision. The Court upheld the trustee’s decision to refuse termination on the basis that doing so would violate a material purpose of the trust expressed in the spendthrift provision.

The decision predates, but is consistent with, current statutory provisions in the Minnesota Trust Code. The case illustrates how a spendthrift clause can affect modification or termination of a trust. It also demonstrates why a trustee considering a modification or termination request involving a trust with a spendthrift provision may wish to petition the probate court for instructions before acting on the request.

Any type of challenge to a spendthrift provision is subject to the statutory provisions summarized above. Minnesota law is stricter about exceptions to spendthrift provisions than many other states. As such, it typically is difficult for a beneficiary or creditor to defeat the protections of spendthrift provisions in the state.

Litigation relating to a trust is always complex. When bankruptcy litigation or probate court litigation involves a spendthrift provision, the issues are especially complex. It is essential for any creditor or beneficiary interested in challenging a spendthrift provision to consult with an attorney experienced in trust litigation.

Talk With an Experienced Minnesota Bankruptcy and Probate Litigation Attorney

At the Dave Burns Law Office, my practice includes both bankruptcy litigation and probate court litigation. I handle cases involving spendthrift provisions in a trust, regardless of how the matter arises.

If you are a creditor, beneficiary, or settlor needing assistance with spendthrift provision or any type of trust dispute or litigation matter, I invite you to contact me at (612) 677-8351 or by emailing dave@daveburnslaw.com. I welcome inquiries from clients and referring attorneys throughout the State of Minnesota and am available to meet with clients in both Minneapolis and St. Paul.