Friday, April 27, 2012

Our clients are increasingly concerned about the preserving the assets their children will inherit from them in the event of divorce. The New Jersey court in Tannen v. Tannen, 416 N.J. Super. 248, 3 A. 3d 1229 (2010) wrestled with the issue of the extent to which a trust created by parents should impact the award of alimony in a divorce.

In this case, after Mark and Wendy Tannen were married, they moved into a large house that was given to Wendy by her father. Several years later, Wendy’s parents created an irrevocable discretionary trust for Wendy’s sole benefit, of which Wendy and her parents served as the co-trustees. The Trust provided that distributions were to be made for “the beneficiary’s health, support, maintenance, education and general welfare,” and were to be made in the sole discretion of the Trustees “in the beneficiary’s best interests, after taking into account the other financial resources available to the beneficiary…” The Trust further provided that “the beneficiary shall not be permitted, under any circumstances, to compel distributions of income and/or principal prior to the time of final distribution.” There was a spendthrift provision in the Trust precluding the beneficiary from anticipating or alienating her interest in the Trust “without first procuring the written consent of the Trustees.” Prior to the divorce, Wendy had conveyed the couple’s home to the Trust, in return for which the trust paid the real estate tax on the home and half the cost of the housekeeper, and paid the cost of some significant improvements to the home. The Trust also paid the private school tuition for their children.

Just prior to the trial of the economic issues relating to the divorce, the trial court issued an order for Mark to file a third-party complaint against the Trust. The trial court ruled that (1) Wendy had a fiduciary duty to seek income from the Trust and if she failed to do so, the income would be imputed to her in determining the fair amount of alimony to be paid to her by Mark, and (2) the trial court had the authority to compel a distribution of income from the Trust to Wendy, and ordered the Trustees to distribute $4,000 per month to Wendy, and (3) the trial court considered that income in determining the amount of alimony to be awarded to Wendy. The trial court relied on the Restatement (Third) of Trusts § 50 comment d(2), which provides that the terms “support and maintenance required the trustees to make distribution to Wendy. (This provision of the Restatement (Third) of Trusts is perhaps the worst fear of parents who seek to protect their child’s inheritance through the use of trusts.)

On appeal, the court reviewed the New Jersey statute concerning the factors to consider in determining the alimony to award in a divorce. One such factor is “[t]he income available to either party through investment of any assets held by that party[.]” This factor would require the trial court to consider the ability of each spouse to contribute to support, considering such things as the voluntary underemployment of a spouse or the spouse’s investment decisions that result in earning a lesser amount of income. However, the court stated that this factor is not the equivalent of imposing a spousal fiduciary duty. The court did recognize that an asset may be counted in determining alimony even though it is not actually owned by a divorcing spouse, if that spouse has the ability to access the funds, or has control of the funds. The court then considered whether Wendy had the ability to access or control the assets in the Trust, and determined that the extent of the trust beneficiary’s control of the trust assets depends on the intent of the settlor. Citing the Restatement (Second) of Trusts § 155 and § 128, the court found that a beneficiary of a discretionary trust could not compel payment to himself from the trust, and concluded the same would be true of a support trust. The court reviewed the case law from other jurisdictions and, despite the lack of consistency in other jurisdictions,

“concluded that it is not appropriate to consider a party’s beneficial interest in a discretionary trust as an asset for purposes of alimony or child support because the spouse has no current right to the fund.”

Importantly, the court addressed the provisions of the Restatement (Third) of Trusts, § 50, which has adopted significant changes in the law relating to the access available to beneficiaries of discretionary and support trusts, giving the beneficiary of a discretionary trust an enforceable interest even in the face of broad trustee discretion. The court then specifically refused to adopt the provisions of the Restatement (Third) of Trusts or to apply those provisions to this case, stating that such a determination would have to be accomplished by the New Jersey Supreme Court. Therefore, the court ruled that it was improper to consider Wendy’s beneficial interest in the Trust in determining Mark’s alimony obligation, and further that it was improper to order the Trusts to be a party to the divorce or to order the trustees to distribute trust income to Wendy.

It is interesting to note, that while the court recited the fact that Wendy had contributed her residence to the Trust and that she could alienate her interest in the trust with the consent of the trustees, the court ignored those facts in reaching its decision.

Each state has different laws regarding what assets can be considered in the event of a divorce.  If you are concerned about preserving your children’s inheritances, you should speak with a qualified estate planning attorney about how best to accomplish this goal.

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