In the complex world of estate planning, irrevocable trusts offer a robust mechanism for protecting assets from various threats, including bankruptcy and divorce. This article delves into the specific protections offered by irrevocable trusts in Florida, supported by relevant federal and state statutes, as well as case law from the 11th Circuit and Florida courts. Additionally, we will explore fraudulent transfer rules and look-back periods under both federal and Florida law and highlight how spendthrift provisions can further safeguard assets from creditors.
Understanding Irrevocable Trusts
An irrevocable trust is a type of trust that, once established, cannot be modified, amended, or revoked by the grantor. This lack of control results in significant asset protection benefits. The trust’s assets are no longer considered part of the grantor’s estate, thereby shielding them from creditors, legal judgments, and other financial liabilities. Because ownership of the assets is legally transferred to the trust, usually via third-party trustee, these trust assets are unreachable by the grantor’s personal creditors, including those arising from bankruptcy proceedings.
Asset Protection in Bankruptcy
Irrevocable trusts are particularly effective in bankruptcy situations. Under federal law, specifically the Bankruptcy Code (11 U.S.C. § 541), assets placed in an irrevocable trust are generally not included in the debtor’s bankruptcy estate. Particularly, a restriction on the transfer of the debtor’s interests under applicable non- bankruptcy law continues to be effective during bankruptcy. Spendthrift and support trusts are excluded from a debtor’s bankruptcy estate to the extent they are protected from creditors under applicable state law. The combination of the trust being irrevocable and containing spendthrift provisions establishes a legal barrier against creditor claims on the trust assets. In bankruptcy, only assets that the debtor actually owns or controls can be considered part of the estate subject to creditor claims. Since an irrevocable trust is designed to exclude such creditor intervention, and since the debtor has no ability to alter the trust provisions, the assets held by an irrevocable trust are effectively shielded from being pulled into the bankruptcy estate.
In re Schultz, the court concluded that the assets held in the irrevocable trusts should be excluded from the debtor’s, Stephen L. Schultz’s (“Stephen’s”), bankruptcy estate. The Frank L. Schultz Irrevocable Trust and the testamentary trust established by the Last Will and Testament of Frank L. Schultz contained spendthrift provisions that explicitly prevented the beneficiary, Stephen, from anticipating, encumbering, or transferring his interests in the trusts; and also prohibited creditors from attaching to Stephen’s interests in the trusts.
As part of the divorce settlement with his ex-wife, Dr. Cynthia Justice (“Dr. Justice”), Stephen signed a $250,000 promissory note, but never made any payments to her. Two years later, Dr. Justice obtained a $250,000 judgment against Stephen and executed on the judgment by seizing Stephen’s vehicle and garnishing his bank account. Shortly thereafter, Stephen filed a Chapter 11 bankruptcy petition, listing Dr. Justice as a secured creditor on his schedule of liabilities. Dr. Justice later filed motion to dismiss Stephen’s bankruptcy case for “cause” pursuant to § 1112(b)(1) of the Bankruptcy Code. According to Dr. Justice’s exhibits, the irrevocable trust had a value of $147,232.55, and the testamentary trust had a value of $819,567.26, which was more than enough to satisfy her judgement.
Although the court granted Dr. Justice’s motion to dismiss, it found that the assets in the Schultz Irrevocable Trust and a testamentary trust were excluded from the bankruptcy estate due to spendthrift provisions that legally protected these assets from anticipation, encumbrance, or transfer, ensuring that Stephen (the debtor) could not access or leverage these assets to settle his debts.
Protections in Divorce
In the context of divorce, irrevocable trusts can provide significant protection since assets held by these types of trusts are generally not subject to equitable distribution under Florida law. This principle is supported by section 61.075 of the Florida Statutes, which excludes trust assets from being considered marital property if they were not commingled or used for marital purposes. According to this statute, nonmarital assets include those acquired and incurred before marriage, during the marriage through non-spousal gifts or inheritance, income from nonmarital assets (unless treated as or used for a marital purpose), and those excluded by valid written agreement.
Florida courts have upheld the exclusion of irrevocable trust assets from divorce settlements. In Nelson v. Nelson, the court ruled that the asset held by an irrevocable trust created by the ex-husband (“Raymond”) for the benefit of the ex-wife (“Leah”) during the marriage was not a marital asset subject to equitable distribution upon divorce. Initially, Raymond purchased the Palm Desert, California residential home (“California home”) and titled the deed in both his and Leah’s names, jointly. The couple then transferred the California home to the Leah W. Nelson Marital Trust (the “Trust”), an irrevocable trust established by Raymond for the benefit of Leah and her descendants, and Leah was named as the sole Trustee of the Trust. The Trust instrument did not set forth any terms authorizing Raymond, as settlor, to amend or revoke the Trust; nor did the Trust instrument contain a provision dissolving the Trust upon divorce.
Section 736.04113(1) of the Florida Statutes states: “Upon the application of a trustee of the trust or any qualified beneficiary, a court at any time may modify the terms of a trust that is not then revocable….” Leah, as trustee and beneficiary, did not file an application to request modification or termination of the Trust, nor did Leah’s adult daughter (also a beneficiary of the Trust).
The court found that although the California home was a marital asset when Raymond initially purchased it and titled the home jointly with Leah, it ceased in character to be a marital asset upon its transfer into the Trust. Additionally, the court emphasized that the Trust, being an entity distinct from both Raymond and Leah, held the home beyond the reach of equitable distribution in the divorce proceedings.
Spendthrift Provisions
A spendthrift provision is a clause in a trust that restricts the beneficiary’s ability to transfer or encumber their interest in the trust. This provision is critical in protecting trust assets from the beneficiary’s creditors. Under Florida Statute § 736.0502, a valid spendthrift provision will generally prevent creditors from reaching trust assets to satisfy the beneficiary’s debts.
Both Federal and Florida courts have upheld the enforceability of spendthrift provisions. In Bacardi v. White, the Florida Supreme Court confirmed that a spendthrift provision in an irrevocable trust effectively protects the trust assets from the beneficiary’s creditors; however, disbursements from a spendthrift trust may be garnished to enforce alimony orders under certain limited circumstances because Florida’s strong public policy favors the enforcement of alimony and child support orders.
Although the 11th Circuit Court of Appeals has consistently recognized the validity of spendthrift provisions in shielding trust assets from creditors, the presence of a spendthrift clause will not prevent the court from scrutinizing amendments under fraudulent transfer laws if the irrevocable trust is later amended or the court finds that fraudulent transfers occurred to protect assets from creditors. In Tolar v. Bradley, the 11th Circuit determined that despite the presence of spendthrift provisions, Greg Tolar’s amendments to the Tolar Family Trust, which was purportedly an irrevocable trust created by his father, James Tolar, could be scrutinized under fraudulent transfer laws as potential attempts to shield assets from Marion Bank, the creditor.
In this case, James Tolar created the Tolar Family Trust to benefit his wife, Martha Tolar, during her lifetime; and upon Martha’s death, the trust income was to be distributed to James’s four children, including Greg and Andrew Tolar. After the death of James’s last surviving child, the trust was to terminate, and the entire corpus was to be equally distributed among James’s grandchildren, including Reid Tolar (Greg’s son).
Greg Tolar, an Alabama attorney, handled loan closings and collections work for Marion Bank (the “Bank”) and also maintained two loans totaling $125,000 with the Bank. After Greg defaulted on these loans, resulting in judgments against him totaling $161,558 in September 2010, the Bank pursued collection actions to recover the damages. In February 2010, amidst these proceedings, Greg, as trustee, executed an addendum to the Trust that removed himself as a beneficiary and designated his son Reid as the successor trustee and a beneficiary. James Tolar died in December 2011 and the Bank obtained a copy of the original Trust and the 2010 addendum in January 2012.
In February 2012, the Bank filed a complaint under the Alabama Fraudulent Transfer Act (AUFTA), alleging that Greg’s restructuring of the trust was intended to frustrate its collection efforts, leading the court to grant a temporary restraining order (“TRO”) in March 2012 to prevent any distributions from the Trust. This decision allowed the Bank to pursue Greg’s share of the Trust assets and income despite the spendthrift provisions and the Trust’s purported irrevocability. In April 2012, Greg filed for Chapter 13 bankruptcy, which the Bank opposed, accusing him of bad faith. The parties ultimately settled in the fall of 2012, with Reid withdrawing $170,000 from his Trust interest to satisfy Greg’s debts, resulting in the dismissal of the Chapter 13 petition and the AUFTA claim. The spendthrift provision did not work in this case because the court found sufficient grounds to scrutinize and challenge the trust amendments under fraudulent transfer laws.
Fraudulent Transfer and Look-Back Periods
Both Federal and Florida law address the issue of fraudulent transfers, which occur when a debtor transfers assets to avoid creditors. Under the Uniform Fraudulent Transfer Act (UFTA), incorporated into Florida law as the Florida Uniform Fraudulent Transfer Act (FUFTA), transfers made with the intent to hinder, delay, or defraud creditors can be voided.
Federal law (11 U.S.C. § 548) provides a two-year look-back period for fraudulent transfers in bankruptcy cases. Florida Statute § 726.105 extends this period to four years. Courts will scrutinize transfers made into irrevocable trusts during these periods to ensure they were not intended to defraud creditors.
In re: McCuan, involves fraudulent transfers made by William P. McCuan to hinder the collection of over $14 million in judgments by Regions Bank, leading to the court ruling that many of these transfers were made with intent to defraud. As such, the court affirmed the avoidance of specific transfers to entities including MJF Associates, LLP, McCuan Trust, and K&M Development Corporation, Inc. The court deemed the following transfers, totaling $1,350,256.85, by William P. McCuan as fraudulent:
- $200,000 to MJF Associates, LLP on March 20, 2009;
- $44,000 to McCuan Trust on July 22, 2009;
- $100,000 to McCuan Trust on September 26, 2011;
- $750,256.85 to McCuan Trust on January 27, 2012;
- $100,000 to K&M Development Corporation, Inc. on January 13, 2012; and
- $78,000 transfer of McCuan’s interest in MDG-Patriot, LLC to McCuan LLC on January 1,
2010.
Under the Bankruptcy Code (11 U.S.C. § 544(b)), the bankruptcy trustee can avoid any transfer of the debtor’s property that is voidable under applicable state law, such as FUFTA. FUFTA’s look-back period is typically four years from the transfer date or one year from when the transfer was discovered. In this case, Florida Statute § 56.29(3)(a) provided a one-year look-back period from when McCuan was served on April 13, 2009, making the start date April 13, 2008. The transfers listed above were made by McCuan within this period and deemed to be made with fraudulent intent. As such, these transfers were subsequently avoided by the court.
Conclusion
Irrevocable trusts are a powerful tool for asset protection in Florida, and by understanding the nuances of relevant federal and state statutes, as well as pertinent case law, individuals can effectively utilize these trusts to shield their assets in bankruptcy and divorce.
If you are considering setting up an irrevocable trust to protect your assets in Florida, contact the experienced estate planning attorneys at Fleurinord Law at 305-900-3139. Our team can help create a tailored estate plan that meets your unique needs and safeguards your assets for generations. Schedule a free consultation to learn more about how we can assist you in achieving your estate planning goals. Fleurinord Law PLLC specializes in estate planning and asset protection, offering expert guidance to help clients navigate the complexities of trust law and secure their financial future.
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