By Fred Franke
Franke Beckett LLC
Two provisions of the Maryland Trust Act (MTA) offer a terrific planning opportunity for clients. MTA § 14.5-504 codifies the spendthrift clause which existed under common law. It robustly shields trust assets created by third parties from most (but not all) of a beneficiary’s creditors. The “exception creditors” are former spouses owed alimony or child support or the government owed taxes. Most other creditors cannot attach spendthrift trusts. See Duvall v. McGee, 375 Md. 476, 484 (2003).
MTA § 14.5-510 states that a spendthrift clause will be enforced even when the beneficiary is acting as the sole trustee of the third-party trust for his or her benefit. Thus, a trust should be able to be established by a parent for his or her child, making the child his or her own trustee, yet preserving the assets from that child’s creditors. How foolproof is this planning?
Creditors and their counsel, of course, will want to attach trust assets to satisfy the beneficiary’s/trustee’s debts. One theory for permitting attachment involves an extension of “reverse veil piercing” used in the corporate setting. Traditional veil piercing seeks to impose corporate debts on the shareholder whereas the “reverse piercing” seeks to impose the shareholder’s debts on the company. In either case, it would be a remedy only imposed when necessary to prevent a fraud or to enforce a paramount equity. See Greystone Operations, LLC v. Steinberg, No. 454, 2017 WL 1365365 (Md. Ct. Spec. App. April 12, 2017). There is no case in Maryland that extends this theory to trusts. Also, Maryland case law does not easily permit corporate veil piercing. See Bart Arconti & Sons, Inc. v. Ames-Ennis, Inc., 275 Md. 295, 312 (1975). So even if reverse veil piercing would be theoretically available against trusts in Maryland, it would still be an uphill battle for the creditor.
Courts elsewhere, however, have looked at the issue and concluded otherwise. A Nevada unreported case granted a temporary restraining order on numerous trusts and limited liability entities because the plaintiff had shown it would likely succeed on the merits in its reverse veil piercing claims against those entities. There, funds flowed out of three trusts and four limited liabilities entities seemingly at the unfettered request of the beneficiary to pay for his personal expenses. See TransFirst Group, Inc. v. Maglianditi, No. 17-CV-00487, 2017 WL 2294288, at *7 (D. Nev. May 25, 2017).. The TransFirst Court held that although there was no Nevada law on the issue, its highest court probably would permit attachment of a spendthrift trust where it was a mere alter ego of the debtor. See Id. at *5. See also Bash v. Williams, No. 5:16CV257, 2016 WL 1592445, at *3 (N.D. Ohio April 20, 2016). (determining that current Florida law would not recognize the piercing of a trust under any circumstances but that “nearly every court to have addressed the issue outside of Florida has concluded that alter ego liability should apply to trusts to the same extent that it applies to other legally created fictions.”).
A recent reported federal bankruptcy case took a very different view: “Veil-piercing of trusts is as controversial as reverse-piercing of corporations – but without the extensive case law. The few courts to address the question have disagreed on the theory’s validity.” In Re Glick, 568 B.R. 634, 665 (Bankr. N.D. Ill. 2017).
As noted, there is no Maryland case extending veil-piercing to trusts. Also, veil piercing would be extremely rare absent a finding of fraud in the corporate setting. See Residential Warranty Corp. v. Bancroft Homes Greenspring Valley, Inc., 126 Md. App. 294, 306–07 (1999). Nevertheless, beneficiaries/trustees must be careful not to ignore the terms of the trust and they should refrain from using the trust as a private bank. Given human nature, however, techniques should be employed during the planning process to minimize potential alter ago attacks. Such techniques include restricting ownership equivalency provisions (broad rights to withdraw or general testamentary powers of appointment), mandating that the trustee is replaced if the beneficiary/trustee develops a creditor issue, and/or always having multiple trustees acting. Generally, however, spendthrift trusts in Maryland even with the beneficiary being the sole trustee ought to preclude creditor attack except in the rare and/or unusual situation.