Spendthrift clause

Spendthrift clause
See also

Spendthrift clause "is a simple and valuable feature included in almost every trust. It has long been used in every state to do two things (M.T. Palermo 2005, s. 220):

  1. The spendthrift clause prevents a beneficiary who goes on a drinking or spending binge, for example, from selling the right to his future trust payments to a loan company for a lump sum of cash.
  2. It takes the trust "off the table" for creditors in the (unfortunate but likely) event the beneficiary is sued as a result of his financial or another irresponsibility".

The spendthrift clause prevents the third party (creditor) from receiving directly what the recipient was to obtain from the trust. However, after making a payment to the beneficiary, it is no longer subject to the clause - it is now the beneficiary's money, and hence, third parties (creditors) can reach for it (M.T. Palermo 2005, s. 221).

How a spendthrift clause works

To illustrate the way in which spendthrift clause works, Michael Palermo cites the following example (M.T. Palermo 2005, s. 220):

"A thirty-five-year-old man driving while drunk killed a mother of two. He was prosecuted for manslaughter, but the victim's family desperately needed compensation for the loss of her income. Although the defendant had the minimum liability insurance allowed by law, it was common knowledge that he had recently inherited a lot of money. The family sued for wrongful death. The jury decided in favor of the family, awarding it almost $1.5 million in damages. Unfortunately for the family, the defendant's inheritance actually took the form of quarterly trust payments of $25,000 from his late father's trust, made at the discretion of a bank trustee. Legally, the trust principal was not the defendant/beneficiary's property; therefore, it was not available to pay the victim's judgment. Courts around the country have ruled along similar lines for many years. Topping it off, the trustee suspended payments to the beneficiary in anticipation of the several years he will spend behind bars. Even in heartbreaking situations like this, the courts virtually always honor spendthrift provisions".

Spendthrift trust

Spendthrift trust is a trust containing a provision that protects the tangible assets of the trust against the creditors and reckless expenditure of the beneficiary. With such a trust clause, creditors cannot take over the principal and interest on that amount until they have been received by the beneficiary and the beneficiary cannot assign the principal and interest before they are received. Without such a provision, the beneficiary entrusted with the money could take the fiduciary instrument to the bank, take out a loan and transfer the rights to the money to the bank as collateral for the loan (G. Brown, S. Myers 2009, s. 239).

Within the spendthrift trust concept, two types of transfers are distinguished (P.T. Wendel 2018, s. 281):

  1. Voluntary transfers - a spendthrift clause need not limit either the beneficiary's voluntary or involuntary transfers. There are savings clauses that block only voluntary transfers made by the beneficiary, but leave open involuntary transfers, thus enabling the beneficiary's third parties (creditors) to reach the property;
  2. Involuntary transfers - a spendthrift clause that only excludes transfers made by the beneficiary which are not in accordance with his will, are considered to be contrary to public policy and are invalid. If a beneficiary has the right to voluntarily transfer his interest, he must also bear the risk that his creditors will be entitled to claim interest on him.

References

Author: Patrycja Czerwiec