On April 5, 2016, the Massachusetts Supreme Judicial Court is scheduled to hear arguments in a case that has major implications for the future of estate planning with protective trusts in Massachusetts. The case is Pfannenstiehl v. Pfannenstiehl, 88 Mass. App. Ct. 121 (2015). In that case, the Appeals Court approved the judgment of the Probate Court ordering that a portion of a spendthrift trust with a discretionary support distribution standard be paid out to the spouse of a beneficiary. The case goes farther than any other Massachusetts case in weakening spendthrift trust protection in the divorce context.
For a number of reasons, the Appeals Court decision should be, and probably will be, reversed. The dissenting opinion by Judge Fecteau is much more in accord with existing Massachusetts law. In some ways the more critical question is whether the Supreme Judicial Court will take this opportunity to clarify and harmonize the conflicting decisions on the inclusion of trust assets in a division of property under Mass. Gen. Laws chapter 208, section 34.
Problems with the Pfannenstiehl decision include the following:
- Spendthrift protection. The majority opinion fails to cite or even acknowledge decisions such as Pemberton v. Pemberton, 9 Mass. App. Ct. 9 (1980), which held that an ex-spouse seeking alimony could not force payments from a spendthrift trust. Instead, the Court relied on ill-considered dictum in Krokyn v. Krokyn, 378 Mass. 206 (1979), a case that did not involve distributions from a trust. In addition, the Court failed to consider the impact of the Massachusetts Uniform Trust Code. The majority opinion essentially creates a spendthrift exception for spouses in divorce cases, an exception that the Massachusetts Legislature expressly rejected in enacting the MUTC.
- Distribution standards. The majority holds that a grant of discretion in a distribution standard is effective to insulate trust assets only if the standard is purely one of discretion, not accompanied by a support standard. This is contrary to long-standing law in Massachusetts, including the Pemberton case previously cited. Once again, the majority does not address contrary precedent directly on point, but instead tries to find support in tax cases construing the term “ascertainable standard.” These tax cases, and the other cases cited by the majority, simply do not support its position.
- Disregard for settlor intent. There was testimony by the trustee at trial that distributions to the beneficiary spouse were curtailed as the divorce approached in order to give effect to the settlor’s intent to keep trust property in the bloodline. The majority, rather than giving effect to settlor intent in construing the protective provisions of the trust, concluded that the trustees’ actions proved that they were not “independent” or “impartial.” This evinces a serious misapprehension of the obligations of a trustee in administering a trust.
There is one other aspect of the Pfannenstiehl decision that has not received much attention. The trust in this case did not involve separate shares for each beneficiary, but all funds were held in what is called a “common trust” or “pot trust” in which trustees were empowered, in their discretion, to make unequal distributions to beneficiaries based upon their needs and upon the other resources available to them. At some point in the future, the trust would be terminated. At that point, “the husband will receive a share equal to his siblings.” Pfannenstiehl, 88 Mass. App. Ct. at 134.
The Probate Court awarded the husband an immediate one-eleventh interest in the trust. After principal has been depleted in order to satisfy the judgment against the husband, the trust still provides that upon termination the husband is entitled to one-eleventh of the trust assets. So what was the impact of the decision? It reduced the value of the interest of all trust beneficiaries, and reduced the income available to all beneficiaries.
Consider what would happen if the husband remarries, and is once again divorced. If the facts are sufficiently compelling, the Probate Court might once again decree that one-eleventh of the trust principal is the husband’s, and order payment from the trust to satisfy the division of property. But still, on division into separate shares, the husband will be entitled to one-eleventh of the principal under the terms of the trust.
In a common trust of the sort involved in this case, distributions to one beneficiary necessarily affect the interests of other beneficiaries. The Supreme Judicial Court has recognized that under such circumstances the due process rights of other beneficiaries must be considered. In Town of Randolph v. Roberts, 346 Mass. 578 (1964), the issue was whether a town could be reimbursed out of trust proceeds for welfare benefits paid to a beneficiary of a trust with discretionary support provisions. The Court noted that the discretionary element of the distribution standard meant that the beneficiary could compel payments from the trust only upon a showing of an abuse of discretion. The Court went on: “A remainderman would be entitled to be heard upon the question whether the trustees should be compelled to exercise their discretion.” Id. at 579. There is no indication that the majority in Pfannensteihl gave any thought to the rights of the other beneficiaries, let alone an opportunity for them to be heard.
A guardian ad litem, acting on behalf of the children of the marriage, who are beneficiaries of the same trust, might well argue against distribution of funds to the mother. As it currently stands the children’s trust share is in a protective trust, being managed by experienced professionals and business people. Given their needs and lack of other resources, the children may be entitled to a disproportionately high percentage of the assets of the common trust. However, once the money is distributed to the mother, she will be managing the funds, and it will be available to her creditors. Should she be negligent in an accident that causes serious personal injury to someone, or should she divorce after a remarriage, or should she decide to spend the funds for her own needs, the money is no longer available to the children of the marriage, as it would be if it had stayed in trust. On these grounds, they might object to the distribution.
The decision in Pfannenstiehl, both in its rationale and in its result, goes far beyond any previous Massachusetts case in diminishing creditor protection in trusts. Because it takes such a broad approach to denying trust protections, there is a risk that its reach could extend beyond division of property to other aspects of divorce, and even to other types of creditors.
Pfannenstiehl should be reversed. Hopefully, the Supreme Judicial Court will do so, and will, at the same time, clarify Massachusetts law, so that future decisions of this sort can be avoided, and so that estate planners can provide their clients’ beneficiaries with a predictable balance of access and protection.