Can A Divorce Court Pierce Spendthrift Trusts?

Can A Divorce Court Pierce Spendthrift Trusts?

Can a divorce court pierce spendthrift trusts that were established to protect family assets from equitable distribution obligations? A recent opinion from a state appellate court provides a surprising answer.  While the decision is not precedential in Western Pennsylvania (where I represent clients in family law matters), it may signal a shift in the perspectives of the family courts.  Or, it might be an isolated incident that will not be replicated elsewhere.  Still, it is worthwhile for high net-worth individuals and business owners to be aware, and take precautionary measures to ensure their intent is fulfilled when doing their estate planning.

Pfannenstiehl v. Pfannenstiehl, 37 N.E.3d 15 (Mass.App.2015)

Curt and Diane Pfannenstiehl were married for ten years when they separated in August 2010.  Diane continued to stay at home to care for their two special needs children, ages 11 and 8.  Curt had been employed during the marriage as Assistant Manager of the Bay State College bookstore, where he earned $170,000 per year.  (Uh-huh.)  A year prior to separation, Curt took a four-year sabbatical to explore a career in carpentry; he continued to collect his bookstore salary during his time off.

Curt was a beneficiary of the Frederick G. Pfannenstiehl 2004 Trust, an irrevocable spendthrift trust established by his father. The trust held the stock of Bay State College and Harrison College, two for-profit universities owned by Educational Management Corporation. From the trust, Husband received distributions — an outright $300,000 in 2008 followed by monthly payments of several thousand dollars – until August 2010, when the trust distributions to Husband abruptly terminated.  Meanwhile, Husband’s twin brother and his sister continued to receive monthly trust distributions.

The two trustees were Frederick’s twin brother and a lawyer who had represented EDMC for many years.  The opinion states: “To use understatement: the record shows the 2004 trust was not administrated impartially by the two trustees. To the contrary, the judge expressly found that as the divorce began, ‘the proverbial family wagons circled the family money.’“

The trial court found that the 2004 trust was worth $24.9 million, in which Husband had a one-eleventh interest based on the number of beneficiaries.  Husband’s 1/11th share, worth $2.265 million, was included in the marital estate, of which Wife was allocated half to be paid by Husband in twenty-four monthly installments of $48,699.77 each.

Can a Divorce Court Pierce Spendthrift Trusts?

On appeal, the appellate court affirmed, relying on Lauricella v. Lauricella, 409 Mass. 211, 565 N.E.2d 436 (1991), where the appellate court held that: “husband’s interest is unlike a mere expectancy . . . [his] rights in the trust property are present, enforceable, and valuable.” On the same basis, in Pfannenstiehl, the intermediate appellate court held that “the spendthrift provision is being invoked as a subterfuge to mask the husband’s income stream and thwart the division of the marital estate in the divorce.” The Court noted that the 2004 Trust contained a standard for the exercise of the trustees’ discretion:

“…the 2004 trust differs from wholly discretionary trusts, with no distribution standards regarding support, health, maintenance, welfare, or education.”

“…the 2004 trust has an ascertainable standard pursuant to which the trustees, as fiduciaries, were obligated to, and actually did, distribute the trust assets to the beneficiaries….”

“Given these ascertainable standards, the husband’s interest in the trust is vested in possession, with a presently enforceable right to the trust distributions to support his lifestyle during his lifetime including for maintenance, welfare, and education.”

The trust was held to be subject to equitable distribution.  Yet, it seems highly unlikely that the Pfannenstiehl result would be replicated in other jurisdictions.

“All-Property Jurisdictions” are Unique and Rare

First, Massachusetts is an all-property equitable distribution jurisdiction, whose statute reads: “In addition to or in lieu of a judgment to pay alimony, the court may assign to either husband or wife all or any part of the estate of the other, including but not limited to, all vested and non-vested benefits, rights and funds accrued during the marriage…”  In most states, the law differentiates between marital or community property (which is divided upon divorce), and separate property (which is not). Trust property is generally regarded as separate property, except to the extent that it is within the possession or control of one of the spouses.  See, e.g., Solomon v. Solomon, 611 A.2d 686 (Pa. 1992).  If trust property is designated as separate property, it would not be divided in a dual-classification equitable distribution state.

Second, the beneficiary spouse in Pfannenstiehl suddenly stopped receiving income when the divorce was filed, raising the divorce court’s suspicion.  The case emanated a strong odor of collusion between the trustees and beneficiary, in the opinion of the divorce court. And, when the beneficiary spouse was cut off from trust distributions, his brother and sister continued to receive their monthly benefits.  This fact pattern motivated the divorce court to seek a “creative” solution.

The full opinion appears here.  To coordinate your family law tax strategy with estate planning techniques like spendthrift trusts, consult my book Frumkes & Vertz on Divorce Taxation Chapter 18.  In Western Pennsylvania, call me, Brian C. Vertz (412-471-9000) for a family law consultation or visit my law firm’s website: pollockbegg.com.