How a Distribution Trustee May Protect Your Beneficiaries

If you have read anything that I have written, you know that I am a fan of trusts. They can be drafted to do all kinds of magical things to protect both grantors and beneficiaries. Many of our clients with significant assets wish to leave their assets to beneficiaries in a trust that the beneficiary controls.By adding a Distribution Trustee to a beneficiary’s trust, we can bifurcate the role of the trustee, separating the managerial and investment responsibilities from the distribution making authority. This results in stronger creditor protection and forces your beneficiary to think about large purchases. This strategy can be important when you want your  beneficiaries to have the ability to control their trust assets, but also wish to give them a higher level of creditor protection. We often make the beneficiary his or her own trustee as to administrative and investment matters and give the beneficiary the authority to name a friend or other unrelated third party to make distributions. You can also designate the Distribution Trustee yourself.

North Carolina’s version of the Uniform Trust Code (“UTC”) makes it clear that a creditor may not reach the interest of a beneficiary who is also a trustee or co-trustee, or otherwise compel a distribution, if the trustee's discretion to make distributions for the trustee's own benefit is limited by an ascertainable standard. We typically use the ascertainable standard of “health, education, maintenance, or support.” So even without a distribution trustee, North Carolina law gives pretty good creditor protection to beneficiary-controlled trust, if they are drafted correctly.

But there are a few issues that you may want to consider. First, judges don’t always understand, agree on, or follow the law. On June 5, 2018, the North Carolina Court of Appeal issued opinions in 10 civil cases. In half of these ten cases, the Court of Appeals affirmed the trial court with no dissent. In three cases, the Court of Appeals affirmed, but there was a dissent. In one case the trial court judgment was vacated. And in one case, the Court of Appeals said the trial court got part of it right and part of it wrong. Three days later, the North Carolina Supreme Court issued 5 opinions in civil cases. One was reversed and remanded. Two were affirmed without dissent. And two were affirmed but had dissenting opinions. Without any knowledge of the substance of the cases, we can say that in the first half of June 2018, the North Carolina appellate courts didn’t fully approve what the lower courts did in about half of the cases, and in several they sent the case back down with instructions to do it over. No matter how good your case is, you can always lose.

I have seen lots of things happen in court that shouldn’t have happened. Most of the time the cases don’t get appealed. The litigants get mad with their lawyers, the judge, the legal system, and the opposing party. But they don’t want to keep spending money fighting when there are no guarantees. The solution is to stay out of court. If you can’t stay out of court, you need to win at the trial level. While I can imagine a judge ignoring or misinterpreting the nuances of law of beneficiary-controlled trusts, I can’t think of a situation where a judge would: 1) make a Distribution Trustee a party to a case against a beneficiary that does not involve claims against the trust; and 2) ordering the Distribution Trustee to make a distribution to the beneficiary’s creditors.

Perhaps more realistically, your child could move to a state that doesn’t have the level of creditor protection that we have in North Carolina.

Finally, if your child doesn’t keep the checkbook, it takes away the possibility of spontaneous financial decisions. Your son can’t buy a new car on the way home from work because he’s frustrated that the Bluetooth won’t connect and the oil needs changing. Your daughter may not order $10K worth of new clothes if she must ask her friend to pay the credit card bill next month.    

In the worst-case scenario, a creditor may be able to step into the beneficiary’s shoes to force a distribution or your child ignores the terms of the trust and wastes money. But if the power to make distributions is vested solely in the discretion of an independent Distribution Trustee, the beneficiary can otherwise control all other aspects of his trust without exposing the trust to creditors’ claims.

Every case is different, and we can't give you specific recommendations unless we understand your specific facts. But there are many cases in which a Distribution Trustee should be considered.