February 4, 2014

Spendthrift Clause

Great Wall of China
Some people are fortunate to be prudent with money. These people live within their means and do not spend lavishly or superfluously. The necessities of life such as food, clothing and shelter are accounted for, with the occasional luxury sprinkled in. Conversely, there are those cursed by profligate spending. These people make reckless spending decisions, much to their detriment. Silly items such as fancy cars, jewelry and clothes often are associated with these people.

In the context of estate planning, a person is able to somewhat protect the free-spending beneficiary from themselves by inserting a spendthrift clause into their trust. This clause generally bars a creditor from attaching to the beneficiary's interest in the principal, income or both of a trust. Prob C § 15300.

For example, Samuel established a trust for his irreverent nephew Benito. This trust was to benefit Benito during his lifetime. In the trust, Samuel wrote that Benito's interest in the principal and income of the trust was not subject to voluntary or involuntary transfer. This amounted to a spendthrift provision as Samuel was concerned that Benito's recklessness would jeopardize his trust funds. Samuel had worked tirelessly in life and wanted to benefit Benito, as opposed to a creditor. 

Unfortunately Benito is spell-bound by a black Friday sale at a local retail store and incurs a massive credit card bill. Naturally Benito is unable to pay this bill and the credit card company obtains a money judgment against Benito. However, since the trust had a spendthrift provision, the credit card company cannot simply demand payment from Benito's trust. Rather, the creditor can either wait until a distribution is made to Benito from the trust or it can petition the court to direct Samuel to pay Benito's portion of trust principal and then collect. CCP § 709.010.

While California provides for a collection method as stated above, many creditors do not wish to engage in this for multiple reasons. First, it is expensive and time-consuming to petition a court to direct a trustee to satisfy the money judgment on behalf of the beneficiary-debtor. Second, if the trustee already paid the money to the beneficiary, the creditor has to be timely in their collection methods. The phrase "here today gone tomorrow" is apropos because the beneficiary can spend as they see fit when they receive it. They are under no duty to wait for the creditor to attach the judgment to it. This can easily disintegrate into a game of cat and mouse which taxes anyone's patience. 

To be clear, a spendthrift provision is not an impregnable barrier that will thwart the attempts of any creditor. A determined creditor can collect their judgment provided they have available funds, time and patience. Yet for many creditors, this can be seen as a lost cause because there is an opportunity cost for everything. Time spent chasing down a debtor like Benito sacrifices time that could have been spent chasing down a debtor with potential easier to attach assets.