The New Jersey Uniform Trust Code – Part Seven: Creditor’s Claims and Spendthrift and Discretionary Trusts

Creditor’s Claims and Spendthrift and Discretionary Trusts

Article 4 of the NJ UTC deals with creditor’s claims and spendthrift and discretionary trusts.  See N.J.S.A. §§ 3B:31-35 to -41.

  • Spendthrift provisions

To the extent a beneficiary’s interest is not protected by a spendthrift provision, N.J.S.A. § 3B:31-35 permits a creditor or assignee of a beneficiary to reach the beneficiary’s interest by attachment of present or future distributions to or for the benefit of the beneficiary.  The statute expressly provides that these creditors’ rights are subject to the law relating to wage execution or other applicable law.  In addition, “[t]he court may limit the award of such relief as is appropriate under the circumstances.”  N.J.S.A. § 3B:31-35.

As a general rule, spendthrift provisions are enforceable in New Jersey.  However, there are certain circumstances when a spendthrift provision is not recognized.  For instance, New Jersey law provides a generous exemption from attachment involving self-settled trusts that are Qualified Retirement Accounts, Individual Retirement Accounts (IRAs), ROTH IRAs, Coverdell Education Savings Accounts, and Section 529 Plans.  See N.J.S.A. § 25:2-1 et seq.  Other statutory exemptions from a creditor include the inability of a creditor to attach life insurance policy proceeds (N.J.S.A. § 17B:24-6); annuity proceeds (N.J.S.A. § 17B:24-7); health and disability insurance benefits (N.J.S.A. § 17B:24-8); and group insurance policy proceeds (N.J.S.A. § 17B:24-9).

N.J.S.A. § 3B:31-36 sets certain parameters for spendthrift clauses.  Specifically, a spendthrift provision is valid only if it restrains both voluntary and involuntary transfer of a beneficiary’s interest.  N.J.S.A. § 3B:31-36(a).  A trust providing that a beneficiary’s interest is subject to a “spendthrift trust” or similar terminology is sufficient to restrain both voluntary and involuntary transfer of a beneficiary’s interest.  N.J.S.A. § 3B:31-36(b).

A beneficiary may not violate a valid spendthrift provision by transferring an interest in a trust.  N.J.S.A. § 3B:31-36(c).  Likewise, a creditor or assignee of the beneficiary generally may not reach the interest or a distribution by the trustee before its receipt by the beneficiary.  Id.

A spendthrift provision is valid even if a beneficiary is named as the sole trustee or as a co-trustee of the trust.  N.J.S.A. § 3B:31-36(d).  A valid spendthrift provision, however, does not prevent the appointment of interests through the exercise of a power of appointment.  N.J.S.A. § 3B:31-36e.

  • Important distinction between UTC and NJ UTC

The Uniform Trust Code, as opposed to the version adopted in New Jersey, provides that there are certain creditors (i.e., “exception creditors”) that can attach a trust with a spendthrift provision.  No creditors can compel distribution from a trust.  The exception creditor can attach distributions once made to the beneficiary.  These “exception creditors” include:  child support; a spouse; a former spouse who has a judgment for support or maintenance; a judgment creditor who has provided services for the protection of a beneficiary’s interest; and government claims.  However, the insertion of additional protected classes — in the matrimonial setting and in the area of special needs trusts — as exception creditors has drawn national criticism.  The New Jersey version of N.J.S.A. § 3B:31-37 deleted the UTC provision entirely and in its place included a provision clarifying issues relating to “special needs trusts” at N.J.S.A. § 3B:31-37.

  • Special needs trusts

Special needs trusts present an exception to the rules governing spendthrift trusts, even if the trust contains a spendthrift provision.  The details are addressed in the later section of this article on special needs trusts under the NJ UTC.

  • Discretionary trusts

Regardless of the presence of a spendthrift provision, a creditor of a beneficiary cannot compel a distribution that is subject to trustee discretion.  This rule applies even if the discretion “is expressed in the form of a standard of distribution” or the trustee “has abused the discretion.”  N.J.S.A. § 3B:31-38(a).

A beneficiary may still maintain a judicial proceeding against a trustee for an abuse of discretion or failure to comply with a standard for distribution.  N.J.S.A. § 3B:31-38(b).

  • Creditor’s claims against settlor

Under the NJ UTC, there are also certain rules that apply to trusts, even those without a spendthrift provision.

For revocable trusts, the property of a revocable trust is subject to the claims of the settlor’s creditors during the lifetime of the settlor.  N.J.S.A. § 3B:31-39(a)(1).

For irrevocable trusts, a creditor or assignee of the settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit.  N.J.S.A. § 3B:31-39(a)(2).  In those instances where there is more than one settlor, the amount the creditor or assignee may reach may not exceed the settlor’s interest in the portion of the trust attributable to that settlor’s contribution.  Id.

Following the death of a settlor, and subject to the settlor’s right to direct the source from which liabilities will be paid, the property of a trust that was revocable at the settlor’s death is subject to claims of the settlor’s creditors, costs of administration of the settlor’s estate, the expenses related to the settlor’s funeral and disposal of remains, and to a surviving spouse or partner in a civil union and children to the extent the settlor’s probate estate is inadequate to satisfy those claims, costs, and expenses.  N.J.S.A. § 3B:31-39(a)(3).  As to claims by a spouse, domestic partner, or children, rights would exist in a revocable trust, if any, only under N.J.S.A. § 3B:3-30 (during contest), N.J.S.A. §§ 3B:5-15 and -16 (omitted spouse and children), or N.J.S.A. § 3B:8-1 et seq. (elective share).

The holder of a power of withdrawal is treated in the same manner as the settlor of a revocable trust to the extent of the property subject to the power, during the period in which the power may be exercised.  N.J.S.A. § 3B:31-39(b)(1).  Further, upon the lapse, release, or waiver of the power, the holder is treated as the settlor of the trust only to the extent the value of the property affected by the lapse, release, or waiver exceeds the greater of the amount specified in 26 U.S.C. §§ 2041(b)(2) or 2503(b) of the federal Internal Revenue Code.  N.J.S.A. § 3B:31-39(b)(2).

  • Overdue distributions

The UTC defines “mandatory distribution” as a “distribution of income or principal that the trustee is required to make to a beneficiary under the terms of the trust, including a distribution upon termination of the trust.”  N.J.S.A. § 3B:31-40(a).  The statute expressly excludes from this term any distribution subject to the exercise of the trustee’s discretion, regardless of whether the terms of the trust (1) include a support or other standard to guide the trustee in making distribution decisions, or (2) provide that the trustee “may” or “shall” make discretionary distributions, including those pursuant to a support or other standard.  Id.

Except as otherwise provided in N.J.S.A. § 3B:11-4.1, which concerns limitations upon a trustee’s powers granted by a governing instrument, a creditor or assignee of a beneficiary may reach a mandatory distribution of income or principal, including a distribution upon termination of the trust, “if the trustee has not made the distribution to the beneficiary within a reasonable time after the mandated distribution date.”  N.J.S.A. § 3B:31-40(b).  This type of claim is permitted, whether or not a trust contains a spendthrift provision.  Id.

  • Personal obligations of the trustee

Trust property is not subject to the personal obligations of a trustee.  N.J.S.A. § 3B:31-41.  This limitation exists, even if the trustee becomes insolvent.  Id.