Asset Protection in a Divorce

by Steven Shane

In some cases, a divorcing spouse will try to pierce a third party “spendthrift” trust (that is a trust established by someone else for the benefit of that spouse) in an effort to make a claim against those assets held in trust.  Can this generally be done?  The answer to the question is that it depends.  In general, in some states, Delaware being one, public policy is such that the rights of a divorcing spouse to access the assets of a spendthrift trust override the rights of a settlor to establish a spendthrift trust for the benefit of the settlor’s intended beneficiaries such as the divorcing spouse.

However, Delaware is not the only state where a divorcing spouse can pierce through such a trust. Some states have exceptions carved out by state law. Others do so through something called “exception creditor” laws.

It is well-established that a court will generally not interfere with the intent of a settlor in establishing a trust for the settlor’s intended beneficiaries under the terms desired by the settlor. However, over the years, courts in some jurisdictions have made exceptions to this general rule.

If a client’s goal is to protect assets in a potential divorce situation, there are two ways to address this. One is to site the trust in a state where a divorcing spouse is not a so-called exception creditor. The other is to create something called a discretionary trust where distributions are completely at the discretion of an independent Trustee that is not required by the trust instrument to provide distributions for the beneficiary’s support and maintenance. Of course, this isn’t always full proof, as, in the case of Delaware, where the state has carved out a specific exception for spouses. And of course, there is no guarantee that laws won’t change in the future.

Furthermore, as of today, there are about seven states (not in any particular order) that have laws that provide very strong protection against creditors, and more particularly, divorcing spouses. The other three states also have strong laws which are adverse to creditors, though the laws in these jurisdictions allow a divorcing spouse to pierce the trust.

1. South Dakota – Protected
2. Alaska – Protected
3. Nevada – Protected
4. Tennessee – Protected
5. (tie) Delaware – Not Protected (Garretson v. Garretson (1973))
5. (tie) Wyoming – Protected
6. New Hampshire – Not Protected (N.H. Rev. Stat. Ann. §564-B:5-503(b)(1)-(2))
7. Ohio – Protected
8. Illinois – Protected
9. Florida – Not Protected (Fla. Stat. Ann. §736.0503(2)(a) codifying Bacardi v. White (1985))
 

Steven Shane is a principal in Offit Kurman’s Baltimore/Washington office. Mr. Shane provides strategic counseling to clients with estate planning, charitable giving, and business continuity planning while minimizing estate, gift and generation-skipping transfer tax exposure.  He can be reached at 301.575.0313 and sshane@offitkurman.com.