Parents often come to us asking how they can protect an inheritance they want to give to a child who has a shaky marriage. A trust can provide protection if it is properly crafted and implemented. It all hinges on whether the child has the ability compel a distribution from the trust.
Let’s take as an example. the case of Ferri v. Powell-Ferri. This case shows us how a trust can provide no protection of the assets for the benefit of a child embroiled in a divorce. It also clarifies how giving the people managing the trust (“the Trustees”) complete authority over whether and when to make distributions can provide effective protection of assets in a divorce.
In 1983, Paul J. Ferri funded the Paul John Ferri, Jr. Trust with $1M for the sole benefit of his 18 year old son, Paul John Ferri, Jr. (known as “the 1983 Trust”). The trust was created in Massachusetts and is governed by Massachusetts law. The 1983 Trust established two methods by which the Trustees can distribute assets to Paul Jr. First, the Trustees may "pay to or segregate irrevocably" trust assets to Paul Jr. This means the Trustees can either pay trust funds directly to Paul Jr. or can set aside funds for his future use. Second, after Paul Jr. reaches the age of thirty-five, Paul Jr. may request certain withdrawals of up to fixed percentages of trust assets, increasing from 25% of the principal at age 35 to 100% after age 47.
In 1995, when Paul Jr. was 30 years old he married Nancy Powell. Fifteen years later in October, 2010, Nancy filed for divorce in Connecticut. In March, 2011, the current trustees of the 1983 Trust, Michael Ferri (Paul, Jr’s brother) and Anthony Medaglia (the “Trustees”) create the Declaration of Trust for Paul John Ferri, Jr. (known as “the 2011 Trust”) in order to shield the trust assets from Paul Jr.’s soon to be ex-wife. They subsequently moved the assets from the 1983 Trust to the 2011 Trust.
As with the 1983 Trust, Paul Jr. is the sole beneficiary of the 2011 Trust. Under the 2011 Trust, the Trustees have complete authority over whether and when to make payments to Paul Jr., if at all; Paul Jr. had no power to demand payment of trust assets. The spendthrift provision of the 2011 Trust bars Paul Jr. from transferring or encumbering his interest. This means the 2011 Trust shields the trust from Paul's creditors including his ex-wife Nancy. The Trustees moved the assets into the 2011 Trust out of concern that Nancy would get part of the assets of the 1983 Trust in the divorce. They moved the assets without informing Paul Jr. and without his consent.
At the time the assets were moved from the 1983 Trust to the 2011 Trust, Paul Jr. had a right under the 1983 Trust to request a withdrawal of up to 75% of the principal. During the course of the divorce, his vested interest matured into 100% of the assets in the 1983 Trust.
In August, 2011, the Trustees of the 1983 Trust and the 2011 Trust commence a declaratory judgment action against Nancy and Paul Jr. in the Connecticut Superior Court. A declaratory judgment action is a type of lawsuit that interprets a legal document like a trust. The Trustees asked the Court to declare that:
(1) the Trustees validly exercised their powers under the 1983 Trust to distribute and assign the property and assets to the 2011 Trust; and
(2) Nancy has no right, title, or interest, directly or indirectly, in the 2011 Trust or its assets, principal, income, or other property.
Nancy moved for summary judgment asking the court to rule in her favor without a trial, and the Trustees filed a cross motion to block Nancy from receiving any of the Trust assets. In support of their cross motion, the Trustees filed an affidavit from Paul Sr. (“the Settlor”) who was still alive. The affidavit stated that the Paul Sr. intended to give the Trustees of the 1983 Trust the specific authority to do whatever they believed necessary and in the best interest of Paul Jr., including irrevocably setting aside the trust principal in a separate trust for Paul Jr.’s sole benefit.
In August, 2013, the Connecticut trial judge struck Paul Sr.’s affidavit and granted Nancy's motion for summary judgment. If upheld on appeal, the court’s ruling would allow Nancy to reach the Trust assets in the divorce. The court determined that the affidavit was not necessary to the disposition of this case because the 1983 Trust document itself was clear. According to Judge Munro, allowing the assets from the 1983 Trust to move to the 2011 Trust would improperly remove the provisions of the 1983 Trust that gave Paul Jr. the right to withdraw money from the trust. If Paul Sr. had wanted to make the Trustees power absolute, he could have done so in the 1983 Trust. Anything less than giving the Trustees absolute power over the trust principal could not defeat the intent of the trust section giving Paul Jr. the absolute right to withdraw the trust property.
The Connecticut court ruled that the Trustees of the 1983 Trust moved the assets to the 2011 Trust without the proper authority to do so. In June, 2014, Judge Munro ordered restoration of 75% of the assets of the 2011 Trust to the same terms as the 1983 Trust, an accounting of the 2011 Trust from inception to the date of restoration, and an award of reasonable attorney's fees to Nancy.
Paul Jr. appealed the decision to the Connecticut Supreme Court. The Connecticut Supreme Court referred the case to the Massachusetts Supreme Judicial Court (“Mass. SJC”) because it is the state in which the 1983 Trust was set up. In a decision dated March 20, 2017, the Mass. SJC ruled that under Massachusetts law the Trustees had the power to move the assets from the 1983 Trust to the 2011 Trust. The Court found that the Trustees had a lot of latitude when it came to deciding what to do with the 1983 Trust. The 1983 Trust plainly allows the Trustees to act with no oversight other than the requirement to provide reporting at the request of Paul Jr. The Court noted that the 1983 Trust allowed the Trustees to "segregate irrevocably for later payment to” Paul Jr. and show that Paul Sr.’s intent was to allow the Trustees to move assets to a new trust for Paul Jr. The Court also mentioned that the Trustees not only had the power to pay trust assets directly to Paul Jr.; they could apply the payment for his or her benefit which included moving the assets from the 1983 trust to the 2011 trust. Because the language of the trust was almost identical to another case where assets were moved from one trust to another in Morse v. Kraft, a 2013 case, the Court said the Trustees could move the assets from the 1983 Trust.
Nancy’s lawyers argued that the assets in the trust should be included in the divorce because Paul Jr. had the ability to ask for trust assets. The Mass. SJC recognized that Paul Jr. had the power to withdraw the trust principal. Yet, the Court found that Paul Jr.’s ability to request assets from the trust did not prevent the Trustees from being able to move the assets from the 1983 Trust to the 2011 Trust. The Court reasoned that if the Trustees couldn’t move the assets over which Paul had the power to withdraw, it meant that the Trustees would lose the ability to exercise their fiduciary duties over those assets. Under Nancy' s interpretation, the Trustees would be without a role when Paul Jr. turned 47. At the time the Trustees moved the assets from the 1983 Trust to the 2011 Trust, Paul Jr. had withdrawn only a small percentage of the assets. Therefore, a substantial portion of the trust assets remained in the 1983 Trust, subject to the Trustee's authority and stewardship. This means that just because Paul Jr. had the ability to withdraw assets from the trust, it did not mean the Trustees lost the authority to move the assets from the 1983 Trust into the 2011 spendthrift trust. In other words, the Trustees did have the power to deny creditors like Nancy access to the trust assets.
In a concurring opinion, Chief Justice Gants made clear that the Mass. SJC was not deciding whether Massachusetts law will permit assets to be moved from one trust to another for the sole purpose of removing trust assets from the marital estate that might be distributed to the beneficiary’s spouse in a divorce action. Chief Justice Grant wrote, “I do not offer any prediction as to whether this court might invalidate as contrary to public policy a new spendthrift trust created for the sole purpose of decanting the assets from an existing non-spendthrift trust in order to deny the beneficiary’s spouse any equitable distribution of these trust assets. I simply make clear that, in this opinion, we do not decide this issue; we will await a case that presents such an issue before we decide it.”
In conclusion, the case of Ferri v. Powell-Ferri recognizes that trusts can play an important role in protecting family assets in a divorce. Trusts with withdrawal powers or that allow the child to compel distribution will not work. For instance, a trust that requires distributions be made for the child’s health, education, maintenance and support will not protect the trust principal. Instead, like the 2011 Trust, the Trustee must have complete authority over whether and when to make payments to the beneficiary.
Come see the estate planning attorneys at Cipparone & Zaccaro, PC if you want to leave an inheritance to a child with a shaky marriage.
