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Protecting Family Assets From A Child’s Ex-Spouse

scissors cutting through a marriage certificate and a rose stem, with orange rose petals scattered on the paper

As anyone who has survived a messy divorce knows, common sense is not always a reliable measure of what the law actually says.

Say you want to set up a trust for your children and grandchildren. You choose to create a discretionary trust, in which distributions are controlled by a pair of trustees, designed to see to the beneficiaries’ comfort and well-being, ideally for years to come. If one of your children divorces his spouse, you would not expect his interest to become subject to claims by his ex.

Yet that is exactly what happened in the case of Curt and Dianne Pfannenstiehl.

Curt was a beneficiary for a trust his father created in 2004, one of 11 such beneficiaries at the time of his divorce proceedings. The trial judge in the divorce proceeding decided that Curt’s share of the trust could and should be assignable to the marital estate, largely due to the argument that the trustees’ discretion was subject to the “ascertainable standard” required by Massachusetts law. This standard requires trustees to consider beneficiaries’ health, education, support and maintenance when deciding to make a distribution. Dianne’s lawyers thus argued that the trust was not purely discretionary. The judge awarded Dianne 60 percent of Curt’s share, valued at one-eleventh of the total trust assets at the time.

Curt appealed this decision, but the Appeals Court ruled against him, 3-2. In addition to leaning on the ascertainable standard, the Appeals Court also characterized the trust distributions as “woven into the fabric of the marriage.” The two dissenting judges found Curt’s interest in the trust too remote and speculative to include in the marital estate.

The Massachusetts Supreme Judicial Court agreed with the dissenters. Although the ruling acknowledged that judges have “considerable discretion in determining how to divide [marital] assets equitably,” the justices found that whether an interest in a trust may be included is a matter of law, not judicial discretion.

In the case of this particular trust, Curt’s interest was characterized as an eligibility for distributions, with no “present or enforceable interest.” Despite the ascertainable standard, the trustees will necessarily balance Curt’s needs with those of his siblings, children, nieces and nephews. The trustees must also keep in mind the needs of future beneficiaries, a real possibility given the trust’s structure. Distributions from the trust had not been equal from year to year, or from beneficiary to beneficiary, at the time the case was heard.

As an illustration of this very point, Curt made an effort to obtain funds from the trust to pay Dianne the approximately $1.4 million mandated in the original divorce proceeding. The trustees, however, refused to distribute the funds. Dianne filed a complaint for contempt, but the Appeals Court set aside this judgment, since Curt hadn’t willfully violated the original order.

On a human level, the lower courts’ compassion for Dianne is somewhat understandable. Her income is significantly less than that of her ex-husband, and she was awarded primary physical custody of the pair’s two children, both of whom have special needs. However, the Supreme Judicial Court’s decision affirms that the trusts’ distributions are clearly in the hands of the trustees. In this case, that means that the interest should not be included in the marital estate. Curt’s attorney argued that this stance was a matter of honoring the grantor’s intentions as much as reasonably evaluating the situation.

It is not at all uncommon to use trusts in order to shield gifts to children from divorce settlements (as well as other creditors). For instance, if a child and his or her partner resist the idea of a prenuptial agreement, a cautious parent may turn to a trust to protect the child’s future inheritance. In the case of a trust like the Pfannenstiehls’, a grantor can also provide for future generations, even without knowing exactly how many beneficiaries a trust will serve or what various needs they will have.

As this case illustrates, however, a trust is not a cure-all. It is important to draft foundational documents carefully and to keep an eye on applicable state law. For instance, in some cases, an ascertainable standard may be omitted, which would make it clear that all distributions are in the trustees’ discretion and that the beneficiary has no enforceable claim against undistributed trust funds. The Pfannenstiehl trust also illustrates one benefit of creating a single trust for all children and grandchildren that allows for unequal distributions.

No one wants to assume their child or grandchild will endure the emotional and financial strain of a contentious divorce. But thinking ahead will allow you to create a foundation that rests on law, rather than hoping for common sense to win the day.

Vice President David Walters, who is based in our Oregon office, contributed several chapters to our firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55, including Chapter 5, “Estate Planning,” and Chapter 6, “Transfer Taxes.” He was also among the authors of the firm’s book The High Achiever’s Guide To Wealth.

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