Common Reasons for Creating a Spendthrift Trust

Nearly all of us have relatives who need extra help managing their income and assets. When we can, we try to find ways to help them. In some instances, you might have a grandson or granddaughter who’s having trouble holding down a steady part-time job during college – or trying to make ends meet after battling a lengthy addiction. Your troubled relative might also be older and starting to struggle with handling all his monthly financial affairs.

Whatever the individual’s special needs may be, you can often help by making the person a beneficiary of a spendthrift trust.

How Should You Define This Type of Trust to the Beneficiary?

You may first want to simply say that, because you greatly care for this individual, you want to remove all or most of her current money management problems from her life. You can then say that you’ve named the person as a beneficiary of a special trust account that will be managed by a trustee. You should then quickly point out that you’ll be personally choosing the exact terms governing the trust so the trustee can properly meet specific needs of the beneficiary.

Should the beneficiary ask if she can personally manage the money, you must be ready to say that you have considered that alternative and prefer to disburse the funds over time. You might also note your desire to prevent the funds from being taken by untrustworthy creditors. (Of course, there are legal exceptions that do allow some creditors to reach these funds, and they’ll be briefly addressed below).

It’s also useful to tell the beneficiary that the funds or property that you’ll be placing in the trust as its creator (grantor) are generally referred to as the trust principal.

What Basic Terms and Provisions Are Normally Included in a Spendthrift Trust?

As your Houston estate planning lawyer will tell you, specific language must be included in the trust document, making it clear that you’re creating a spendthrift trust, in keeping with Texas law. This enabling language is designed to fully protect all the property and funds that you’re placing in the trust from others who might try to illegally reach them. All of this is clearly explained in the Texas Property Code, Title 9, entitled “Trusts.”

Your spendthrift trust language will clearly state that since the beneficiary has no right to directly reach and control the funds – neither can most creditors. Most grantors also include some specific language indicating that they are trying to provide for the beneficiary’s general needs.

As the grantor/settlor you must also clearly state all the trustee’s rights, duties and obligations while administering the trust. The trustee’s job can be a very difficult one, especially if the beneficiary decides to legally challenge the trustee by demanding large sums of money for serious medical, educational or basic living expenses not expressly referenced in the trust.

When Can Creditors & Other Parties Successfully Obtain Funds from a Spendthrift Trust?

The laws in most states allow creditors that can prove that a beneficiary owes them money for basic “necessities” (like shelter or food) to win judgments and collect funds from these types of trusts. Other legal obligations that can be paid out of spendthrift trust funds (once legal action has been taken) include child support, alimony or support of a past (or current) spouse and certain government claims.

When funds are periodically released to a beneficiary, creditors can also try to obtain them based on judgments they’ve obtained. 

Please feel free to contact one of our Murray Lobb attorneys to learn more about the various types of trusts and other estate planning tools that we can draft to meet all your needs, including a spendthrift trust.

A Basic Understanding of Trust Documents

A Basic Understanding of Trust Documents

Although many people still request Wills from their attorneys, it’s now often best for tax purposes to have the bulk of your estate transfer to others through one or more trusts. To better understand how trusts work, you first need to understand that there are living trusts and testamentary trusts.

Living trusts, also known as “inter vivos” trusts, are created during the grantor’s (or requesting party’s) own lifetime. By contrast, a testamentary trust is created within a Will and doesn’t become legally enforceable until after the grantor has died. As your estate planning attorney will tell you, there are two types of living trusts – those that are revocable and those that are irrevocable.

Revocable trusts let you maintain control over the trust assets, allowing you to revoke or change the trust’s terms whenever you believe it’s necessary. Should you instead create an irrevocable trust, the law no longer views the assets in the trust as yours – therefore, you normally cannot make any changes to the trust without the trust beneficiary’s consent.

While there are many different types of trusts and ways to set them up, the following ones are among those commonly requested by clients.

Frequently Requested Trusts

The Charitable Lead Trust. This type of trust can be created during the grantor’s own lifetime or upon that individual’s death. It provides for a type of annuity to be given to a charity for life or for a specific term of years. If there are any remaining trust assets, they are passed on to non-charitable beneficiaries when the trust terminates.

The Credit Shelter Trust. Many married couples with children often choose this type of trust because the surviving spouse can maintain full rights to the trust assets until his or her death. At that time, the trust benefits can then pass to the children. This trust is also commonly used because it allows the creator to escape estate taxes when passing the trust assets on to heirs.

The Irrevocable Life Insurance Trust. When you move your life insurance out of your estate by having this type of trust created, it’s no longer part of your taxable estate. The funds are then readily available to help pay for any possible estate costs or for other immediate cash needs of your beneficiaries.

Generation-Skipping (or Dynasty) Trusts. Grandparents often like to set these up because they’re designed to allow grantors to give tax-free money to beneficiaries who are two or more generations their junior.

The Qualified Terminable Interest Property (Q-TIP) Trust. If you’re in a second or third marriage and you and your current spouse had children during earlier marriages, you’ll want to learn more about this trust. It helps you not only leave your surviving spouse with income, it also lets you leave specific assets to your various children.

The Qualified Personal Residence Trust. You can use this to remove the value of either your main residence (or a vacation home) from your estate. It’s especially wise to create this type of trust regarding a property that’s very likely to increase in value over time.

The Special Needs Trust.  Many families have at least one member who suffers from some type of serious physical or mental disability. When you set up this type of trust, its terms can be restricted regarding how the assets can be used – thereby still allowing your loved one to qualify for certain types of government benefits.

As this article indicates, there are many different types of trusts that offer distinct advantages and disadvantages. Please feel free to contact our firm with any questions you may have about the specific types of trusts that may best suit your goals and preferences.

A Few “Factors” to Consider

Should a Subcontractor be allowed to assign, sell, or otherwise transfer (factor) an account receivable due from a general contractor for work performed on a construction project? We say, absolutely not. Here’s the problem.

Construction funds are trust funds. Texas Property Code §162.001(a) (commonly referred to as the “Trust Funds Statute”). Even loan receipts are trust funds. Texas Property Code §162.001(b).

A contractor, subcontractor or owner, or an officer, director, or agent of a contractor, subcontractor, or owner, who receives trust funds or who has control or direction of trust funds, is a trustee of the trust funds. Texas Property Code §162.002.

An artisan, laborer, mechanic, contractor, subcontractor, or materialman who labors or who furnishes labor or material for the construction or repair of an improvement on specific real property is a beneficiary of any trust funds paid or received in connection with the improvements. Texas Property Code §162.003.

A general contractor is a trustee of construction funds paid to it by the owner. A subcontractor would be a beneficiary of the trust funds paid to the general contractor in connection with the improvements at the project. In turn, once paid, the subcontractor becomes a trustee.

A trustee who, intentionally or knowingly or with intent to defraud, directly or indirectly, retains, uses, disburses, or otherwise diverts trust funds without first fully paying all current or past due obligations incurred by the trustee to the beneficiaries of the trust funds, has misapplied the trust funds. Texas Property Code §162.031.

A trustee who misapplies trust funds amounting to $500 or more in violation of Chapter 162, with intent to defraud, commits a felony of the third degree. Texas Property Code §162.032 (b). If the misapplication of trust funds by a trustee constitutes another offense punishable under the laws of this State, the State may elect the offense for which it will prosecute the trustee. Texas Property Code §162.033.

Under Section 9.406 of the Texas Business and Commerce Code, once the account debtor (General Contractor) receives notification of the assignment of an account (invoice), the account debtor cannot discharge its obligation by paying the assignor (Subcontractor). After receipt of the notification, the account debtor (General Contractor) may discharge its obligation only by paying the assignee (Factor Company).

This situation results in a legal paradox.

1. On the one hand, Subcontractor has relieved itself from the implications of the Trust Fund Statute. Subcontractor is no longer receiving “trust funds” for its services provided at the construction project. It is receiving funds for the work from a third source, Factor Company. After receipt of these funds, Subcontractor can “retain, use or disburse” those funds any way it chooses without worry of the implications imposed by the Trust Fund Statute.

2. Factor Company would argue that it is not a Trustee, subject to the Trust Fund Statute. Thus, after receiving payment of trust funds from the account debtor, it does not have to pay any beneficiaries of Subcontractor.

3. On the other hand, General Contractor is required to pay Subcontractor under the Trust Fund Statute. If General Contractor pays Factor Company, General Contractor, its owners, or officers, or directors face potential criminal liability. Further, if General Contractor pays Factor Company, and Factor Company does not pay Subcontractor beneficiaries, the project is subject to lien. If General Contractor does not pay Factor Company, then General Contractor is subject to liability under Section 9.406 of the Texas Business and Commerce Code.

By factoring the accounts receivable, Factor Company, Subcontractor, its owner or officers, and directors have circumvented the trust fund statute, is not a trustee, and thus can use those funds for any purpose thus avoiding a criminal penalty. This unintended result cannot be tolerated in the construction setting.

Keeping an owner’s construction project property free and clear of liens is a constant concern for general contractors. Because subcontractors typically purchase materials to be incorporated into the construction project from third parties, it is important that the flow of funds from the owner to the general contractor to the subcontractor make their way to the suppliers to prevent liens filed by these outside third party suppliers. If a subcontractor were allowed to assign (factor) its account receivable due under a construction contract, and if payment would have to be made to the assignee, how would the assignor’s (subcontractors) suppliers, materialmen, and laborers be paid to prevent liens?

It could be argued that Subcontractor could (and should) pay the funds it receives from the factor to the beneficiaries. However, in the real world that does not happen. That’s why we have the Trust Fund Statute. It is for these reasons that the factoring, sale, or assignment of a right to payment under a construction contract for construction or repair of an improvement on specific real property in this State be declared void as against public policy. A seemingly legal means to avoid criminal prosecution should not be tolerated and in the interest of public policy should be invalidated and voided.