Trusts: Legally Protecting Assets from the Settlor's Creditors
New York law allows individuals to limit their liability to creditors by arranging their affairs in a manner that legally protects their assets. One of the ways this is accomplished is by “making irrevocable transfers of their assets, outright or in trust, as long as such transfers are not in fraud of existing creditors . . .” (Matter of the Joseph Heller Inter Vivos Trust, 613 Misc 2d 369 [Sur Ct, 1994]). The circumstances under which a trust’s assets will be validly protected are limited to the existence of specific parameters in the trust instrument.
According to EPTL §7-3.1, “[a] disposition in trust for the use of the creator is void as against the existing or subsequent creditors of the creator.” In other words, an individual cannot transfer his or her assets to a trust and continue to retain control or enjoy the benefits of that trust, while simultaneously enjoying protection from creditors. Instead, transfers to irrevocable trusts will only be deemed valid for purposes of sheltering the assets from creditors where the grantor does not reserve a power to revoke the trusts or to dispose of the property during his lifetime, and where the transfers to the trust did not make the grantor insolvent (see Matter of Granwell, 20 NY2d 91 [1967]; Debtor Creditor Law §273).
A transfer resulting in the grantor’s insolvency or one that is made while the grantor is already insolvent may be deemed a fraudulent conveyance (see Debtor Creditor Law §273). In such cases, the creditors may set aside conveyances and reach the assets. But if trust assets remain available for the grantor’s benefit, creditors need not establish fraud to invalidate the transfer (see Vanderbilt Credit Corp. v Chase Manhattan Bank, N.A., 100 AD2d 544 [2d Dept 1984]; Colgate v Guaranty Trust Co. of New York, 159 Misc 664, 666 [Sup Ct, New York County 1936]). For example, in Vanderbilt Credit Corp. v Chase Manhattan Bank, N.A., 100 AD2d 544 (2d Dept 1984), the Appellate Division held that trust assets are not protected from creditors if the trustee has discretion to make payments to the grantor (see Vanderbilt Credit Corp. v Chase Manhattan Bank, N.A., 100 AD2d 544 [2d Dept 1984]).
Not surprisingly, this concept extends beyond the life of the trust settlor and remains applicable to his or her estate. Indeed, courts recognize that where an individual reserves the power to dispose of trust property during his or her lifetime, “he or she must be regarded as the absolute owner of the funds until death and those funds would be therefore available to pay estate debts” (Estate of Hughes, 3/20/2003 NYLJ 23 [col 2] [Sur Ct, Kings County], citing Matter of Granwell, 20 NY2d 91 [1967]; Matter of Batiste, 5/4/99 NYLJ 30 [col 6]). Also notable is the fact that, "any property covered by a general power of appointment which is presently exercisable, or a postponed power which has become exercisable, is subject to creditors' claims" (Estate of Chappell, 7/24/09 NYLJ 26 [col 1] [Sur Ct, New York County], citing EPTL §10-7.2).
In light of the foregoing, it is clear that individuals may legally protect their assets from the claims of creditors, provided they are willing to forego the control and benefits of the funds and of course, do not transfer their assets fraudulently.
Court Examines Beneficiary's Right to Sell Real Property
The issue of ownership of real property has frequently arisen in Surrogate’s Court proceedings, most particularly, in the context of applications by a testamentary beneficiary to sell or dispose of realty devised pursuant to the terms of the decedent’s Will. As discussed in my article in the New York Law Journal several years ago, often-times the outcome of such a application hinges upon a determination of whether the beneficiary holds a life estate in the premises or simply a right of occupancy or other lesser interest (see Ilene Sherwyn Cooper, The Meaning of a Life Estate and Other Decisions of Interest, NYLJ, Nov. 10, 2005, at p.3).
Recently, this issue was again before the court in In re Gullo, 7/6/2009 NYLJ. 37 (col 1) (Sur Ct, Suffolk County). In Gullo, the threshold issue before the court was whether the provisions of the decedent’s will provided the petitioner with a life estate in the decedent’s residence. The petitioner requested leave of court to purchase the premises, and to credit herself with the value of her life estate in the property and improvements she made to the premises subsequent to the decedent’s death. The application was opposed by the trustee under the decedent’s will, on the grounds that the petitioner did not receive a life estate in the realty, but rather a fee on limitation. Petitioner claimed the contrary, maintaining that the language in the decedent’s Will provided her with a life estate, and that a sale of the property was both expedient and in the best interests of the estate.
Pursuant to the pertinent provisions of his Will, the decedent devised and bequeathed the subject property to the petitioner, his daughter, as a “life estate”, and authorized her to reside and remain in the premises for as long as she wished, so long as it remained her principal residence. If for any reason the decedent’s daughter declined the life estate, or decided to vacate the property, the Will directed that the property be sold and the net proceeds be distributed pursuant to the provisions of the residuary clause.
In analyzing the issue as to the nature of the petitioner’s interest in the subject premises, the court held that a life estate in property conveys exclusive ownership of the land during the lifetime of the life tenant, subject only to certain well-defined limitations or duties. Moreover, the holder of a life estate may, under certain circumstances, be able to force the sale of the property and collect the value thereof, assuming it is demonstrated that the sale is expedient. The court opined that in comparison to a life estate, a right of occupancy or a lesser interest to a life tenancy is a personal privilege that does not confer the benefits of a life estate.
Although the language of the decedent’s Will utilized the words “life estate” in referring to the petitioner’s interest, the court did not consider that fact dispositive of the issue raised. Further, the Court found that the conditions expressed in the Will requiring the petitioner to pay taxes and maintenance on the property were inconsequential to the result, and insufficient to elevate petitioner’s ownership from a right of occupancy to a life tenancy. Rather, the Court held that the language employed in the instrument was significant of a “fee on limitation”, as defined in EPTL 6-1.1(a)(3). That being the case, the court concluded that petitioner’s interest did not lend itself to computation or application of a credit for a life estate.
Accordingly, the court determined that the petitioner held a fee on limitation in the property and was not entitled to a credit for a life estate. The court further opined that the expediency of the sale was unclear from the record inasmuch as the circumstances which usually give rise to such a conclusion usually involves sales to third parties, and not necessarily parties in possession of the property.
