Setting up an irrevocable trust for your children’s education after you have already been threatened with a lawsuit, or been sued, is not a good asset protection. Yet, new clients frequently propose making a educational trust and irrevocably transferring money for the benefit of their children to avoid the parents’ creditors.
I read an article by attorney Jay Adkisson about a Ninth Circuit case where the appeals court set aside a minors trust both as a fraudulent transfer and as the alter-ego of the debtor. Husband and wife established two separate trusts for their child’s education trust while they were $5.4 million in debt. The couple filed bankruptcy. The bankruptcy trustee sought to set aside the trusts as the debtors’ alter egos.
The court pointed out that there is a valid planning reason to establish a trust for minor children, the generally acceptable purpose does not is generally validate a trust set up to avoid creditors. Secondly, the court found that the trust was the alter ego, or same person, as the husband and wife even though they had no beneficial interest in the trust. The court said that although there was an independent trustee the husband in fact dominated trust decisions and noted that the trusts paid unexplained fees to the husband as trustee. The court said that the husband controlled and benefited to the extent that he had an equitable interest in trust property.
It is not sufficient that a child’s trust be set up before creditor problems are in view. The trust must also be administered solely for the child’s benefit and not be used as the parents’ piggy bank. I have heard any clients propose funding a children’s trust but using trust money to pay for household expenses. They seem to believe that as long as the child lives in their home the child’s trust can help pay the mortgage. It does not work. As this case shows, if the trustmaker retains substantial control over the trust and also receives unreasonable fees a court could collapse the trust as the alter ego of the trustmaker parent. In re Schwarzkoph, Case No. 08-56974