An interesting court decision with an interesting name may undermine the efforts of parents to provide for their children and grandchildren while protecting their inheritance from lawsuits and in the event of divorce. In Pfannenstiehl v. Pfannenstiehl (Mass. App. Ct., Nos. 13-P-906, 13-P-686 & 13-P-1385, August 27, 2015), the Massachusetts Appeals Court ruled that a portion of a trust created by the parents of Curt Pfannenstiehl for his benefit and that of his siblings would be considered as a marital asset in his divorce from Diane Pfannenstiehl. This ruling, which undermines centuries of established trust law, was based in part on the equities of the situation and in part on a misunderstanding of wording commonly used in trusts.
Curt and Diane were married in 2000 and have two children, both with special needs. Curt, who has dyslexia and ADD, works as an assistant bookstore manager at one of the family's colleges, earning $170,000 a year for a job that the trial court judge found usually paid between $50,000 and $60,000. Diane had been an officer in the United States Army Reserve, but gave up her position under pressure from Curt and his family in order to care for their daughter just two years before 20 years of service would have earned Diane a military pension. She still worked one day a week as an ultrasound technician, earning almost $23,000 a year. She also was the primary homemaker and caretaker of the children whose needs are quite demanding.The family income totaled about $350,000 a year, almost half of which came from tax free trust distributions.
Curt was the beneficiary of a family trust created by his parents for the benefit of his twin brother and sister and their children. It held interests in the family's for-profit colleges, including Bay State College in Massachusetts, valued at almost $25 million and made distributions of hundreds of thousands of dollars to Curt and his siblings between 2008 and 2010. The Court emphasizes that: "Only as to [Curt] did these substantial monthly payments end, and they did so precisely on the eve of [Curt's] divorce filing." Curt's brother, who is also vice-president and secretary of the family's holding company and president and treasurer of Bay State College, serves as trustee of the family trust along with the family's long-time attorney.
The trust contains a standard "spendthrift" clause which reads as follows:
Neither the principal nor income of any trust created hereunder shall be subject to alienation, pledge, assignment or other anticipation by the person for whom the same is intended, nor attachment, execution, garnishment or other seizure under any legal, equitable or other process.
The Court holds that despite this language, the pattern of the trust distributions to Curt and the manipulative nature of the termination of the trust distributions at the start of the divorce proceedings mean that this spendthrift provision does not apply. It cites an earlier court decision which states: "The law does not require that an obligor be allowed to enjoy an asset—such as a valuable home or the beneficial interest in a spendthrift trust—while he neglects to provide for those persons whom he is legally required to support."
The Court then turns to the "ascertainable standard" in the trust included in the trust provision governing distributions from the trust. It reads in relevant part:
. . . the Trustee shall pay to, or apply for the benefit of, the Donor's then living issue such amounts of income and principal as the Trustee, in its sole discretion, may deem advisable from time to time, whether in equal or unequal shares, to provide for the comfortable support, health, maintenance, welfare and education of each or all members of such class . . . . (emphasis included in the court decision)
The Court finds that this language gives Curt "a present enforceable right to distributions from the 2004 trust." It says that this language "differs from wholly discretionary trusts, with no distribution standards regarding support, health, maintenance, welfare, or education," referencing a decision that held a trust to be outside of the marital estate because it was "wholly discretionary." It concludes:
Reduced to essentials, it is clear that the 2004 trust has an ascertainable standard pursuant to which the trustees, as fiduciaries, were obligated to, and actually did, distribute the trust assets to the beneficiaries, including the husband, for such things as comfortable support, health, maintenance, welfare, and education.
. . .
Given these ascertainable standards, the husband's interest in the trust is vested in possession, with a presently enforceable right to the trust distributions to support his lifestyle during his lifetime including for maintenance, welfare, and education (and including educational funds needed for the special needs of the two children).
The Court also discusses how the trust distributions "were woven into the fabric of the marriage." It points out that Curt will receive a substantial distribution from the trust upon its termination. And it upholds the trial court's determination that Curt has a one eleventh share in the trust and that approximately half of this should be transferred to Diane as part of the divorce.
It is clear in the trial court's decision that the judge grew to dislike Curt and his attorneys, describing "scorched earth litigation." The Appeals Court upholds the award of $175,000 in attorney's fees to Diane but overturns a contempt order.
The dissent of two of the five judges deciding the case concludes that Curt's "interest in the 2004 income distribution trust (the 2004 trust) is too remote and speculative, too dependent on trustee discretion, and too elusive of valuation to have been included in the marital estate for purposes of division." It acknowledges that neither the difficulty of valuing an interest in property nor a spendthrift on its own "necessarily preclude[s] the trust from being included in the marital estate." But in this case, the combination of "the spendthrift clause, the uncertain value of the interest and the discretionary nature of the instrument, render [Curt's] interest in the trust too speculative and remote for inclusion in the divisible estate."
The dissenting judges argue that the ascertainable standard must be read in the context of the discretion accorded the trustees and that there are "serious problems" with respect to the determination of Curt's interest in the trust given that the number of beneficiaries of the trust may change and that distributions may "be made in equal or unequal shares, and upon consideration, in the trustees' discretion, of funds available from other sources for the needs of each beneficiary." It concludes that "the fractional share methodology employed by the judge has produced an arbitrary result."
The dissent also rejects the majority's focus on the cessation of trust distributions on the eve of the husband filing for divorce, arguing that "the primary focus of the instant inquiry should be the terms of the trust instrument itself, not how those terms may be or have been manipulated."
The equities of this case appear to favor Diane. She gave up her employment to care for their children with special needs and provide the primary support and care for these children. Curt has been and no doubt in the future will be supported by his wealthy family. Yet, in terms of trust law, should parents be able to set aside protected funds for their children and grandchildren? Consider the equities if Diane were from the wealthier family. Should her trust be split with Curt if he was providing no hands on, moral, or economic support for their two children? What if it were a much smaller trust holding what her middle-class parents were able to leave her? Do we want a system where the decisions are made by individual judges? On the one side, this permits them to react to the facts of each situation and attempt to come up with a fair result. On the other, everyone comes to every situation with their own experiences and prejudices and ability to be swayed by persuasive lawyers. Should we have more certainty about results ahead of time? Should parents who are choosing whether or not to create trusts with various provisions for their children have the right to certainty?
Let's turn to two other issues: the ascertainable standard and the role of the independent trustee.
The so-called ascertainable standard—health, education, maintenance and support, also referred to as the HEMS standard—on trust distributions comes from the tax code, where it is treated as a restriction on the discretion of the trustee. The trustee under this standard does not have free rein to disburse trust funds for any purpose, including yachts, sports cars and spa vacations, but is limited to spending money only on health, education, maintenance and support. This has certain implications for tax purposes, often meaning that the trustee is not deemed to be the owner of the trust assets for tax purposes.
Yet, in this case, both the majority and the dissent read the ascertainable standard as obligatory, that the trustee must pay for the health, education, maintenance and support of the beneficiaries as needed, with discretion only applying to the timing and amount of the payments. This interpretation also flows from the use of the word "shall" in the trust language. No doubt, the drafter of the trust used "shall" to mean the same as "will," in that the distributions will be made in the future. But this court and no doubt the lay reader interprets "shall" to be directive, directing the trustee to make distributions for health, education, maintenance and support. To avoid this ambiguity, we often substitute the word "may" for "shall."
The trustees of the Pfannenstiel family trust are Curt's twin brother and the longtime family lawyer. The Court rejects the independence of the family lawyer both because of his relative un-involvement in trust decisions and his being beholden to the family due to his firm's work as their corporate attorneys as well. As with the Court's interpretation of the HEMS standard, this disregard for the independence of the trustee is inconsistent with IRS tax law, where attorneys and other professionals who are not part of the family or trust beneficiaries are deemed to be independent, with a number of tax results following from their role as trustee. Even without this inconsistency with tax law, for the Court to question the decision of the grantor of a trust to appoint her longtime advisor who understands interests and goals as trustee raises questions. In this case, shouldn't the question be the attorney trustee's independence from Curt, not from the parents who created the trust?
There is an old saying that "bad facts make bad law." This may be one of those cases where the fact that since Diane is a much more sympathetic litigant than Curt could overturn well-settled law that has been well-settled for many good reasons. Interestingly, we learn in the footnotes that this decision was a 3-2 vote by the participating justices with the two dissenters being two of the original three judges who heard the appeal. After they circulated a draft opinion, two other justices joined the case. We don't know what the original draft opinion was, but apparently the court's decision changed during the process. No doubt an appeal will go up to the Supreme Judicial Court.