You would think that people who donate substantial sums of money to charity would get a break when defending their charitable planning from judgment creditors. This past week a client asked me whether her creditors could attack a charitable trust she established. The debtor created the trust several years before she had any creditor problems, and the debtor was solvent at the time. The charitable trust was known as a “charitable remainder unitrust” under IRS regulations. The client donated marketable securities to the trust. When the debtor dies the trust will distribute all its property to a charity. During the debtor’s lifetime the trust pays the debtor an annual payment equal to 7 percent of trust value. The trust document contains a “spendthrift provision” which states that the trust’s payments to the client may not be assigned to her creditors. The client wanted to know if her judgment creditors can seize her annual payments or reverse the entire gift as a fraudulent transfer.
Florida law prohibits creditors from attaching payments to a debtor from a trust where the trust agreement has a spendthrift clause. However, there is an exception when the trust was established by the debtor- a so-called “self-settled trust.” Courts have held that a spendthrift clause does not protect a debtor’s right to payment from a trust established by the debtor even when the trust is primarily for the benefit of a charity.
A second issue is whether a creditor can reverse a charitable trust as a fraudulent transfer to avoid or delay creditors. If a debtor makes a charitable bequest of non-exempt assets to keep the assets away from his creditors the bequest could be subject to fraudulent transfer claims. A creditor could argue the debtor intended to benefit from an income tax deduction from the charitable gift rather the lose the money to the judgment creditor with no tax deduction ( assuming the debtor could not deduct the loss to the creditor). The new bankruptcy law enacted in 2005 specifically prohibited fraudulent transfer claims against charitable gifts. The bankruptcy provision is not applicable in state court fraudulent transfer claims.