The Self-Inflicted Drafting Defect that Keeps on Giving

By Doug Chalgian on January 6, 2016

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Discretionary trusts are important for all sorts of reasons. Essentially, the law holds that when a beneficiary’s interest in a trust is subject to the pure and unfettered discretion of a trustee, because that beneficiary has no ability to control what, if anything, comes out of the trust for their benefit, creditors have nothing to glob onto.

The protection afforded beneficiaries of discretionary trusts importantly applies to situations where the creditor (or would be creditor) is a government entity that offers assistance through a needs-based government programs; such as Supplemental Security Income (SSI) and Medicaid. Accordingly, one of the important applications of pure discretion is with respect to so-called “special needs trusts” – trusts that allow people to become or remain eligible for these benefits even though they have a beneficial interest in a trust.

A discretionary trust interest is commonly defined by what it is not. Specifically, a discretionary trust interest is not a fixed right such as: “Beneficiary A shall receive $10,000 per month” or “Beneficiary A shall receive all income distributed quarterly.”  In addition, a discretionary trust interest is not an “ascertainable standard.”  An interest in a trust creating an ascertainable standard would say something like “the trustee shall make distributions for the health, education and welfare of Beneficiary A.”  In both cases [a fixed right interest and an ascertainable standard interest (also known as a “support trust”)] the trust gives the beneficiary something tangible, something they can go to court and enforce.  If the trustee fails to make a distribution mandated by a fixed right interest, or fails to make a distribution that falls within the scope of the ascertainable standard interest, the court will order the trustee to make that distribution.  And it is this right to compel a distribution that makes the beneficiary’s interest reachable by his/her creditors.

The problem is that in the context of discretionary trusts there is a history and continuing inclination of attorneys to draft language that confuses or mixes the standards, particularly the standards of discretion and an ascertainable standard. It is not uncommon to see trusts intended to be purely discretionary contain language such as:  “Trustee may distribute trust property for the health and maintenance of Beneficiary A, as the Trustee in its sole discretion may deem appropriate.”

A recent example is the case of Cook v Ohio Department of Job and Family Services. (click on the name to read the case).  In this case, Ms. Cook applied for Medicaid and was denied because she was a beneficiary of a trust that contained mixed language – discretion and ascertainable standard.  The agency denied benefits and the Court of Appeals of Ohio upheld that decision.

The appeal was well-argued by highly qualified counsel, but the Court held that the language was sufficiently subject to interpretation as an ascertainable standard and accordingly sided with the agency. In a nod to the proposition that the meaning of a trust is a matter of state law, the appellate court simply said that Ms. Cook could have gone to state court and obtained a declaratory ruling regarding the meaning of the trust, but because she did not do so, the agency’s interpretation would be adopted.

It is frustrating to learn of these cases, and yet they come up frequently. Discretionary and special needs trusts have been around a long time. The law is well developed.  Perhaps it is because, decades ago, the law was less defined and lawyers are reaching for old forms in creating these trusts; or perhaps it is because lawyers tend to be verbose and simply can’t leave the simple statement of “Trustee may make distributions to Beneficiary A in its sole and unfettered discretion” alone.  In any event, this common but completely unnecessarily problem never seems to go away.

To read more on discretionary trusts and the Michigan Trust Code, click here.

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mm By: Doug Chalgian
Doug Chalgian

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