Does a Trust Protect You From a Lawsuit?
If you have a trust, plan to create one or are the beneficiary of one, you’ll want to understand whether or not a trust can be sued. It’s not a simple yes/no, according to a recent article titled “Estate Planning: Can You Sue a Trust?” from Yahoo! Finance. For instance, a trust generally cannot be sued, but a trustee can.
Understanding when a lawsuit can be brought against a trust should be considered when creating an estate plan, a good reason to work with an experienced estate planning attorney.
A trust is a legal entity used to hold and manage assets on behalf of one or more beneficiaries. A trustee can be a person or business entity responsible for managing the trust and the assets it holds. Trusts can be revocable, meaning the person who created them (the grantor) can make changes, or irrevocable, meaning transfer of assets is permanent (for the most part).
Trusts are used to manage assets while the grantor is living and after they have died. There are many different types of trusts, from a Special Needs Trust (SNT) used to manage assets for a disabled person, or a CRT (Charitable Remainder Trust) used for charitable giving.
To illustrate these concepts, one should know about the three parties to a trust. Think of them as “three hats”. One person can wear only one or can wear all “hats”.
The first “hat” is the settlor. The second “hat” is the trustee. The third “hat” is the beneficiary.
The settlor establishes the trust and usually funds it (other states may refer to this person or persons as “grantor”, “grantors”, “trustor”, or “trustors”), creates the trust document and appoints a trustee.
The trustee is the person that manages the trust property for or on behalf of the beneficiary of the trust, pursuant to the instructions provided by the settlor in the trust instrument.
The beneficiary is the person who will ultimately benefit from the trust.
Revocable Trusts. One person can operate under all three “hats”. A trust can be established whereby the settlor appoints himself as trustee and allows himself to benefit from the trust as a beneficiary for is life. All three hats are worn by the same person during life. This is the best way to think about a “revocable” trust. The settlor establishes the trust for himself as the beneficiary, and therefore, can “revoke” the trust usually for the life of the settlor.
Now, if the settlor can revoke the trust that he or she established, then the assets can be used to satisfy the general claims of the creditors of the settlor during the settlors life. So, for example, if the settlor is involved in a car accident for which he or she is at fault, the person injured can claim that the assets in the trust can be used to satisfy that claim. This is because if the settlor can revoke the assets from the trust, the courts can do the same for him on behalf of the person injured.
So when it comes to revocable trusts, generally it does not Protect You From a Lawsuit.
Keep in mind that even when it comes to revocable trusts, all of them at some point are intended to become irrevocable, thereby enhancing their asset protection features. So, for example, if the settlor dies, the settlor is no longer able to revoke the trust. It would become “irrevocable” on the death of the settlor.
Irrevocable Trusts. With an irrevocable trust, the settlor establishes the trust to be managed by the trustee, for the benefit of the beneficiary (usually the children or family members of the settlor) but specifies that the trust is not able to be revoked. In this case, the irrevocable trust is usually beyond the reach of the general creditors of the settlor (as long as the liability of the settlor arose after the establishment and funding of the irrevocable trust, and as long as it was not established to avoid bona fide creditors at the time of funding). In this case, the settlor can establish the trust, appoint him or herself as the trustee, but name the children as the beneficiary. This would effectively be a gift.
If, on July 1, a settlor creates an irrevocable trust and transfers property to the trust, and the transfer occurs when the settlor has no creditors that could potentially claim that property, and then on July 2 the settlor gets into a car accident, arguably the assets that the settlor transferred to the trust on July 1 are beyond the reach of the potential judgment creditor (the person injured in the car accident).
So when it comes to irrevocable trusts, they often can Protect You From a Lawsuit.
Keep in mind that there are consequences to establishing an irrevocable trust, many of them significant tax consequences, and sometimes the tax costs of establishing an irrevocable asset protection trust outweigh the benefits of asset protection. That is, unless your trust is properly established by a qualified estate planning attorney.
Yes, you can have your cake and eat it too when it comes to irrevocable trusts. But they must be established the right way, with the correct language, or else you run the risk of making the assets you transfer into your trust subject to income taxes.
Conclusions. The bottom line is this: A trust cannot always protect the grantor or beneficiaries from litigation. If a person has debt and creditors want to be paid, they can sue a revocable trust, as you have not given up much in the way of control using this type of trust—you still directly own the assets in the trust!
Irrevocable trusts provide more protection. Once assets are in the trust, the settlor (grantor) has given up control of the assets. However, if the trust was created mainly to protect assets from creditors, a court could determine the trust was created fraudulently, and rule against the settlor (grantor), leaving all of the assets in the trust vulnerable to creditor lawsuits.
Can you sue a trust directly? Generally, no, but you can sue the trustee of a trust. You can also sue beneficiaries of a trust.
Another Note. Trustees are bound as fiduciaries to manage the trust assets as directed by the grantor and for the best interest of the beneficiaries. The trustee can be sued if someone, typically a beneficiary, believes the trustee is not carrying out their duties. A beneficiary might sue a trustee, if they were supposed to receive a certain amount of money at a specific time, but the trustee has not distributed the funds. This is known as a “breach of fiduciary duty.”
Trustees are also prevented from self-dealing or using trust assets for their own benefit. If a beneficiary believes a trustee is taking money from the trust for their own benefit, they can sue the trustee.
Also, under Louisiana law, trustees can be sued if they do not provide an annual accounting to the beneficiaries. The settlor can waive this requirement, but it is usually not waived. This is the most common issue I see in my practice. That is, the trustee who has not provided annual accountings to beneficiaries. This lapse can lead to other problems, such as the trustee believing he or she can do whatever they want without being subject to review.
A trust can also be “contested,” which is different from suing. Contesting a trust occurs when someone believes the grantor was coerced or subjected to undue influence in creating the trust. It also happens if someone believes the trust or amendments to the trust were the result of elder financial abuse, or if it appears trust documents have been forged or fraudulently altered.
Before a trust can be contested, there needs to be a valid suspicion the trust is somehow in violation of your state’s estate planning laws. You also have to have legal standing to bring a claim. The court may or may not side with you, so there are no guarantees.
BOOK A CALL with me, Ted Vicknair, Board Certified Estate Planning and Administration Specialist, Board Certified Tax Law Specialist, and CPA to learn more about estate planning and asset protection.
If you liked this article, “Does a Trust Protect You From a Lawsuit?” read these articles: Will I Be Ready for Long-Term Care? and What to Do with an Inherited IRA? and Handling Guilt When Moving Loved One to Assisted Living Versus Nursing Home and Do Grandchildren Get Some of the Estate If Their Dad Dies before Me?
Reference: Yahoo! Finance (Nov. 17, 2021) “Estate Planning: Can You Sue a Trust?”