MEMO TO:
Alexsei Demo US
RESEARCH ID:
#40008198171652
JURISDICTION:
State
STATE/FORUM:
Texas, United States of America
ANSWERED ON:
August 12, 2022
CLASSIFICATION:
Estates and trusts
Debtors and creditors

Issue:

Can a judgment debtor escape the judgment creditor by transferring their assets to a revocable trust?

Conclusion:

A settlor cannot shield their assets by placing them in a revocable trust for their own benefit. (U.S. v. Estabrook, 78 F.Supp.2d 558 (N.D. Tex. 1999))

The person who provides the consideration for a trust is the settlor even if another person or entity nominally creates the trust.  (Brooks, Matter of, 844 F.2d 258 (5th Cir. 1988))

Tex. Prop. Code § 112.035(d) sets out that if the settlor of a spendthrift trust is also a beneficiary of the trust, a provision restraining the voluntary or involuntary transfer of the settlor's beneficial interest does not prevent the settlor's creditors from satisfying claims from the settlor's interest in the trust estate. (Tex. Prop. Code § 112.035 (2022))

Furthermore, revocable savings account trusts are subject to the claims of the settlor-trustee's creditors. Where a person deposits money in their own name in trust for another, thereby creating a tentative trust, they are so far the owner of the deposit that during their lifetime their creditors can reach it. (Soto v. First Gibraltar Bank, FSB San Antonio, 868 S.W.2d 400 (Tex. App. 1993))

Additionally, subsection (a)(1) of Tex. Bus. & Com. Code § 24.005 (2022) sets out that a transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor's claim arose before or within a reasonable time after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation with actual intent to hinder, delay, or defraud any creditor of the debtor. (Tex. Bus. & Com. Code § 24.005 (2022))

Tex. Bus. & Com. Code § 24.008 (2022) sets out ways that a creditor may reach fraudulently transferred assets in an action for relief against a fraudulent transfer. (Tex. Bus. & Com. Code § 24.008 (2022))

In the unpublished case of Ernst v. Banker's Servs. Group, 2001 Tex. App. LEXIS 7076, 2001 WL 1256524 (Tex. App. Dallas October 22, 2001), the appellants argued that because at the time of the initial transfers to the trust, the trust was a self-settled revocable trust and the transferred assets remained fully accessible to creditors, the transfers could not have been in fraud of the creditors. The Texas Court of Appeals for the Fifth District disagreed and explained that whether a transfer is fraudulent is determined by the intent of the debtor, rather than the character of the trust. Therefore, the Court found that the fact that the trust was initially revocable and the assets potentially subject to execution by the settlor's creditors was only one of many factors for the factfinder to consider in determining whether the transfers were made with actual intent to hinder, delay, or defraud any creditor.

Law:

In U.S. v. Estabrook, 78 F.Supp.2d 558 (N.D. Tex. 1999), the United States District Court for the Northern District of Texas explained that a settlor cannot shield their assets by placing them in a revocable trust for their own benefit. Thus, in this case, where the defendants created a revocable trust funded by all their present and future assets, received net income from the trusts in regular installments, and had sole discretion to make use of the trust assets as they deemed prudent, the trust assets were not beyond the reach of creditors (at 560-561): 

The threshold issue in this case is whether plaintiff can reach the assets of the various Estabrook trusts, in particular the Sunnyvale property, to satisfy defendants' outstanding tax liabilities. Plaintiff argues that "[a]ssets transferred to a revocable trust are subject to the claims of the settlor's creditors."2 (Plf. Motion at 9). Indeed, a settlor cannot shield his assets

Page 561

by placing them in a revocable trust for his own benefit. Matter of Brooks, 844 F.2d 258, 261 (5th Cir.1988); Matter of Johnson, 724 F.2d 1138, 1140-41 (5th Cir.1984); In re Witlin, 640 F.2d 661, 663 (5th Cir. 1981). "Where a person creates a trust for his own benefit ... his ... creditors can reach the maximum amount which the trustee under the terms of the trust could pay to him or apply for his benefit." Bank of Dallas v. Republic National Bank of Dallas, 540 S.W.2d 499, 501 (Tex.App.—Waco 1976, writ ref'd n.r.e.), quoting RESTATEMENT (SECOND) OF TRUSTS § 156(2). Such is the case here. Defendants created a revocable trust funded by all their present and future assets. (Plf.App. at 81). They receive net income from the trusts in regular installments and have sole discretion to make use of the trust assets "as they may deem prudent." (Id. at 80, 90). Under these circumstances, the Sunnyvale property and other trust assets are not beyond the reach of creditors.

Similarly, in Brooks, Matter of, 844 F.2d 258 (5th Cir. 1988), the United States Court of Appeals for the Fifth Circuit explained that Texas law forbids a person from placing their own assets in trust and then, by a spendthrift clause or some other restraint, shielding the trust from claims of their current or future creditors. Additionally, the Court noted that the person who provides the consideration for a trust is the settlor even if another person or entity nominally creates the trust. The Court explained that neither Texas courts nor federal courts that follow Texas law ought to follow a purely paper trail; instead, courts should look to the reality that lies behind (at 263): 

Following this pattern, the Texas Property Code authorizes spendthrift trusts and sets forth the criteria for their creation. 26 Like all other states that recognize spendthrift trusts, however, Texas forbids a person to place his own assets in trust and then, by a spendthrift clause or some other restraint, to shield the trust from claims of his current or future creditors. 27 A person is not allowed to make provision for his own support or comfort to the prejudice of his creditors. 28

The mold in which the transaction is cast does not determine who is the settlor of a trust. The person who provides the consideration for a trust is the settlor even if another person or entity nominally creates the trust. 29 Neither Texas courts, nor federal courts that follow Texas law, ought to follow a purely paper trail. We look instead to the reality that lies behind.

Likewise, in Daniels v. Pecan Valley Ranch, Inc., 831 S.W.2d 372 (Tex. App. 1992), the Texas Court of Appeals for the Fourth District explained that in Texas, a settlor cannot create a spendthrift trust for his own benefit and have the trust insulated from the rights of creditors (at 378): 

[...] In Texas, a settlor cannot create a spendthrift trust for his own benefit and have the trust insulated from the rights of creditors. Such an instrument is "self-settled" and, therefore, invalid. See Tex. Prop. Code Ann. § 112.035(d) (Vernon 1984); see also First Bank & Trust v. Goss, 533 S.W.2d 93, 95 (Tex.Civ.App.--Houston [1st Dist.] 1976, no writ); Glass v. Carpenter, 330 S.W.2d 530, 534 (Tex.Civ.App.--San Antonio 1959, writ ref'd n.r.e.). [...]

Subsection (a) of Tex. Prop. Code § 112.035 (2022) sets out that a settlor may provide in the terms of the trust that the beneficiary's interest in the income, principal, or both may not be voluntarily or involuntarily transferred before payment or delivery of the interest to the beneficiary by the trustee. However, subsection (d) sets out that if the settlor is also a beneficiary of the trust, a provision restraining the voluntary or involuntary transfer of the settlor's beneficial interest does not prevent the settlor's creditors from satisfying claims from the settlor's interest in the trust estate: 

(a) A settlor may provide in the terms of the trust that the interest of a beneficiary in the income or in the principal or in both may not be voluntarily or involuntarily transferred before payment or delivery of the interest to the beneficiary by the trustee.

(b) A declaration in a trust instrument that the interest of a beneficiary shall be held subject to a "spendthrift trust" is sufficient to restrain voluntary or involuntary alienation of the interest by a beneficiary to the maximum extent permitted by this subtitle.

(c) A trust containing terms authorized under Subsection (a) or (b) of this section may be referred to as a spendthrift trust.

(d) If the settlor is also a beneficiary of the trust, a provision restraining the voluntary or involuntary transfer of the settlor's beneficial interest does not prevent the settlor's creditors from satisfying claims from the settlor's interest in the trust estate. A settlor is not considered a beneficiary of a trust solely because:

(1) a trustee who is not the settlor is authorized under the trust instrument to pay or reimburse the settlor for, or pay directly to the taxing authorities, any tax on trust income or principal that is payable by the settlor under the law imposing the tax; or

(2) the settlor's interest in the trust was created by the exercise of a power of appointment by a third party.

[...]

In Soto v. First Gibraltar Bank, FSB San Antonio, 868 S.W.2d 400 (Tex. App. 1993), the trust was a tentative trust created by a deposit by the appellant and his wife of their own money and in their own name as trustees for their daughter. The Texas Court of Appeals for the Fourth District explained that creditors of the trustee-settlor may reach the assets in a tentative trust. That is, revocable savings account trusts are subject to the claims of the settlor-trustee's creditors. Where a person deposits money in their own name in trust for another, thereby creating a tentative trust, they are so far the owner of the deposit that during their lifetime their creditors can reach it (at 402): 

Soto pleaded and offered to prove the following facts, which we accept as true. The Sotos gave $242 to their daughter and deposited it in the bank account; the Sotos were co-trustees; withdrawals required both signatures; the money was supposed to be used ultimately for the daughter's education; the Sotos told a bank officer about their goals and needs, and he suggested the trust account; almost all the money came from Nora Soto's savings; the Sotos were having marital difficulties and each wanted to insulate the account from unilateral withdrawals by the other; the Sotos dealt with San Antonio Savings Association, which was taken over by appellee First Gibraltar; Nora was never given a copy of the bank's depository agreement and was never told of the bank's right to offset.

The trust before us is known as a tentative trust, or a Totten trust, named for the New York case approving the use of revocable inter vivos trusts.

A deposit by one person of his own money in his own name as trustee for another standing alone, does not establish an irrevocable trust during the lifetime of the depositor. It is a tentative trust merely, revokable at will, until the depositor dies or completes the gift in his lifetime by some unequivocal act or declaration....

In re Totten, 179 N.Y. 112, 71 N.E. 748, 752 (1904). Revocable inter vivos trusts are valid in Texas. See Westerfeld v. Huckaby, 474 S.W.2d 189, 192 (Tex.1971); Citizens Nat'l Bank v. Allen, 575 S.W.2d 654, 657-58 (Tex.Civ.App.--Eastland 1978, writ ref'd n.r.e.). See generally Kenneth McLaughlin, Jr., Joint Accounts, Totten Trusts, and the Poor Man's Will, 44 TEX.B.J. 871 (1981).

The authorities that have considered the issue hold that creditors of the trustee-settlor may reach the assets in a tentative trust. That is, revocable savings account trusts are subject to the claims of the settlor-trustee's creditors. Prestige Vacations, Inc. v. Kozak, 471 F.Supp. 410, 411 (N.D.Ohio 1979); In re Marriage of Flohr, 672 P.2d 1024, 1026 (Colo.Ct.App.1971); Passaic Nat'l Bank & Trust Co. v. Taub, 137 N.J.Eq. 544, 45 A.2d 679, 680 (1946); Vickers v. Lavine, 56 A.D.2d 731, 392 N.Y.S.2d 753, 754-55 (App.Div.1977); Banca D'Italia & Trust Co. v. Giordano, 154 Pa.Super. 452, 36 A.2d 242, 243 (1944). The restatement summarizes the rule as follows:

Although creditors of the settlor cannot reach the trust property merely because he has reserved the power of revocation (see § 330, Comment o), creditors of a person who makes a savings deposit upon a tentative [Totten] trust can reach his interest since he has such extensive power over the deposit as to justify treating him as in substance the unrestricted owner of the deposit.

RESTATEMENT (SECOND) OF TRUSTS § 58, comment d (1959). Professor Scott phrases the same principle this way:

Where a person deposits money in his own name in trust for another, thereby creating a tentative trust, he is so far the owner of the deposit that during his lifetime his creditors can reach it.

1A AUSTIN W. SCOTT & WILLIAM FRATCHER, THE LAW OF TRUSTS § 58.5, at 226-27 (4th ed. 1987).

The Court explained that tentative trust funds have exposure to creditors, whether or not those creditors have reduced their claims to judgment. Additionally, banks have a common law right to offset and apply a depositor's general deposit to an indebtedness the depositor owes the bank on another account. Because, in reality, the settlor-trustee owns the funds in a tentative trust, the Court held that a bank should have the same rights of offset that it would have if the funds had been placed in an ordinary account (at 402-403): 

Banks have a common-law right to offset and apply a depositor's general deposit to an indebtedness the depositor owes the bank on another account. 1 First Nat'l Bank

Page 403

v. Winkler, 139 Tex. 131, 161 S.W.2d 1053, 1056 (1942); Security State Bank & Trust Co. v. Texas Bank & Trust Co., 466 S.W.2d 590, 592 (Tex.Civ.App.--Waco 1971, writ ref'd n.r.e.). But banks may not offset trust account funds in which the true owner is not the depositor. When a bank has actual or constructive knowledge that funds are held in trust for another, who is the true owner, "it may not seize and retain the funds held in trust in order to offset a debt of the depositor." National Indem. Co. v. Spring Branch State Bank, 162 Tex. 521, 348 S.W.2d 528, 529 (1961); see also Western Shoe Co. v. Amarillo Nat'l Bank, 127 Tex. 369, 94 S.W.2d 125, 128-29 (1936). The court in National Indemnity went further and held that even when the bank lacks constructive knowledge that the funds are held in trust, it may not offset them unless it has somehow changed its position detrimentally. National Indem. Co., 348 S.W.2d at 529-31.

These decisions are not at odds with the Restatement and Professor Scott. The cited Texas authorities contemplated trust accounts in which the true owner was the beneficiary, not tentative trusts in which the true owner is the settlor-trustee. The funds at issue in National Indemnity were the insurance company's premiums, held for the company in trust by its agent, who was the depositor. By contrast, the Soto account was in reality owned by the parents, not by the beneficiary, their daughter. The parents had the use of the funds, and to this extent the "gift" of the money to the daughter was revocable. The rules stated in National Indemnity do not apply to trusts in which the settlor retained near-complete ownership and control. The Sotos' desire to accumulate funds for their daughter's education did not make the account a deposit for a specific, special purpose; they were general funds owned by the parents and available to the parents' creditors, including the bank. See generally Martin v. First State Bank, 490 S.W.2d 208, 211 (Tex.Civ.App.--Amarillo 1973, no writ) (discussion of general and special deposits). There is no suggestion that there were limits on the bank's right to use the funds while they were on deposit; on the contrary, the bank was entitled to mingle the Soto funds with its other funds. See id. at 211-13.

Soto argues that even if a settlor's creditors can reach funds in a tentative trust by garnishment, banks should not have the same right to offset. It is true that a post-judgment garnishment plaintiff has reduced his claim to judgment, while an offsetting bank has not. But we think this makes no difference because the issue is not the strength of the bank's claim but the degree to which the corpus in a tentative trust is shielded by the law of trusts. Tentative trust funds have exposure to creditors, whether or not those creditors have reduced their claims to judgment. Because in reality the settlor-trustee owns the funds in a tentative trust, a bank should have the same rights of offset that it would have if the funds had been placed in an ordinary account.

Additionally, subsection (a)(1) of Tex. Bus. & Com. Code § 24.005 (2022) sets out that a transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor's claim arose before or within a reasonable time after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation with actual intent to hinder, delay, or defraud any creditor of the debtor:

§ 24.005. Transfers Fraudulent As To Present And Future Creditors

(a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor's claim arose before or within a reasonable time after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation:

(1) with actual intent to hinder, delay, or defraud any creditor of the debtor; or

(2) without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor:

(A) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or

(B) intended to incur, or believed or reasonably should have believed that the debtor would incur, debts beyond the debtor's ability to pay as they became due.

(b) In determining actual intent under Subsection (a)(1) of this section, consideration may be given, among other factors, to whether:

(1) the transfer or obligation was to an insider;

(2) the debtor retained possession or control of the property transferred after the transfer;

(3) the transfer or obligation was concealed;

(4) before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit;

(5) the transfer was of substantially all the debtor's assets;

(6) the debtor absconded;

(7) the debtor removed or concealed assets;

(8) the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred;

(9) the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred;

(10) the transfer occurred shortly before or shortly after a substantial debt was incurred; and

(11) the debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.

Tex. Bus. & Com. Code § 24.008 (2022) sets out ways that a creditor may reach fraudulently transferred assets in an action for relief against a fraudulent transfer:

§ 24.008. Remedies Of Creditors

(a) In an action for relief against a transfer or obligation under this chapter, a creditor, subject to the limitations in Section 24.009 of this code, may obtain:

(1) avoidance of the transfer or obligation to the extent necessary to satisfy the creditor's claim;

(2) an attachment or other provisional remedy against the asset transferred or other property of the transferee in accordance with the applicable Texas Rules of Civil Procedure and the Civil Practice and Remedies Code relating to ancillary proceedings; or

(3) subject to applicable principles of equity and in accordance with applicable rules of civil procedure:

(A) an injunction against further disposition by the debtor or a transferee, or both, of the asset transferred or of other property;

(B) appointment of a receiver to take charge of the asset transferred or of other property of the transferee; or

(C) any other relief the circumstances may require.

(b) If a creditor has obtained a judgment on a claim against the debtor, the creditor, if the court so orders, may levy execution on the asset transferred or its proceeds.

In the unpublished case of Ernst v. Banker's Servs. Group, 2001 Tex. App. LEXIS 7076, 2001 WL 1256524 (Tex. App. Dallas October 22, 2001), the appellants argued that because at the time of the initial transfers to the trust, the trust was a self-settled revocable trust and the transferred assets remained fully accessible to creditors, the transfers could not have been in fraud of the creditors. The Texas Court of Appeals for the Fifth District disagreed and explained that whether a transfer is fraudulent is determined by the intent of the debtor, rather than the character of the trust. Therefore, the Court found that the fact that the trust was initially revocable and the assets potentially subject to execution by the settlor's creditors is only one of many factors for the factfinder to consider in determining whether the transfers were made with actual intent to hinder, delay, or defraud any creditor (at 9-11): 

The gravamen of appellants' contention is that at the time of the initial transfers to the trust, the trust was a self-settled revocable trust and, as such, the transferred assets remained fully accessible to Ernst's creditors. See, e.g.Daniels v. Pecan Valley Ranch, Inc., 831 S.W.2d 372, 378 (Tex. App.-San Antonio 1992, writ denied) ("In Texas, a settlor cannot create a spendthrift trust for his own benefit and have the trust insulated from the rights of creditors. Such an instrument is 'self-settled' and, therefore, invalid."); see also In re Brooks, 844 F.2d 258, 261 (5th Cir. 1988) (noting under Texas law settlor cannot shield his assets by placing them in a spendthrift trust for his own benefit). Appellants therefore contend the transfers could not have been in fraud of Ernst's creditors.

Although appellants cite authority for the proposition that assets in a self-settled, revocable trust may be reached by the settlor's creditors,  [*10]  appellants cite no authority that this fact alone precludes a finding that appellants engaged in fraudulent transfers. Case law, in fact, is to the contrary. See United States v. Estabrook, 78 F. Supp. 2d 558, 560-62 (N.D. Tex. 1999) (granting summary judgment for creditor on claim brought under the Texas Uniform Fraudulent Transfer Act where debtor transferred assets to revocable trust); see also In re Shurley, 171 B.R. 769, 781-82 & n.10 (Bankr. W.D. Tex. 1994) (noting rule providing that self-settled trust is ineffective against creditors "applies irrespective of fraudulent intent" and different remedies apply when creditor proceeds under fraudulent conveyance theory rather than under self-settled trust rule), rev'd on other grounds, 115 F.3d 333 (5th Cir. 1997). Whether the transfer is fraudulent is determined by the intent of the debtor, rather than the character of the trust. See TEX. BUS. & COM. CODE ANN. § 24.005(a)(1) (Vernon Supp. 2001) (stating transfer made by debtor is fraudulent as to a creditor if transfer is made "with actual intent to hinder, delay, or defraud any creditor of the debtor").  [*11]  In our view, the fact that the trust was initially revocable and the assets potentially subject to execution by Ernst's creditors is only one of many factors for the factfinder to consider in determining whether the transfers were made "with actual intent to hinder, delay, or defraud any creditor."

Authorities:
U.S. v. Estabrook, 78 F.Supp.2d 558 (N.D. Tex. 1999)
Brooks, Matter of, 844 F.2d 258 (5th Cir. 1988)
Daniels v. Pecan Valley Ranch, Inc., 831 S.W.2d 372 (Tex. App. 1992)
Tex. Prop. Code § 112.035 (2022)
Soto v. First Gibraltar Bank, FSB San Antonio, 868 S.W.2d 400 (Tex. App. 1993)
Tex. Bus. & Com. Code § 24.005 (2022)
Tex. Bus. & Com. Code § 24.008 (2022)
Ernst v. Banker's Servs. Group, 2001 Tex. App. LEXIS 7076, 2001 WL 1256524 (Tex. App. Dallas October 22, 2001)