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August 28, 2014

Uniform Fraudulent Transfer Act Does Not Override Common-Law Rule Subjecting Self-Settled Trusts To Creditors’ Claims

The Illinois Supreme Court recently held that the Uniform Fraudulent Transfer Act does not limit or replace the common-law rule that a settlor's creditors can reach the assets of a self-settled trust. Such a trust is vulnerable to claims even if the settlor's conduct in establishing the trust does not meet the Act's definition of a fraudulent transfer (for example, because the settlor was not insolvent at the time of the transfer).

The decision puts to rest the uncertainty surrounding the ability of a creditor to reach revocable trusts (so-called "living trusts") after the death of the settlor. And because the Illinois court's ruling concerns the intersection between a uniform statute and a common-law rule that "remains the law in the vast majority of states across the nation," it is likely to have strong persuasive force in many other jurisdictions that have not enacted asset protection trust legislation.

In 1994, Robert W. Sessions created the “Sessions Family Trust,” an irrevocable trust naming himself as beneficiary. Sessions was the trust protector, with the power to appoint or remove trustees and veto any of their discretionary actions. He also had the power to appoint or change beneficiaries, and the trust contained a spendthrift provision that protected trust assets from creditors of Sessions or his estate.

In 1995, Sessions made an irrevocable pledge of $1.5 million to Rush University Medical Center for the construction of a “Rush University Presidential Residence.” Sessions then executed codicils to his will and sent a letter to Rush agreeing that any balance on the pledge should be paid to Rush upon his death and that the pledge was binding upon his “estate, heirs, successors and assigns.”

Relying on Sessions’ pledge, Rush constructed the president’s house at a cost of more than $1.5 million. Rush named the house the “Robert W. Sessions House,” and Sessions attended the public dedication ceremony. But he did not make any payments toward the pledge during his lifetime.

In February 2005, Sessions was diagnosed with terminal lung cancer. He blamed Rush for not diagnosing him sooner. He executed a new will omitting the pledge. He also created a second trust and made several gifts to that trust, reducing the value of his estate.

After Sessions died, Rush filed a claim in probate to enforce the $1.5 million pledge. The court granted Rush summary judgment on its claim, but Sessions’ estate contained less than $100,000, so it could not satisfy the judgment. Rush then filed a supplemental action against the trustees of the Sessions Family Trust to recover the full pledge amount. Rush argued that it could reach trust assets because self-settled spendthrift trusts are void as to creditors under common law. The Illinois Attorney General intervened in support of Rush’s position.

The trial court granted Rush summary judgment on its supplemental claim. But the appellate court reversed, holding that the Uniform Fraudulent Transfer Act, which requires specific findings of debtor fraud, abrogated the common-law rule regarding self-settled trusts.

The Illinois Supreme Court unanimously reversed the appellate court’s ruling and affirmed the original judgment, finding that “the Uniform Fraudulent Transfer Act did not displace or abrogate the common law trust rule with respect to self-settled trusts” and that Rush “was a creditor of Sessions for the purposes of the common law rule.” The Supreme Court emphasized that common law is not abrogated unless it is expressly repealed by legislation, inconsistent with legislation, or modified by court decision.

The UFTA provides that a transfer is fraudulent as to a creditor (whether the creditor’s claim arose before or after the transfer was made) if the debtor made the transfer (a) with actual intent to defraud any creditor or (b) without receiving reasonably equivalent value in return under circumstances in which the debtor was not likely to be able to pay.

The common-law rule shares the Act’s purpose of protecting creditors, but “it addresses the specific situation where an interest is retained in a self-settled trust with a spendthrift provision. … [T]he rule is ‘applicable although the transfer is not a fraudulent conveyance … and it is immaterial that the settlor-beneficiary had no intention to defraud his creditors.’” The common-law rule “prevents the distinct injustice of allowing a person to use a trust as a vehicle to park his assets in a way that preserves his own ability to benefit from those assets, while keeping them outside the reach of his present and future creditors.” “If the law were otherwise,” the court explained, “‘it would make it possible for a person free from debt to place his property beyond the reach of creditors, and secure to himself a comfortable support during life, without regard to his subsequent business ventures, contracts, or losses.’”

Finding that the common-law rule focused on assets retained by the settlor, whereas the Fraudulent Transfer Act focused on assets transferred by the settlor, the Supreme Court determined that both laws protect creditors and that they are “supplementary, not contradictory.”

The court rejected an argument that the common-law rule did not apply because (a) Rush did not become a judgment creditor as to Sessions before he died and (b) a creditor cannot reach trust assets that “could have been, but were not, distributed to the settlor during his life.” A settlor’s interest in a self-settled trust “includes all income and principal thatcould have been distributed to the settlor, even when the trustee exercises complete discretion over such distributions.” And if the settlor’s interest is void as to his creditors, “there is no sound reason to treat the creditors’ rights as suddenly defeated the moment the settlor dies, thereby giving the commensurate economic benefit to the settlor’s heirs.”

The court recognized that the common-law rule would not apply “where assets contributed by the settlor are irrevocably deeded to the trust for the benefit of other beneficiaries, such as where income from the trust is payable to the settlor but principal may be distributed only to designated remaindermen after the settlor’s death, in which case the settlor’s ‘interest’ includes only the trust income, and the trust principal is not subject to claims by the settlor’s creditors.” The court also noted that some states, like Alaska and Delaware, have enacted statutes permitting asset protection trusts that would not be subject to the common-law rule.

The Sessions decision may also have implications for a surviving spouse’s claim to assets in a decedent’s living trust. For example, in Johnson v. LaGrange State Bank, 383 N.E.2d 185 (Ill. 1978), the court held that a spouse’s renunciation right — the statutory right to claim a share of the decedent’s assets even if the decedent did not provide for the spouse — did not extend to a decedent’s revocable trust. A surviving spouse could rely on Sessions to argue that Johnson and decisions like it are no longer good law, and that a decedent may not remove assets from the spouse’s reach by placing them into a living trust.

Rush University Medical Center v. Sessions, 2012 IL 112906 (Sept. 20, 2012).

© 2014 Schiff Hardin LLP

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