Trust Settlors, Beneficiaries, and Issues Regarding Creditors

Trust Settlors

A settlor is the person who creates or contributes property to a trust.  A settlor has the presumed right to revoke or amend a trust, unless the terms of the trust expressly provide that the trust is irrevocable.  There are, however, some limitations if there are multiple settlors, and the limitations are concerning community property versus separate property.  To the extent the trust holds community property, the trust may be revoked by either settlor as to his or her share of the community property, but the trust may only be amended by the joint action of both settlers with community property interests in the trust; and to the extent of separate property, each settlor may revoke or amend the trust as to the portion of such property he or she contributed to the trust.

In addition to the rights of a settlor regarding revocation and amendment, the Arizona Trust Code grants the settlor other rights including standing as one of the parties who can maintain a proceeding to enforce a charitable trust; the right to receive property that is in excess of that needed for the intended uses of an honorary trust; the right to maintain a proceeding to modify a charitable trust under the cy pres doctrine; while the trust is revocable, the right to be the only beneficiary to whom the trustee owes any duties; the right to receive notice of a trustee’s rejection of his or her appointment; the right to 30-days notice of a trustee’s resignation; if the settlor is also a trust beneficiary, the right to petition for a substitution of the trustee; while the trust is revocable or if the terms of the trust so provide, the right to direct the trustee, even if the direction is contrary to the terms of the trust; and the right to notice of the trustee’s proposed change in calculating the distributions from a total return trust.

Trust Beneficiaries 

The Arizona Trust Code’s definition of beneficiary is very broad.  In fact, it allows a person to be a trust beneficiary even if he or she is not currently living or ascertainable.  The beneficiaries may also be persons who obtain their interest in the trust indirectly, such as by intestate succession upon the death of a predecessor beneficiary, by another beneficiary’s assignment or disclaimer of their interest, or as an appointee of a power of appointment over trust property.  The Arizona Trust Code also defines a narrower category of beneficiaries called qualified beneficiaries, and the rights of beneficiaries differ from the rights of qualified beneficiaries.  In both cases, some rights are alterable by the trust instrument, and some are not.  Because a beneficiary is an interested person as defined by statute, he or she may enter into nonjudicial settlement agreements and invoke the court to intervene in the administration of a trust.

Issues Regarding Creditors 

While a spendthrift provision in a trust or discretionary distribution provision in a trust instrument provides general protection from creditors of a beneficiary, the same protection is not always provided to a settlor who is a beneficiary.  There is generally no creditor protection for the settlor of a self-settled trust in Arizona.  During the lifetime of a settlor, the property of a revocable trust is subject to the claims of the settlor’s creditors.  If a revocable trust has more than one settlor, then each of the settlor’s creditors may reach the portion of that settlor’s contribution to the trust.  It is important to note that these rules do not supersede the laws governing liabilities of a marital community; the liability of a married person and the reach of that person’s creditors is dependant upon the character of the debt and the property subject to creditor claims.

At the death of a settlor of a revocable trust, to the extent the settlor’s probate estate is not sufficient, the trust property is subject to the settlor’s creditor’s claims, costs to administer the settlor’s estate, the settlor’s funeral and burial expenses, and statutory allowances and exempt property rights of the settlor’s surviving spouse and children.  Generally, creditors of a decedent have two years from the decedent’s date of death to make a claim against the decedent’s probate estate for liabilities arising before the decedent’s death, which can be shortened to the later of four months after the publication of notice to creditors or sixty days after actual receipt of notice in the case of known creditors.  A creditor also has two years from the decedent’s death to make a claim against non-probate assets of the decedent, which would include revocable trust property.  The trustee may reduce the time period for claims against non-probate assets of the trust by publishing a notice to creditors and giving actual notice to known creditors as to the revocable trust in the same manner and with the same limitation periods as a probate estate.  Pursuant to statute, the beneficiary of a life insurance policy has priority to the proceeds over a creditor of the person effecting the insurance.

An important aspect of a trust is its potential to provide creditor protection to beneficiaries who are not settlors.  It’s important to note the Arizona Trust Code provides for a court to authorize a creditor or assignee of a beneficiary to reach his or her interest under a trust by attachment or other means in regard to present or future distributions to or for the benefit of the beneficiary.  However, this does not apply when a beneficiary’s interest is protected by a spendthrift provision or is a discretionary trust interest.  If a beneficiary’s interest is in fact protected by a spendthrift provision, a trustee has no liability to any creditor of a beneficiary for any distribution made to or for the beneficiary’s benefit.