The opinion in Livesay v. Carolina First Bank, COA07-1578, filed on August 19, 2008 in the North Carolina Court of Appeals affirms that when a settlor dies after conveying assets to a trust that was revocable at the settlor's death, those assets are subject to the claims of creditors and available to the Personal Representative for the satisfaction of the claims of “the settlor's creditors, costs of administration of the settlor's estate, the expenses of the settlor's funeral and disposal of remains, and statutory allowances to a surviving spouse and children to the extent that the settlor's probate estate is inadequate to satisfy those claims, costs, expenses, and allowances, unless barred by applicable law.”
In this declaratory action, the plaintiff, individually and as the successor trustee of the trust and in her capacity as the guardian ad litem for the minor beneficiaries, appealed the trial court's grant of partial summary judgment in favor of the defendants which included the Administrator CTA of the estate of the decedent settlor. In 1998, the plaintiff and the decedent created the trust for the benefit of the settlors and their children with the decedent as the initial trustee. The settlors enjoyed the usual benefits of such trusts during their joint lives pursuant to the trust instrument. Any contributions to the trust corpus were to retain their original character in the event of a revocation. Upon the death of either settlor, the trust was to inure to the benefit of the surviving settlor and to the settlors' children for their “health, education, and welfare.” Upon the death of the surviving settlor, the trust was to continue for the benefit of the settlors' children, with no principal distributions allowed until they attained twenty-five years of age.
The plaintiff filed a declaratory judgment action seeking a declaration that the trust assets were not subject to the debts of decedent's estate. Ultimately, an order for partial summary judgment was granted for the defendants and the plaintiff appealed. There are several contentions by the plaintiff that the Court did not find persuasive. In the interest of space limitations, we will only address a few of the most pertinent.
N.C.G.S. Section 36C-5-505(a)(3) of the North Carolina Uniform Trust Code was enacted in 2005, became effective on 1 January 2006, and applies to all trusts created before or after that date subject to exceptions in the section and makes the assets of a revocable trust subject to the claims of the estates creditors and administration if the estate has insufficient assets. The plaintiff contended that the section did not apply, but rather that Section 36A-115 of the Uniform Trust Act (which was repealed by the adoption of the NCUTC) applied. That Section of the former statute provided that “all estates or interests of trust beneficiaries are alienable either voluntarily or involuntarily to the same extent as are legal estates or interests of a similar nature[,]” except for (1) discretionary trusts, (2) support trusts, or (3) protective trusts. The plaintiff contended the limiting provisions of the trust agreement made the assets subject to those exclusions. Also, as the trust became irrevocable upon decedent's death the plaintiff argued that the exceptions made the trust inalienable after death. The Court pointed out that “this argument ignores the fact that up until the moment of his death, decedent possessed the power to enjoy (1) the right to distributions of income, (2) the right to distributions of principal, (3) the right to revoke the trust in whole or in part, and (4) the right to alter or amend the trust.”
Court analogized this latter argument with the rule under the Internal
Revenue Code that provides that the value of the gross estate includes the
value of all property over which the settlor retains such power. The Court
determined also that the trust in question did not meet the test of Chapter
36Afor exclusion and that Section 36A-115 could not apply. Further the Court
determined that the exceptions in the applicability provisions of the NCUTC
did not pertain and furthermore, since the “2007 official comment to
section 36C-5-505 clarifies that “[s]ubsection (a) is generally consistent
with North Carolina case law with respect to the ability of a creditor to
reach the property in a trust for the benefit of the settlor.” N.C. Gen.
Stat. § 36C- 5-505 am. cmt. (2007) (citing Pilkington
v. West, 246 N.C. 575, 580, 99 S.E.2d 798, 802 (1957)). As the statute
is consistent with case law, we cannot say the trial court erred in finding
it applicable to plaintiff's case.”
An unanswered question resulting from the limited facts and discussion in this opinion is what would have been the outcome of an attempt to recover trust property obtained as the result of a conveyance to the trustees of property held by the settlors as tenants by the entireties. It is an exceedingly common occurrence in North Carolina and elsewhere for couples to employ inter vivos revocable trusts as an estate planning tool. The Court in this opinion noted that the official comments to Section 36C-5-505 recognize that a revocable trust is usually employed as a will substitute. Thus, in the vast majority of instances of the use of revocable trust agreements, there is no effort to defraud creditors, but rather, plain-old-fashioned financial planning.
As practical matter, when the Personal Representative takes control of any trust corpus for the satisfaction of the decedent settlor’s debts, the action can be said to effect a revocation of the trust or a voiding of the transfer to the trustee. The opinion rules that the property subject to the trust agreement was available to the decedent until the moment of his death and is thus available to his creditors for satisfaction of such debts. It is as if the court is voiding the transfer and putting the property back in his hands a moment before death.
In this opinion the Court of Appeals also noted that the original trust agreement provided that “contributions to the trust assets were to retain their original character such that in the event of revocation, no rights existing prior to contribution would be diminished.” It can be argued that under the express terms of this agreement the property should retain its character as entireties property and pass to the spouse free of the claims of creditors unless it can be shown that the transfer was done solely for the purpose of defrauding creditors. Any other result would likely have catastrophic, unintended, and inequitable consequences where a couple conveys entireties property in trust pursuant to an ordinary estate planning trust agreement long before circumstances such as those in this case might arise.
Where does this leave the practitioner? One has to be alert when dealing with a transfer out of a revocable trust as to whether the trust settlor has an open estate administration or has died within the preceding two years. In the instance of an open estate, a review of the estate file will be required and the proposed transfer treated as one by the heirs which at a minimum will require publication to have begun and joinder of the Personal Representative. In the instance of an unadministered estate within two years of death, consideration will have to be made as to the need for an administration to cut off potential claims of creditors. In either case, if title insurance is involved, consultation with underwriting counsel is a must. If the estate is properly administered and closed, or if the settlor died more than two years prior to the proposed conveyance, there should be no remaining remedy for any supposed creditors.