Article on The Trustee and the Spendthrift

Philip J. Ruce recently published his article entitled The Trustee and the Spendthrift: The Argument Against Small Trust Termination, 48 Gonz. L. Rev. 163 (2012/2013). The introduction to the article is below: 

In the latter half of the Nineteenth Century, a mother transferred her estate, in trust, to her children in separate shares. One child, having failed at a business venture, declared bankruptcy and proposed to his creditors that he make a general assignment of all his property to them, which was understood to include the assets of his respective trust.  Unbeknownst to the creditors, the trust document contained a provision stating that if the son "should alienate or dispose of the income to which [he is] entitled ... or if, by reason of bankruptcy or insolvency, ... [the] income could no longer be personally enjoyed by [him]," his interest in the trust would cease to exist.

The trustee remained true to the language of the document.  Left holding the bag, the creditors took the predictable course and sued.  The court ruled that the insolvency of the son "terminated all his legal vested right in [the] estate, and left nothing in him which could go to his creditors, or to his assignees in bankruptcy";  the creditors, in short, were out of luck. This case, Nichols v. Eaton, demonstrated the first enforcement of a spendthrift trust provision in the American courts and was a significant departure from the English common law rules that favored creditors. 

A spendthrift trust prohibits, either by its terms or by operation of law, both voluntary and involuntary alienation of a beneficiary's interests. Through the establishment of a spendthrift trust, the continuous flow of funds to the beneficiary theoretically "cannot be diverted by ... attachment or assignment of ... income."  So:

if A transfers to B, as trustee, $ 100,000 in bonds to hold in trust for X, with a provision that B shall pay to X the net income of such bonds, but that X shall not have the power to transfer his right to receive such income, and that the creditors of X shall not have the power to reach the right to future income in the hands of the trustee, the trust is a spendthrift trust. 
 
The purpose of a spendthrift trust is to protect a beneficiary, often when a beneficiary is not capable of managing his own affairs. As Professor Bogert's treatise states:

A settlor may consider such a trust desirable, where provision is to be made for an inexperienced, incompetent or wasteful person. If such person had the power to dispose of his right to receive the income from the trust, his incapacity or carelessness would lead him to anticipate his income and convey to money lenders and creditors the right to receive future income as it became due. If the incompetent or spendthrift can be restricted so that he can do nothing with the income until it is paid into his hands by the trustee, then the beneficiary is more likely to be protected, as least to some extent, against want. 
 
Note that a spendthrift beneficiary does not have to be "incompetent or subnormal in any way" - the beneficiary is in most cases a perfectly normal, healthy person with responsible money management skills.  A settlor may simply be watching out for the beneficiary's interests, and spendthrift clauses are found in carefully drafted trusts everywhere in the United States. 

Spendthrift trusts run into a conflict with another aspect of trusts, one that is both practical and central to corporate trustee services: efficiency. Corporate trustees must, of course, turn a profit in exchange for the investment and fiduciary services they provide. As a trust is administered over time, a trustee is very likely sending money - whether it be income checks, fixed monthly payments, or discretionary principal - to a beneficiary. Additionally, the trustee is charging its own corporate trustee fee, as well as paying any additional expenses for tax preparation, counsel, and taxes due. At some point, a trust will invariably deplete, and the balance will become very small. A corporate trustee then must perform a balancing act and determine at which point a trust is too small to justify charging a fee to manage the assets. If no fee is being charged, then the corporate trustee is providing its valuable services for free - not something any business person would likely view as an effective method of revenue management. On the other hand, allowing any windfall, even a small one, to fall into the hands of a spendthrift could be a problem for one unable to manage his own affairs.

At which point should a corporate trustee close a small trust for being uneconomical? This article will first discuss the history and development of spendthrift trusts, particularly in the Uniform Trust Code (U.T.C.). This article will then examine the controversy regarding spendthrift provisions, highlighting the desires and efforts of creditors to access spendthrift trust assets.  Next, this article analyzes the reasons for the development of small trust termination rules. Most notably among these are the demise of the rule against perpetuities (hereinafter "Rule") and two of the key legal doctrines used by courts in modifying and terminating trusts in light of the erosion of the Rule: the Claflin Doctrine and the Equitable Deviation Doctrine. The information found within these and other sources leads to this article's conclusion: when contemplating the closure of small trusts with spendthrift provisions, absent direct instruction from the settlor, a trustee should opt to administer a spendthrift trust until it depletes to a zero balance.