Spendthrift Provision Saves Beneficiaries from Their Folly

(Note:  On August 8, 2012, the Iowa Court of Appeals revised their earlier opinion regarding the amount of the inheritance tax reimbursement. The earlier opinion was vacated and the August 8, 2012 opinion replaces it.) 

Spendthrift clauses are valid in Iowa and are created when language within a trust document imposes a valid restraint on 
transfer of the beneficiary’s interest. These clauses are sufficient to restrain voluntary and involuntary transfers, assignments, or encumbrances of the beneficiary’s interest and protect the trust assets from creditors before asset distribution. The clause can also prohibit any transfer of a right to future payments or prohibit creditors from collecting future trust payments. 

The power of a spendthrift provision was challenged in a recent case.

At the death of a farmer, a trust was established with the farmer’s undivided one-half interest in 210 acres of farmland. His wife was given a life estate in the trust and the couple’s six nieces and nephews received equal shares of the remainder. The couple’s long-term tenant was named co-trustee with the wife. The trust provided for quarterly payments to be made to the wife and other disbursements as necessary. The trust also contained a spendthrift clause, which stated the following:
No interest, under this Article, shall be transferable, assignable, or become subject to any encumbrances by any beneficiary, nor shall such interest be subject to the claims of any creditors of any beneficiary prior to the actual distribution by the Trustees to the beneficiary

The wife was not pleased with the fact that limitations were placed on the property by the trust. She convinced the estate’s attorney to send letters to each of the six remainder beneficiaries. The letter advised the relatives that the present value of their portion of land was worth $12,471 and that inheritance tax due from each of them was about 10% of the value. The letter asked each of the relatives to quitclaim their interest to the wife in exchange for her payment of their portion of the inheritance taxes. The letter did advise the relatives to seek legal counsel, but neglected to tell them they could defer payment of the taxes until the wife’s death.

None of the relatives sought legal counsel or obtained a copy of the husband’s will. They had little understanding of what they had inherited or the value. Five of the six relatives quitclaimed their interest back to the wife despite the only consideration being the payment of the inheritance taxes. The co-trustee was unaware of the transfers and never read the terms of the trust in the farmer’s will. 

The wife died in 2009. She left all of the farmland to the tenant/co-trustee, including the five shares of the trust assets she received. The value of the farmland had appreciated significantly and was now worth $789,000. The six nieces and nephews received little from the wife’s estate. At that time, they obtained a copy of the farmer’s will (and presumably legal counsel) and filed a petition to set aside the transfers made to the wife as void under the spendthrift clause in the farmer’s will. 

A motion for summary judgment was filed, and the trial court agreed on summary judgment that the transfers violated the spendthrift clause because the beneficiaries’ interests were transferred before distribution of the trust asset. The court also held that the tenant had breached his fiduciary duty as co-trustee. The court, however, determined a fact question existed as to whether the tenant could rely on the doctrine of laches as a defense to the suit. The case proceeded to trial.

After trial, the court determined the beneficiary’s interest in the trust property had vested upon the death of the wife and the quitclaim deeds executed eighteen years earlier were subject to the after-acquired property doctrine. The doctrine enables title to property acquired after the owner attempts to sell or transfer the title to another person before actually having legal title. In this case, the transfer to the wife before her death was made before the beneficiaries had legal title, but once the wife died and the beneficiaries were to receive the trust assets, the previous transfer of title would become valid and the wife’s estate would own title to the property.

The court reasoned that the relatives could have voided the transfer during the wife’s lifetime for violation of the spendthrift provision, but this right terminated upon the wife’s death. Because of this, the court would not void the transfers. The court also held the doctrine of laches was a defense against the claims that the tenant breached his fiduciary duty as co-trustee. The relatives filed a motion to amend, which was denied, and then an appeal.

On appeal, all parties agreed a spendthrift provision existed in the will. The court held that the provision “clearly and unequivocally” prohibited the relatives’ transfer of their remainder interests. Therefore, the transfers were invalid. The court also held that the statute of limitations for challenging the conveyances had not expired because the claim did not accrue until the wife died and only one year had passed, so the claim to set aside the transfers was valid. Because the conveyances were invalid and the action was timely filed, the court held that the relatives were entitled to their remainder interests in the assets of the trust. The court remanded the case to the trial court to distribute the assets and to determine the amount of and reimburse the tenant for his payment of inheritance taxes on the beneficiaries’ portion of the farmland. In re Estate of Hord, No. 1-1004/11-0935, 2012 Iowa App. LEXIS 616 (Iowa Ct. App. Aug. 8, 2012).