How to Protect Your Beneficiaries from Their Creditors

By John O’Grady, O’Grady Law Group

When creating trusts, estate planning lawyers use tricks of the trade such as “spendthrift” and “shutdown” clauses to protect trust money from claims of the creditors of beneficiaries. But on appeal, the court showed Cynthia Vedder that there are exceptions to most every rule. Vedder’s grandparents left her a trust containing spendthrift and shutdown clauses. After her divorce from David Pratt, he filed a petition to enforce his judgments against Vedder for wrongfully-taken community property funds and unpaid child support. Her ex-husband insisted that the money be drawn from the trust’s principal and income, but the court shut him down, citing the shutdown clause. A court of appeals later reversed that decision, clarifying that the shutdown clause only protects trust funds from discretionary payments of income or principal: mandatory principal distributions (such as past-due child support bills) are fair game.

When creating trusts, it’s perfectly legal and ethically valid to protect your hard-earned money from your beneficiaries’ creditors. The shutdown clause and other such tools can be very useful in this regard, even though they have their limits. Consult your estate planning lawyer about how to best deploy these types of protective provisions in your estate documents. Pratt v. Ferguson, CA 4th, A238435, (2016).

John O’Grady leads a full service estate and trust law firm in San Francisco.  He served as the 2012 chair of BASF’s Estate Planning, Trust & Probate Section. His practice includes Estate Planning & Administration, Probate & Trust Litigation, Collaborative Practice, Mediation, Conflict Coaching, Elder Law & Taxation.