Equitable Distribution and Irrevocable Trusts: The Material Purpose Doctrine
© 2005 National Legal Research Group, Inc.
As a general rule, the law of equitable distribution applies only to property which is owned by one or both spouses. Regardless of whether a particular state recognizes the concept of separate or nonmarital property, assets which are owned by a third party cannot be divided upon divorce. "The kinds of property subject to division, as set out in the statute, all share a common characteristic: they are owned by the parties, either jointly or separately." Elkins v. Elkins, 763 N.E.2d 482, 486 (Ind. Ct. App. 2002). See generally Brett R. Turner, Equitable Distribution of Property 5.07 (2d ed. 1994 & Supp. 2004).
The rule against the division of third-party property applies not only to property owned by individual persons, but also to property owned by legally independent entities. Thus, the court cannot divide assets owned by a corporation or partnership. E.g., Chen v. Li, 986 S.W.2d 927 (Mo. Ct. App. 1999) (corporation); In re Marriage of Werries, 247 Ill. App. 3d 639, 616 N.E.2d 1379 (1993) (partnership). But cf. Coleberd v. Coleberd, 933 S.W.2d 863 (Mo. Ct. App. 1996) (partnership is not an independent entity under unique Missouri partnership statutes).
Likewise, the court cannot divide assets owned by an irrevocable trust. See McGinn v. McGinn, 273 Ga. 292, 540 S.E.2d 604 (2001); Findlen v. Findlen, 695 A.2d 1216 (Me. 1997); Mikhail v. Mikhail, 124 Ohio Misc. 2d 5, 791 N.E.2d 468 (C.P. 2003); In re Marriage of Jones, 159 Or. App. 377, 981 P.2d 338 (1999); Endrody v. Endrody, 914 P.2d 1166 (Utah Ct. App. 1996). The court can, of course, divide any interest owned by the parties in the trust itself. E.g., Heinrich v. Heinrich, 609 So. 2d 94 (Fla. Dist. Ct. App. 1992). But cf., e.g., Williams v. Massa, 431 Mass. 619, 728 N.E.2d 932, 940-41 (2000) (remainder interest cannot be divided if it is unduly speculative; suggesting that most contingent remainders may be unduly speculative).
The assets of revocable trusts can be treated as marital property, however, as the power to revoke the trust is equivalent to ownership. E.g., In re Marriage of Seewald, 22 P.3d 580 (Colo. Ct. App. 2001); Wortman v. Wortman, 308 A.D.2d 486, 764 N.Y.S.2d 282 (2003); Dorn v. Heritage Trust Co., 24 P.3d 886 (Okla. Civ. App. 2001).
There are three major exceptions to the rule against the division of third-party property. The first exception allows the court to divide such property if one or both spouses own an equitable interest in it, even if legal title remains with the third party. E.g., Upchurch v. Upchurch, 122 N.C. App. 172, 468 S.E.2d 61 (1996) (resulting and constructive trust).
The second exception allows the court to divide the property that was formally owned by the parties, and the conveyance transferring the property away is invalid. The most common application is when the court rescinds a fraudulent conveyance made for the purpose of depriving the innocent spouse of marital property rights. E.g., Firmani v. Firmani, 332 N.J. Super. 118, 752 A.2d 854 (App. Div. 2000); Buchanan v. Buchanan, 266 Va. 207, 585 S.E.2d 533 (2003).
The third major exception allows the court to divide the value of the asset if it was dissipated by one spouse in anticipation of divorce, even if the conveyance itself remains valid. E.g., Breitenstine v. Breitenstine, 62 P.3d 587, 592-93 (Wyo. 2003) (ordering husband to pay wife her share of assets held in irrevocable offshore asset protection trust, but not directly revoking the trust itself). See generally Turner, supra, 6.30.
In re Marriage of Epperson: Facts
A recent Montana case contains a very interesting application of the second major exception to the rule against the division of third-party property. The case is In re Marriage of Epperson, 2005 MT 46, 2005 WL 419605 (Mont. 2005).
The parties in Epperson were married in 1975. During the course of a marriage which lasted for almost 30 years, they had seven children. Four of the seven were emancipated at the time of divorce.
In 1999, the husband and the wife executed parallel irrevocable trusts. The purpose of the trusts was to pass their property to the children in a manner which minimized estate and gift taxes. Both spouses were named as trustees of the trust. The property conveyed into the trusts included the marital home, the land upon which it was built, and all personal property owned by the parties, including the tools which the husband used in his business. The beneficiaries of the trusts were the seven children. "Both trusts contained a 'purpose' provision which stated: 'The grantors established this trust for their family, consisting of the persons identified below, because they have contributed substantially and materially to the process of acquiring the property and are, therefore, the equitable owners thereof.'" 2005 WL 419605, at *1, 10.
The wife filed for divorce in 2002. Because her relationship with all seven children was generally positive and the husband's relationship was generally negative, she argued that the assets held in the irrevocable trusts were not divisible upon divorce, and that the parties accordingly had very little property. The husband argued that the court should terminate the trusts. The trial court agreed with the husband, terminated the trusts, and divided the trust assets. The wife appealed to the Montana Supreme Court.
In re Marriage of Epperson: Holding
Montana follows the general rule that assets owned by irrevocable trusts are property of the trust, while assets owned by a revocable trust are property of the parties. In re Marriage of Malquist, 227 Mont. 413, 739 P.2d 482 (1987). Since the trusts at issue in Epperson were irrevocable, their assets were generally not divisible property.
But this conclusion held true only as long as the trusts themselves stood intact. The second exception to the general rule against the division of third-party property recognizes that the conveyance into the trust itself can be attacked. Along similar lines, if sufficient reason can be found under the law of property to terminate the third party's ownership interest after the conveyance, the property may revert back to the parties.
On the facts of Epperson, while the trusts at issue were initially irrevocable, the divisibility of the trust assets depended upon whether the trusts were irrevocable at the time of divorce. If a sufficient reason could be found to revoke the trusts in the divorce case, the trusts could be revoked, and the trust assets could be divided.
In seeking to terminate the trusts, the husband relied upon a specific Montana statute allowing the court to order termination. The statute provides:
(1) Except as provided in subsection (2), if all beneficiaries of an irrevocable trust consent, they may compel modification or termination of the trust upon petition to the court.
(2) If the continuance of the trust is necessary to carry out a material purpose of the trust, the trust cannot be modified or terminated unless the court, in its discretion, determines that the reason for doing so under the circumstances outweighs the interest in accomplishing a material purpose of the trust. Under this section the court does not have discretion to permit termination of a trust that is subject to a valid restraint on transfer of the beneficiary's interest as provided in part 3.
Mont. Code Ann. 72-33-406 (Westlaw 2005). The husband argued, and the Epperson court held, that the court can apply its power to terminate an irrevocable trust under the above statute in the context of divorce proceedings. The official comment to this statute notes that it is based upon a similar California provision and upon Restatement (Second) of Trusts 337 (1957), so its language is obviously not unique.
The question then became whether the requirements of the statute were met. Under the first prong, the court may terminate a trust upon the consent of all beneficiaries. That provision did not apply in Epperson, because the children did not consent. "In the case before us, the beneficiaries did not unanimously request or consent to terminating the Trusts; rather, those beneficiaries who testified strongly opposed such termination." Epperson, 2005 WL 419605, at *3, 21.
Under the second prong, the court may terminate a trust if "the reason for doing so under the circumstances outweighs the interest in accomplishing a material purpose of the trust." Mont. Code Ann. 72-33-406(2). The first step in applying this language is to determine the material purpose of the trust. The wife argued that the purpose was to compensate the children for their active efforts working on the property. As noted in Epperson, above, that was the purpose stated in the trust documents. Nevertheless, the trial court held that the stated purpose was not consistent with the facts:
Based on the evidence presented throughout this proceeding, the court concluded that the true purpose of the Trusts was to avoid probate and inheritance taxes, as opposed to "rewarding the children for their work around the homestead." While recognizing the contribution of the children to the development of the property, the court observed that the labor was typical of that expected of rural children. The court further noted that, contrary to the Trust terms, the children contributed neither labor nor money to the acquisition of the property to the extent that they were "equitable owners."
2005 WL 419605, at *4, 24. The trial court therefore accepted the husband's position that "the dual 'family' purposes of the Trusts were to pass on the family property to the children upon his and Yvonne's deaths, and to use the Trusts as estate planning tools allowing the beneficiaries to avoid probate and inheritance taxes." Id. at *3, 20. Citing the discretion of the trial court to resolve issues of fact involving the credibility of witnesses, the Montana Supreme Court affirmed the trial court finding as to the purpose for the trusts.
After identifying the material purpose of the trusts, the court then had to determine whether the reasons for termination outweighed the interests in favor of accomplishing the trusts' purpose. The reasons for termination were strong, for "without the assets contained in the Trusts, there were 'very few assets in the marital estate.'" Id. Given the very strained relationship between the husband and all of the children, there was good reason to suspect that the husband would not benefit from any property owned by the children, so that allowing the trusts to stand would essentially leave the husband with a very small share of the marital estate. The strained relationship was not the fault of the husband on the facts; indeed, the husband received custody of the three minor children. "Noting that Yvonne displayed an extremely inflexible and judgmental demeanor and attitude, the court found that it had 'infinitely more confidence that Robert will promote a healthy, respectful relationship between the children and their mother than it has in Yvonne's willingness or ability to do the same if the children were placed in her primary custody.'" Id. at *5, 32. "The court determined that if the children remained with Yvonne, their home-schooling might not provide them with an adequate educational basis to pursue college should they choose to do so. There is little doubt that the court was influenced by Robert's testimony that he would allow the children to go to school." Id. at *6, 33. Because the husband was not responsible for the strained relationship between himself and the children, it would not be fair to award the husband little or none of the marital property a result which would occur if the trusts were continued.
By contrast, the remaining interest in achieving the purpose of the trusts was small. The trial court agreed with the husband's argument that "given the hostile circumstances in which the family found itself, [the trusts'] 'family' purposes ceased to exist and the Trusts were no longer viable." Id. at *3, 20. It "determined that the purpose of the Trusts was defeated by the disintegration of the family and that it was 'unreasonable to continue the Trusts to the extreme detriment of one or both of the trustees.'" Id. The Montana Supreme Court affirmed these conclusions:
Given the issues presented to him, Judge Prezeau was obligated to determine whether continuation of the Trusts would defeat or substantially impair the accomplishment of the purposes of the Trusts. Section 72-33- 413(1), MCA. He determined, based upon the serious disintegration of this family, Robert's estrangement from the family, and the possibility that both Robert and Yvonne could experience "extreme detriment" if the assets of the Trusts were not distributed as marital property, that the "family purpose" of the Trusts was defeated. Based upon the record before us, we cannot conclude that the District Court either incorrectly interpreted or applied the statute. To the contrary, the court carefully analyzed the evidence presented in light of the statutory directives. We therefore affirm the District Court's decision to terminate the Trusts.
Id. at *5, 27.
To the author's knowledge, Epperson is the first equitable distribution case to apply a provision in the law of trusts permitting termination of a trust when the harm caused by enforcing it is greater than the benefit of accomplishing its purpose. The rule appears to function as the trust law equivalent of piercing the corporate veil, allowing the court to ignore the independent legal status of the trust or indeed to terminate the trust itself where extraordinary facts so require. Since the court can clearly pierce the corporate veil in a divorce case, e.g., Medlock v. Medlock, 263 Neb. 666, 642 N.W.2d 113 (2002), it seems logical that a divorce court should have power to apply a conceptually similar remedy to an irrevocable trust.
Indeed, there are factual similarities between Medlock and Epperson. In Medlock, most of the marital assets were titled in the name of the husband's shell corporation. If the corporate form were respected, the wife would have received a nominal award of stock, but no share of such traditional marital assets as a home or retirement benefits. Since the corporation did not operate a traditional business, and had little real corporate income to distribute, it is doubtful whether the wife's stock would have had much real value. Just as Medlock pierced the corporate veil to avoid injustice resulting from a decision to title most marital assets in the name of a corporation, Epperson applied the material purpose doctrine of trust law to avoid injustice caused by a decision to title most marital assets in the name of irrevocable trusts.
Note that future cases need not necessarily go as far as Epperson and actually terminate the trusts at issue. The statute quoted in Epperson gives the court authority to terminate or modify the trust. Future cases could arise in which equity demands modification and not termination. For example, if the children had invested more substantial efforts in the property, but the value of their equitable ownership interests was still much less than the value of the property, the court might be able to modify the trusts so that only a portion of it is terminated.
Finally, it is essential to note that the material purpose doctrine, like the court's power to pierce the corporate veil, is an extraordinary remedy intended for use only in extraordinary cases. The trusts at issue in Epperson contained most of the marital property; the children were unusually hostile to the father; and the mother was responsible for that hostility. Equally importantly, the mother was raising the children with a limited education and keeping them significantly isolated from society. The father's apparent willingness to change this pattern, at least to some extent, made him a sympathetic figure and highlighted the injustice of giving the wife effective possession of most of the marital property. In future cases with less extreme facts, the material purpose doctrine is likely to be employed cautiously. The great majority of irrevocable trusts involved in divorce cases will therefore continue to be valid.