UNDER New York’s Estates, Powers
and T rnsts Law “a disposition in trust
for the use of the creator is void as
against the existing or subsequent
creditors of the creator.”‘ The statute has .been
interpreted as denying a settlor protection from
creditors where the trust was settled for the
exdasive use of the seLtlor: It is not’ clear,
however, as co whetl1er creditors of a settler can
reach trust assets even if the trustees have
absolute discretion to pay nothing to the settlor,
and the settlor cannot compel the trustees to
make any payments.
Vanderbilt Credit Corp. v. Chase Manhattan
Bank, N.A.’ is most often pointed to as setting
forth the law in New York that creditors of a
settlor can reach trust assets to satisfy claims where
the trustees have discretion to make payments to
the settlor. 1 There the trust agreement provided
that the trustee must pay the settlor all of the net
income anJ mat portion of ilie tru,t principal a,
tl1e trustee, it1 the trustee’s discretion, deemed
appropriate. The trust agreement declared ilie trust
to be irrevocable and contained a standard
spend ilirift clause.•
In concluding that a creditor could reach that
portion of the trust account that constituted trust
income, the court applied tl1e general rule that “a
propert.y owner c~nnor. ur.ilize ~ spendt.hrifr rmsr.
to insulate his assets from the reach of present or
furore creditors,”‘ as codified in EPTL §7,3.1.
As to principal, the court noted tl1at tl1c scttlor
created a discretionary trust, giving the trustee
absolute discretion whether or not to pay principal
to the settler, but concluded tl1at “when a person
creates for his own benefit a discretionary trust, his
creditors can reach the maximum amount which
ilie trustee under the terms of the trust could pay to
him or apply to his benefit, even iliough ilie trustee
in the exercise of his discretion wishes to pay
nothing to the beneficiary or to his creditors, and
even though the beneficiary could not compel the
Jay H. Rubinstein is a principalw ith Withers
Bergman, resident in the firm’s Connecticut office.
Michael Ben-Jacob is an associate in the
fmn’s New York office.
trustee to pay him anything.”‘
The Vanderbildte cision strongly implies that its
holding with regard to a creditor’s ability to reach
the trust principal is simply a reiteration of
long-standing New York law. It is important to
note, however, that in support of its conclusion,
tl1e Vanderbilcto urt cites to a Massachusetts case, a
Connecticut case, ilie Second Restatement of
Trusts, Scott on Trusts, and notes tile contrast to
tl1e single case, Herzogv. Commissianeri,n1v olving
the application of New York law.
In Herzog 11. Commissioner, tl1e Second Circuit
applied New York law to determine whcilier
creditors could reach trust corpus ·held under a
trust agreement that provided that income be paid
to the senior and his wife at the discretion of the
trustee, and for the trust remainder to be paid to
tl1e settler’s issue after the death of the settlor and
his wife. The. setdor could not compel any
distributions from the trust.
TI1e court observed that, under New York law, a
beneficiary of a discretionary trust established by a
third parly caimol compel the trustee Lo exercise
the trustee’s discretion to make a distribution to
the beneficiary, and went on to conclude that:
“While here the trust was created by tl1e grantor,
tllere is no New York decision holding that the
rights of creditors would differ from iliose available
to them in a case where the trust is set up by a third
party if tile exercise of the power for [the settlor’s]
benefit is wholly dependent upon the discretion of
tl1e trustee” and, tllerefore, tl1e settlor’s creditors
could not reach the trust assets.’
It is interesting to note tl1at tl1e Herzog court
was not considering EPTL §7-3.l (which was
enacted 25 years later) or the common law upon
which EPTL §7-3.1 was based, but instead cited to
New York’s Real Property Law §157 and later
qualified its earlier statement by stating that “[t]he
most that can be said … is that the law of New
York respecting the right of [the settlor’s] creditors
to reach the income of tile trust is in doubt.”‘
Herzog is also unusual in that it ignores at least
one New York c~se th~t. should h~ve served ~s
precedent. In LibertyS torage& \Vareho11C5oe . u.
Van Wyck” tl1e trust agreement provided that
income be paid to the settler, that upon written
request the settlor could receive up to $5,000
annually from principal with the consent of tile
trustee, and that the settlor could exercise a
testamentary power of appointment over 25
percent of the trust corpus. Upon the settlor’s
death 75 percent of the trust assets would be paid
to named remaindermen but if the settlor lived
past Nov. 26, 1943, ilie settlor could revoke
the trust.
TI1e settler’s creditors maintained that under
the Personal Property law then in effect ( which is
currently embodied in EPTL §7,3.1) they could
Teach 25 percent of the trust corpus to satisfy their
claims. In denying the creditors’ claims, the court
explained that ilie Personal Property law was
intended to codify ilie common law that dated
·back to the mid-1800s, wl1id1 provided that only
conveyances in trust “wholly or primarily” for the
use of ilie settlor were void against creditors.11
Here the remaindermen had a vested
contingent interest in 75 percent of the trust and,
therefore, the.settlor’s interest was only .incidental
to the remaindermen’s interest and the settlor’s
creditors could not reach the trust corpus. Had the
court in Herzogc onsidered LibertyS toragei,t might
have concluded that since income and principal of
ilie trust created by the senior in Herzog was not
“wholly or primarily” intended to benefit the
settlor, it was already established under New York
law that tl1e settlor’s creditors could not reach the
trust assets.
Therefore, despite the Vanderbilt court’s
apparent contention to the comrary, the status of
New York law was unclear regarding the questlon
of wheilier a settlor’s creditors could reach trust
assets where tl1e trustees have discretion to use
trust assets for the benefit of tl1e settlor. The
Vanderbilt court’s conclusion has important
feJcni! estate anJ gift tax implicatioru;,.
FederaTl ransfeTr axI mpact
Section 2036 of the Internal Revenue Code
(Code) provides tllat the gross estate includes the
value of all property over which the decedent “has
retained for his life … the possession or enjoyment
of, or tile right to the income from, tl1e property, or
the right, either alone or in conjunction with any
person, to designate the persons who shall possess
or enjoy the properly or income t:herefrom.”
AdditionaHy, §2038 of the Code provides that tile
gross estate includes all property over which the
decedent retait1ed autllority “to alter, amend,
NEW YORK LAW JOURNAL
revoke, or terminate” an interest in the property.
Taken together, §§2036 and 2038 stand for the
proposition that property tnmsfem:J to a trust is
includiblc in the setdor’s estate if the settlor retains
excessive rights or powers with respect to the
transferred property.
The Internal Revenue Service (Service) has
considered whether a settlor’s transfer of
property to a discretionary trust constitutes a
completed gift for gift tax purposes if the
transferred property remained subject to the
claims of the settlor’s creditors.
In Revenue Ruling 76-103 the Service held that
a transfer did not constitute a completed gift under
§2511 as long as the trust property remained
subject-to the claims of creditors under state law.
However, the Service noted that “[i]f and when the
grantor’s dominion and control of the trust assets
ceases, such as by the trustee’s decision to move the
situs of the trust to a State where the grantor’s
creditors cannot reach the trust assets, then the gift
is complete for Federal gift tax purposes …. ”
The ruling went on to state chat “if the grantor
dies before the gift becomes complete, the date of
death value of the trust corpus will be includible in
d1e grantor’s gross estate, for Federal estate tax
purposes, under section 2038 of the Code because
of the grantor’s retained power to, in effect,
tenninate che trust by relegating the grantor’s
creditors to d1e entire property of d1e trust.” Thus,
under me rationale of Revenue Ruling 76-103, if
the creditors of the settlor of a trust have the
power to satisfy judgments against ilie settlor out
of trust corpus, d1e initial transfer of ilie property
to the trust will not be subject to gift tax and
the trust assets will be includible in ilie settlor’s
gross estate,” likely under born §§2036 and 2038
of me Code.”
A. The Service’s Interpretation of New York
Law Prior to 1984, As noted above, in Herzog the
Service was successful in asserting its position mat
the initial gift to the crust was complete for gift
tax purposes and gift tax was due on all of the
property transferred to the trust. In Revenue
Ruling 77-37 8 we see that, in keeping witl1
Herzog, prior to 1984 the Service had taken tl1e
position that under New York law a transfer of
property to an irrevocable trust, under the terms of
which the trustee has cliscret.ionary power t.o
distribute income and principal to me settlor,
constitutes a completed taxable gift of me entire
va luc of the property transferred. This of course
results in gift tax upon the funding of the trust but
no estate tax upon the death of the settler.
Similarly in the estate tax context, where a trust
agreement provided mat the trustees had complete
discretion to pay or apply part or all of the
principal and net income of a trust for me support
and benefit of me descendants of the settlor’s
mother ( including the settlor), d1e Service has
concluded that the trust corpus is not includible in
the settlor’s estate under §2036 of the Oxle.”
Finally, in Technical Advice Memorandum
8213004, which addressed both the gift and estate
tax, the Service concluded, based on Herzog, that
under New York law, where a trustee had discretion
to pay income to the settlor an