What can make a trust vulnerable to litigation?

On Behalf of | May 8, 2023 | Estate Planning

California is one of the most litigious states in the nation, and the United States is the most litigious country in the world. It is not surprising, then, that many California residents place their assets into trusts to protect them from lawsuits, but this strategy can come up short if the wrong kind of trust is chosen or the trust is created after a lawsuit has been filed or damages have been awarded.

Revocable and irrevocable trusts

Revocable trusts are popular because they allow the settlor, which is the term used to describe the party that creates a trust, to make changes and add or remove beneficiaries. However, they are not great tools for asset protection because that flexibility works both ways. If a creditor sues a settlor over an unpaid debt, the judge could declare them a beneficiary. Settlors and beneficiaries cannot make changes to irrevocable trusts, but neither can creditors like lawsuit plaintiffs that have been awarded damages. This is why irrevocable trusts are the preferred choice for protecting assets. When drafting these trusts, it is a good idea to include a spendthrift clause to protect against estate litigation.

Fraudulent conveyance

Even a properly drafted irrevocable trust may not be enough to protect assets if it is created too late. Transferring assets into a trust to keep them out of the hands of creditors is considered fraudulent conveyance, which can lead to both civil and criminal penalties in California. Setting up a trust to protect assets after a lawsuit has been brought but before damages have been awarded would still be considered fraudulent conveyance, so trust paperwork should be drafted long before lawsuits are filed or debts are incurred.

Robust asset protection

Trusts can provide robust asset protection, but only if the appropriate kind of trust is drafted at the right time. Irrevocable trusts are inflexible, but that is what makes them good choices for asset protection. For the most protection possible, irrevocable trusts should include a spendthrift clause. However, irrevocable trusts should be created before lawsuits are filed. If they are not, the settlor could face civil or criminal penalties for fraudulent conveyance.