The U.S. Court of Appeals for the Sixth Circuit recently affirmed a trial court's ruling that, at least under Michigan law, a lender could recover against a living trust that guaranteed a loan from the property held by the trust.
A copy of the opinion is available at: Link to Opinion
A closely-held company obtained a loan of almost a half-billion dollars from a group of banks. The company's principal agreed to guaranty the loan, both individually and on behalf of his living trust.
The borrower defaulted and the lender sued the principal individually and the trust. The trial court found that the principal's liability was limited to $50 million, but not the trust's, and entered judgment for the lender.
The principal paid the lender the $50 million he owed, but the trust paid nothing toward its obligation, which totaled over $750 million. The trial court held that the lender "could recover that money from the property held by the Trust and certified its decision as final under Rule 54(b)."
The principal and the trust appealed.
On appeal, the Sixth Circuit explained that "the question here is whether a creditor can recover against a trust from the property held by the trust." The court found that the answer was "yes" under Michigan law "as well as hornbook trust law … because trusts can enter into contracts no different than anyone else. And when they do, they honor those obligations — sometimes voluntarily, sometimes not—through the trust property."
The Court then reviewed the "black letter" law of trusts, starting with the fundamental features of a trust such as "the separation of legal and equitable title" and that a trustee holds legal title, manages the trust property, and has the power to enter into contracts on behalf of the trust, while the beneficiary holds equitable title or "the right to benefit from the trust property."
The Sixth Circuit further explained that when a trustee enters into a contract, "he doesn't act with impunity. (Otherwise, why would anyone make an agreement with a trust?) Rather, he makes the trust liable on the contract."
When a trust refuses to honor its contractual obligations from trust property, "creditors can sue to recover from the trust property—just like any other contract. … So although the terminology may seem complicated the takeaway is quite simple: a party who has a contract with a trust can recover from the property held by the trust."
The Court rejected the principal's argument "that he 'owns' the trust property because he can revoke the Trust at any time [and] [t]hus, … [the lender] can't take the property to satisfy the Trust's obligation" by explaining that "it doesn't matter who 'owns' the trust property (at least as trust law uses that term). After all, trusts usually don't 'own' property. … So if ownership mattered, creditors of a trust—revocable or not—could almost never recover from the trust property. And that would surely surprise the many authorities who have written to the contrary."
The Sixth Circuit reasoned that it also does not matter that the principal "pays taxes on the trust property or that revocable trusts have been described as 'will substitutes.'" This is because "tax law may not treat revocable trusts as separate entities, but trust law certainly does." In addition, while "revocable trusts might serve similar functions as wills, … that does not make them the same as wills … [because, for example] wills cannot enter into contracts with other parties or be sued when they breach their obligations." Instead, a plaintiff "usually sues the trustee in his representative capacity, not the trust directly."
The Court next rejected the argument that since several Michigan statutes governing "how creditors can recover against a 'settlor' (i.e., the person who creates the trust) … allow the creditors of the settler to recover from the trust property if the trust is revocable[,] … these statutes must prohibit the creditors of the trust from recovering from the trust property as well." This because "these statutes merely codify the principle that creditors can recover from the beneficial interest. … They do not repeal the principle that creditors of the trust can recover from the trust property as well."
The Sixth Circuit also rejected as inapposite cases cited for the rule that "trust property cannot be used to satisfy a trustee's personal liabilities" because "the trust property here would not be used to satisfy [the principal's] personal liability. Rather it would be used to satisfy the Trust's liability."
Finally, the Court found unpersuasive "an unpublished, out-of-circuit decision" out of the Tenth Circuit holding that a creditor cannot recover "from the property held by the settler individually" because "[i]t did not address whether a creditor of a trust can recover from the property held by trust itself."
Accordingly, the trial court's judgment was affirmed.
Ralph T. Wutscher
Maurice Wutscher LLP
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