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Trustee Notice to Creditors Protects Beneficiaries

Trusts can be a useful tool in estate planning. Trusts provide the settlor (the “creator” of the trust) with added control over the distribution of his or her life’s work. They also allow for the protection of beneficiaries against creditors. Finally, trusts provide for the avoidance of Arizona’s probate requirements — well, at least that’s mostly true.

Unfortunately, scenarios may arise where a trustee needs to follow certain probate requirements or risk exposing beneficiaries of a trust to liability to the settlor’s creditors.

For many clients, it seems like common knowledge that any asset in a trust is protected from creditors. People pay thousands of dollars in legal bills for just that advice only to realize that the protection of a trust is somewhat limited. Most people who create a trust form that is known as a “Revocable Trust”. Simply put, a revocable trust is a trust where the settlor still has essentially full control over all of its assets, including the ultimate power to completely change, amend, or revoke the trust (hence the name). Revocable trusts do not provide the creditor protection that most people envision when they think of ironclad safety behind the legal walls of a trust.

For unsuspecting trustees a nightmare scenario could arise long after the settlor passes away. If a trustee is not careful, a past creditor can bring a claim against the estate long after the trust assets have been distributed, which may leave trust beneficiaries on the hook.

Pursuant to Arizona Revised Statutes (“A.R.S.”) Section 14-10505(A)(3), even after the death of a settlor of a revocable trust, the property in the trust is still subject to the claims of the settlor’s creditors. What happens, though, if before the settlor’s creditor learns of the settlor’s death, the trustee, following his or her instructions as set forth in the trust instrument, distributes the trust assets to the intended beneficiaries? Under A.R.S. § 14-6102(A), a transferee of a nonprobate transfer (e.g. the beneficiary of a trust) can be liable for the settlor’s estate for claims made against the settlor. Based on the interplay of these two statutes, just because a beneficiary receives a trust distribution, it does not necessarily mean that the beneficiary can keep the trust distribution. Even worse, creditors can bring a claim against the settlor’s estate up to two years after the settlor passed away if such claim is not properly barred. A.R.S. § 14-3803(A).

So, what steps does a trustee need to take to ensure that the assets distributed to beneficiaries of the trust receive protection from unwanted creditors? Per A.R.S. §14-6103(A), trustee notice to creditors is not mandatory, but is rather something a trustee may perform. Providing this notice protects the trustee and beneficiaries from claims brought months or even years later. The notice requirements include the following: 1) if the trustee is providing a general notice of the settlor’s death, the notice needs to be made in a newspaper of general circulation in the county once a week for three (3) successive weeks, or 2) if the trustee knows of a creditor (or potential creditor), the trustee can provide notice directly to such creditor by mail or other delivery. A.R.S. § 14-3801(A) & (B). By providing such notice, creditors then have either four (4) months to bring a claim against the settlor’s estate if notice is given in the general manner, or the creditors have sixty (60) days to bring the claim if notice is given directly to such creditor. A.R.S. § 14-3801(B).

If a trustee does not provide this notice as set forth in the preceding paragraph, then a creditor of the settlor may have up to two (2) years to bring a claim against the estate and subsequently the beneficiaries of the trust. A.R.S. § 14-3803(A)(1). In such a case, a trust beneficiary could receive a distribution from the trust, use all of the funds, and then have to worry about the decedent’s creditors filing suit to recover such funds from the beneficiary. This is a nightmare scenario for any beneficiary, but it is easily preventable.

In order to protect themselves and trust beneficiaries from unneeded headaches and legal fees down the road, trustees should ensure that they follow the Arizona probate requirements to provide either general or specific notice to creditors upon the settlor’s death either through as estate administration or a trust administration. Failing to take such requirements leaves the door open to potential creditors to file suit against beneficiaries long after the settlor’s death even after trust assets have been distributed and spent by the beneficiaries.

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Jeffrey M. Manley