Protecting Assets from the Claims of Creditors

The concept of tenants by the entirety, available only to a husband and wife, is considered by many to be unique to real property. The Maryland Legislature has passed legislation which has been signed into law which extends the immunity of all types of property held as tenants by the entirety (“T/E”) from the claims of a spouse’s separate creditors.

The statute extends the immunity of T/E to any property, real or personal, which was held by a husband and wife as T/E and transferred to the trustee of a trust in which the husband and wife are the beneficiaries. This immunity lasts for as long as the husband and wife remain married and the property and proceeds continue to be held in trust. Upon the death of one spouse the property would no longer be immune to the claims of the separate creditors of surviving spouse.

Included in the protection from the claims of each spouse’s separate creditors are the “Proceeds” of the property. This includes the proceeds from the sale of the property, insurance proceeds received on account of damage or loss to the property or other property collected or distributed by the trustee on account of property originally conveyed to the trustee by the husband and wife. The legislation is not only forward looking but grants the immunity of T/E retroactively to any property which was transferred by a husband and wife to a trustee of a qualifying trust.

Historically, for estate planning purposes and notwithstanding the loss of protection provided by holding property as T/E, many married couples transferred real property to the trustees of two separate trusts. While the risk involved in such a transfer was usually discussed and understood, the transfer had the effect of subjecting the beneficial interests in those trusts (and thereby the underlying property) to the claims of the husband’s or wife’s separate creditors. Prior to such transfer, the real property, owned as T/E, was not subject to the claims of the separate creditors of the husband or wife.

For example, assume that husband and wife transfer 123 Main Street in equal parts to the Trustees of their respective trusts. The husband is the beneficiary of his trust and the wife is the beneficiary of her trust. Prior to the new statute, the trustees hold title to the property as tenants in common because there is no other way for the trustees to hold title to the property. Thereafter, a judgment is entered against the husband. The judgment creditor of the husband can attach its judgment to the husband’s beneficial interest in the trust. This has the effect of encumbering the underlying real property or the proceeds from the property. Neither the property nor the proceeds can thereafter be transferred or distributed by the trustee free from the claim of such creditor without satisfying the creditor.

To remedy the problem of having transferred the T/E property into two separate trusts and thereby having made the beneficial interests in those separate trusts (and thereby the underlying property) available to the claims of a spouse’s separate creditors, spouses can take advantage of the new legislation.

Provided that the circumstances permit, they can convey the real property back to themselves as tenants by the entirety and immediately re-convey the property to the trustee of a new trust of which both husband and wife are the beneficiaries. If the property is personal property, it should be distributed from the two trusts back to both the husband and wife and then contributed to the new trust. Contemporaneously therewith, the husband and wife could protect the majority of their assets, whether bank or investment accounts, stock, partnership or membership interests, or other assets, by transferring those assets to the trustee of the new trust. While the law does not address whether these assets must be officially re-titled in the name of the trustee of the trust, it implies that the assets could simply be identified in the trust document as having been contributed to the trust. The husband and wife should take care to treat those assets and the proceeds of those assets as trust assets and not as their individual assets.

It is important to note that it is possible for the immunity afforded to property held as T/E which has been transferred to a trust to be waived, voluntarily or involuntarily, as to specific creditors or for specific trust property. The events which would give rise to such a waiver are (1) if the terms of the trust document expressly provide for the waiver, (2) the voluntary written waiver by husband and wife, and (3) if the trustee delivers a financial statement for the trust which fails to disclose the requested identity of the trust property which is immune from the claims of the separate creditors. The waiver is not effective for number three above if the identity of the immune property is otherwise reasonably disclosed by the trust document which is provided with the financial statement or a publicly available recorded document. In the event of a waiver, such waiver is only valid as to that specific trust property and for the specific creditor to which the identity of the immune property was not disclosed.

This major expansion of the immunity provided by holding property as T/E presents a planning opportunity and the opportunity to remedy the potential problems created by prior estate planning decisions.