Most attorneys are familiar with the rigamarole that comes with attempting to reach assets held by the principals of a business entity as a part of analyzing whether a judgment will be collectible—that is, whether the alter ego doctrine will apply such that the creditor may “pierce the corporate veil.” However, the rules for whether a judgment creditor may “pierce the veil” of a trust to reach the settlor behind that trust are a bit quirkier.
Indeed, most of the time when trusts are involved, the creditor is interest in proceeding the opposite direction—that is, reaching the assets held in trust for the benefit of a judgment debtor. Regardless of which direction the creditor may be going, this article discusses the rules of the road for collecting from individual via trust, and trust via individual.
First, it should be noted that the alter ego doctrine doesn’t even come into play where a judgment debtor transfers assets into a revocable trust. In that scenario, the judgment creditor can attach and collect upon the assets in the trust because they are treated as assets of the judgment debtor regardless of their placement into a revocable trust. See Bank One Texas v. Pollack, 24 Cal. App. 4th 973, 980 (1994); Gagan v. Gouyd, 73 Cal. App. 4th 835, 842 (1999), disapproved on other grounds in Mejia v. Reed, 31 Cal. 4th 657, 669 (2003); see also Prob. Code § 18200 (“Property in a revocable trust is subject to creditor claims to the extent of the debtor’s power of revocation.”).
Second, although the alter ego doctrine has been analyzed in the context of trusts rather than business entities, the California Court of Appeal has been careful to note that trusts are in fact not legal entities at all: “‘[A] trust is not a legal person which can own property or enter into contracts . . . It is the trustee or trustees who hold title to the assets that make up the trust estate . . . . [Therefore,] legal proceedings are properly directed at the trustee.’” Greenspan v. LADT LLC, 191 Cal. App. 4th 486, 521 (2010) (quoting Neno & Sullivan, Planning and Defending Domestic Asset-Protection Trusts, Planning Techniques for Large Estates (Apr. 26-30, 2010) SRO34 ALI-ABA 1825, 1869-70)). Moreover, “[b]ecause a trust is not an entity, it is impossible for a trust to be anybody’s alter ego.’” Id. at 522. However, the Court of Appeal did find that “applying the [alter ego] doctrine to trustees” was acceptable because “it’s entirely reasonable to ask whether a trustee is the alter ego of a defendant who made a transfer into the trust.” Id. The court in Greenspan concluded that alter ego doctrine could be applied to a third-party trustee of an irrevocable trust as the potential alter ego of the debtor settlor. Id.
The Ninth Circuit, applying California law a month before Greenspan, reached a similar conclusion in In re Schwarzkopf, 626 F.3d 1032 (2010), with a slight variation: the trust itself, rather than the trustee, can be considered the alter ego of a debtor settlor. In Schwarzkopf, the debtor transferred assets to two irrevocable trusts, naming his minor child as beneficiary and a third party as trustee, but, as to the second trust, “‘dominated and controlled all decisions of the . . . Trust.’” Id. at 1039. The Ninth Circuit first held that the California court’s then-current rule1 against “reverse veil piercing”—that is, attaching the assets of a corporation to satisfy the debts of a shareholder—did not prevent them from considering whether “reverse piercing” could be allowed in a trust context. See id. at 1038 (“In the absence of further guidance from California courts, therefore, we cannot extend the prohibition on reverse piercing to the trust context.”). The court went on to hold that “under California law, equitable ownership in a trust is sufficient to meet the ownership requirement for purposes of alter ego liability.” Id. Although the debtor was not the beneficiary of the trust, nor the trustee, the court still found that the debtor was “an equitable owner of the . . . Trust because he acted as owner of the trust and its assets” because he essentially dictated the actions of the trust to the trustee. Id. Accordingly, the Ninth Circuit held that “the bankruptcy court did not err in finding that the . . . Trust is [debtor settlor’s] alter ego.” Id. at 1040.
But what if the debtor is the trust—or, more accurately, per the admonitions in Greenspan, the trustee—and the creditor wants to reach the assets of the settlor as the debtor trust/trustee’s alter ego? To this author’s knowledge, there has been no California or Ninth Circuit case directly answering this question. One can surmise this is because trusts are used as the vehicle to shield assets of individuals and entities, and do not often themselves incur liabilities. However, it stands to reason that if a trustee of an irrevocable trust can be the alter ego of a debtor settlor per Greenspan, and an irrevocable trust itself can be the alter ego of a debtor settlor per Schwarzkopf, then the converse is also true—that is, a settlor can be the alter ego of a debtor trust or trustee. In other words, alter ego liability would seem to imply a two-way street: the trust/trustee is the settlor and the settlor is the trust/trustee. The waters seem to get murkier if one swaps in the trust beneficiary for the settlor in the foregoing analysis. However, the Schwarzkopf court’s emphasis on equitable title as forming the basis for alter ego liability would seem to suggest that beneficiaries would be subject to the same rules as Greenspan and Schwarzkopf, as well as the potential extension of those opinions to the converse rule. See Walgren v. Dolan, 226 Cal. App. 3d 572, 576 (1990) (“[T]he beneficiary [of a trust] holds only equitable title . . . .”). Of course, the Ninth Circuit’s focus on equitable title, and the California Court of Appeal’s focus on the separation of trust and trustee, could result in a split between state and federal courts in California in how they each handle the trust to settlor liability question.
In short, the current state of the law regarding trust alter ego theories is as follows:
- Debtor = settlor of revocable trust → assets of trust collectible, no alter ego showing required
- Debtor = settlor of irrevocable trust → assets of trust collectible upon alter ego showing
- Debtor = trust or trustee → assets of settlor likely collectible
- Debtor = trust or trustee → assets of beneficiary may be collectible
Scenarios 3 and 4 above may remain opaque until the unique scenario of an asset-poor trust and an asset rich beneficiary or settlor come before a relevant court of appeal, but given the relative rarity of that fact pattern, litigants that find themselves in that scenario will likely have to argue by analogy to the existing rules of Greenspan and Schwarzkopf.