Is a Revocable Trust a Trust (and Related Topics)?

The Sixth Circuit Court of Appeals has recently issued an opinion that discusses a number of topics especially important to asset protection and trust attorneys.[1] Some of the issues discussed involve trust law, tax law, asset protection law, and contract law. As recognized in the dissent, the court’s conclusions on a number of these issues may serve as the premise for future judicial decisions. Given the importance of the legal issues discussed in the opinion and that the opinion is from a circuit court of appeals, careful consideration of the impact of the opinion seems a worthwhile endeavor.

The Winget litigation lasted approximately 15 years. During that time, it generated over 50 judicial opinions including 9 from the 6th Circuit. The ninth such opinion from the 6th Circuit was issued on July 1, 2022 and is the subject of this writing.

Facts

A holding company, Venture Holdings Co., LLC, controlled by Larry Winget (“Winget”), borrowed approximately $450 million from JPMorgan Chase Bank, N.A. (“Chase”).[2] When there was approximately $350 million remaining on the debt, the loan went into default. In negotiating a resolution, Winget offered a guaranty to Chase capped at $50 million. Since the substantial majority of Winget’s assets were held in a revocable trust, Chase requested the trust also execute a guaranty agreement. However, it appears an error may have been made in finalizing the written guaranty agreements.[3] Winget’s guaranty included the $50 million limitation. The trust’s guaranty did not, thereby leaving the trust’s written guaranty agreement unlimited. Ultimately, after continued default, Winget wired Chase $50 million which he argued to be in full satisfaction of the guaranties by both him and the trust (subject to continuing rights of Chase to certain assets pledged as collateral).

Chase’s attempts to collect on its guaranties from Winget’s trust are the subject matter of this litigation. After Chase sued to recover the debt, Winget revoked the trust and distributed the trust’s assets to himself. Throughout over a year of litigation, Winget never disclosed that he had revoked the trust. However, eventually, Winget sought a declaratory judgment seeking the court to confirm Chase had no further recourse against Winget or the trust due to the revocation. Instead, the court found revocation to be a fraudulent transfer under the Michigan Uniform Fraudulent Transfer Act (“UFTA”). At that point, Winget reinstated the trust and returned the assets previously retitled in his name.

Although it may have appeared that all was back to normal by a full return of all assets to the trust, this was not the case. LLC’s[4] originally owned by the trust made large distributions to Winget during the time the trust was revoked. Chase moved the court for summary judgment and sought a constructive trust over the LLC distributions. The court found in favor of Chase on claims involving fraudulent transfer under the UFTA, claims that Winget was unjustly enriched, and Winget’s declaratory judgment action.

Fraudulent Transfer

In order for there to be a transfer under the UFTA, there must be a “transfer.” Therefore, a critical question here is whether any transfer occurred. The UFTA defines transfer as “every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with an asset or an interest in an asset.”[5] This means, that “when a creditor has access to the assets, and a debtor takes action to fraudulently put those assets beyond the creditor’s reach, a creditor has a basis for relief.”[6] The questions thus arises whether the settlor of a revocable trust has engaged in a “transfer” when conveying trust assets to himself in revocation.

Winget argued that, due to his right to revoke the trust, he was the owner of all assets of his revocable trust.[7] He also argued that a trust does not own assets, but rather is an arrangement whereby a trustee owns the trust’s assets for the benefit of another (the beneficiary). Since the trust is the debtor, but Winget owns the assets, Chase cannot recover those assets as Winget is not the debtor. He has completely satisfied his individual liability by tender of the $50 million limit under his individual guaranty.[8]

The court ruled that a transfer under the UFTA “does not turn on who owns the assets. Instead, it turns on how the revocation affected Chase’s access to the assets.” Since the effect of revocation was to place the assets outside of Chase’s reach, it was a transfer under the UFTA.

Once the court determined a transfer under the UFTA occurred, the court next had to determine whether the transfer was “fraudulent” under the UFTA. Chase took the position that the transfer was not actually fraudulent, but constituted constructive fraud.[9] “A transfer of assets is constructively fraudulent if: (1) the creditor’s claim ‘arose before the transfer,’ (2) the debtor was insolvent at the time of transfer or ‘became insolvent as a result of the transfer,’ and (3) the debtor did not receive ‘a reasonably equivalent value in exchange for the transfer.’”[10] The court found all of these factors met.

Winget, however, argued that he had a contractual right to revoke the trust that existed before the trust became indebted to Chase. At the time the guaranty was entered into, Chase had notice of that right to revoke and could have negotiated to limit this power. Chase did not and, therefore, Winget argues it should be subject to those provisions. In effect, Chase was a subsequent unsecured creditor of the trust, Winget’s right of revocation making him a prior unsecured creditor having a superior right to trust assets.

The court simply disagreed with Winget’s position. Instead, the court held that the trust’s guaranty effectively nullified Winget’s right of revocation. This is because the guaranty created rights in Chase to trust assets. As the trust’s settlor and beneficiary, Winget was a third party as to the guaranty between the trust and Chase. However, the court noted that third party rights can be affected by contractual obligations of others. Once the loan went into default, Winget’s right of revocation became unenforceable due to the trust’s obligations to Chase (being greater than the value of all trust assets). In the end, the court found that revocation constituted a fraudulent transfer under the UFTA, giving Chase rights to recover the wrongfully transferred assets.

Unjust Enrichment and Constructive Trust

Unjust enrichment “is rooted in the idea that no one should be allowed to profit inequitably at another’s expense.”[11] To prevail on a claim for unjust enrichment under Michigan law a plaintiff mush show: (1) the defendant received a benefit from plaintiff that (2) resulted in an inequity to the plaintiff.[12] Here, before Chase obtained a charging order against LLC interests held by the trust, Winget revoked the trust, took ownership of the LLC interests, and received distributions. As such, the court found Winget was unjustly enriched since “Chase could no longer receive distributions that it would have received with charging orders but for the fraudulent revocation.”[13] This, the court held, resulted in a benefit to Winget at Chase’s expense.

Winget raised two arguments as to why he was not unjustly enriched. First, he argued that promissory notes distributed to him by the LLC were in payment towards a debt owned by the LLC to Winget. To fund operations, Winget says he chose not to take approximately $100 million in distributions. This constituted a loan to the company in that amount. The problem the court found here is not whether the LLC owed Winget approximately $150 million, which was supported by testimony, but rather that the debt was incurred after the LLC already owed Chase. This was supported by an integration clause in the promissory notes[14] as well as the fact that the forgone distributions would have been owed to the trust as the LLC’s sole member prior to revocation of the trust, thus meaning the debts owed to Winget individually must have been during the period of time when the trust was revoked.

Second, Winget argued he was not unjustly enriched by the portion of cash distributions he used to pay income taxes. The court’s discussion here is interesting in addressing the pass-through entity taxation as well as the taxation of grantor trusts. Initially, the court discussed that the trust is liable for the LLC’s income.[15] Once that was determined, the court had to address who is liable for tax on the trust’s income. The court stated:

If Winget is personally liable, he would have had to pay for the taxes himself, leaving the trust assets to repay Chase. But if the Trust is liable, it would have paid for the taxes out of its own assets and that in turn would have diminished the assets available to Chase. Winget was unjustly enriched only if the former is true.

The court’s conclusion here was a continuation of the court’s finding that Winget lost the right of revocation once Chase was found to have enforceable claims against the trust. Citing to the federal income tax statutes appliable to grantor trusts,[16] the court cited to the statutory provision causing a trust’s settlor to be taxable on the trust’s income to the extent of the settlor’s right to revoke the trust.[17] Since the court had already found Winget lost the right to revoke the trust due to the trusts’ obligations to Chase, the court held this provision no longer applied. In the absence of any authority provided by Chase,[18] the court held this rendered the trust liable for this tax obligation in the amount of approximately $79 million. As such, this amount did not unjustly enrich Winget.

Having found unjust enrichment other than the $79 million attributable to income taxes, the court found a constructive trust in favor of Chase over the assets Winget received in distribution (cash and promissory notes). Winget argued that a constructive trust could not be imposed upon these assets. His position is that equitable remedies, such as a constructive trust, are only available when legal remedies would be inadequate. Here, argues Winget, the UFTA provides an adequate legal remedy. The court disagreed noting that the UFTA supplements common law remedies rather than supplanting them.[19] As a result, Winget individually owes Chase the amount by which he was unjustly enriched, being the promissory notes and cash distributed to him by the LLC less $79 million.

Dissent

The dissent argues that one of the opinions of the 6th Circuit was flawed. The court should correct its prior error which would result in a different outcome. The “bad apple” opinion, per the dissent, was the court’s finding the lack of a mistake or scrivener’s error in preparing the trust’s guaranty agreement. If the court were to recognize the mistake or scrivener’s error, then it would have the power to reform the guaranty agreement to contain the intended $50 million limitation. Then, given the nature of revocable trusts as being one-and-the-same as the settlor, Winget’s payment of $50 million to Chase would have satisfied all obligations of Winget and the trust.

As to the nature of a revocable trust, the dissent cited to Michigan law that “a revocable trust is not a separate legal entity with regard to the rights of creditors.”[20] Then, the dissent discusses the use of revocable trusts primarily for asset management and to effectuate testamentary transfers. After going through some discussion, the dissent states:

Winget is the Trust’s settlor, trustee, and sole beneficiary.  The key point is that Winget owns the assets, all of them, and happens to keep them in his revocable trust.  The Trust does not own any assets.  As settlor, Winget can move his assets to and from, in and out, of his revocable trust at any time, for any reason.  He can put all his assets in it if he wants.  Or he can empty it and close it.  The revocable trust is a storage place, not a distinct legal entity.

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I believe that the Trust and Winget are not separate entities; the Trust, being a revocable trust, is just a place for Winget to put his assets and Winget had every right to fill it, change it, empty it, or close it however he saw fit.  Winget owns all the assets, the Trust “owns” nothing.

Regarding the mistake or scrivener’s error, the dissent felt the prior opinion was simply incorrect. This is for a number of reasons. The court’s reasoning that there was no “binding contract” until the guaranty agreement was signed, and the pre-agreement drafts were not binding agreements precludes there from having been a mistake or scrivener’s error do not disprove such an error. Rather, in every case where there is a scrivener’s error between the negotiations and the final, executed document, these facts would exist. Further, the court’s reliance on the integration clause was misplaced. If there was a mistake in the document, the parties would also have been mistaken about applicability of the integration clause. As such, the reasoning of the court simply cannot be supported. Rather, based on well established law, the court should hear parol evidence as to the parties’ intentions. The trial court took that evidence into consideration and unambiguously found there to have been a mistake or scrivener’s error.

Ultimately, finding that a revocable trust and the settlor are one-and-the-same, there cannot be a fraudulent transfer between the two. With that assumption, most of the majority’s discussion becomes flawed.[21] Based on this, and finding the guaranty agreement should be reformed to include the $50 million limit, all obligations of Winget and the trust were satisfied when Winget rendered payment to Chase in the amount of $50 million.

Conclusion

There is a lot going on in this opinion, covering a number of areas of law (trust, asset protection, contract, creditors’ rights, etc.). While each of the majority and dissent has justified their conclusions, the analysis seems to miss the mark in a handful of areas.

The majority opinion makes incorrect conclusions about tax law and fails to reform what appears to have clearly been a mistake or scrivener’s error, something the trial court documented. Even recognizing Winget and the trust as separate persons, correcting the error may result in a total award to Chase of $100 million ($50 million under Winget’s guaranty and $50 million under the trust’s guaranty). It seems the majority worked hard to avoid reopening previously litigated issues, even if the resolution of those issues may have been in error (which may, or may not, be the case).

The dissent recognizes the scrivener’s error but seems to misstate aspects of trust law. As cited in the 2019 opinion, a revocable trust certainly is a trust. It may be true that revocable trusts are used as a “storage place,” are Will substitutes, and are typically used to effectuate testamentary transfers, but they are valid trusts nonetheless. Further, while it is true that a revocable trust is subject to claims of the settlor’s creditors, this case involved, at least partially, the opposite question – whether the settlor may be subject to claims of the trust’s creditors. The dissent fails to cite to any authority on this point, using the fact that the trust’s assets are subject to claims of the settlor’s creditors as conclusive. It may be that the settlor is subject to claims of the trust’s creditors, but that was not discussed to any degree nor was there any authority cited. Instead, the 2019 opinion cited to authority which may support the opposite.[22]

It will be interesting to see whether Winget appeals this opinion and, if so, whether the U.S. Supreme Court grants certiorari. If so, resolution of the issues raised in this case may have far-reaching effects. Certain aspects of trust law may be significantly impacted depending on how this case progresses.

[1] JPMorgan Chase Bank, N.A. v. Winget, 2022 WL 2389287 (6th Cir. 2022).

[2] The debt was borrowed from a number of lenders, but Chase was the administrative agent.

[3] The dissent cites to the trial court’s previous finding that this was a mistake in failing to include the $50 million limitation in the trust’s guaranty. The Court of Appeals overturned that finding no mistake or scrivener’s error was made. JPMorgan Chase Bank, N.A. v. Winget, 602 Fed.App’x. 246 (6th Cir. 2015). It appears the court found there was no prior agreement as to limiting the trust’s liability the same as Winget’s and the inclusion of an integration clause in the guaranty conclusively negated the importance of any prior discussions among the parties. As discussed below, the dissent in the 2022 opinion takes issue with this 2015 opinion and believes the issue should be revisited to reach a different result.

[4] For the sake of simplicity, this writing will refer to these LLC’s as a single LLC as the outcome is unaffected by the number of LLC’s involved.

[5] Mich. Comp. Laws § 566.31(q)

[6] Citing Glazer v. Beer, 72 N.W.2d 141, 143 (Mich. 1955).

[7] See also JPMorgan Chase Bank, N.A. v. Winget, 942 F.3d 748 (6th Cir. 2019).

[8] Relevant also may be whether a creditor can recover against the settlor for the trust’s debts. At least one court has held that it cannot. In re Brock, 587 F.App’s 485, 488-489 (10th Cir. 2014). This was discussed in the 2019 6th Circuit opinion noting that Chase is not attempting to recover the trust’s debt against Winget’s individual assets, but rather seeking to recover the trust’s debt against the trust’s assets.

[9] See Mich. Comp. Laws § 566.35(1)

[10] Dillard v. Schlussel, 865 N.W.2d 648, 656 (Mich. Ct. App. 2014).

[11] Wright v. Genesee County, 934 N.W.2d 805, 809 (Mich. 2009).

[12] AFT Mich. V. Michigan, 846 N.W.2d 583, 590 (Mich. Ct. App. 2014).

[13] Interestingly, the outcome here actually put Chase in a better position than it would have had under a charging order since, absent additional remedies, Chase would be limited to an effective lien on the LLC interests without any ability to force a distribution. Here, since the assets were distributed and Chase obtained the right to pursue Winget to that extent, Chase had direct access to those LLC assets.

[14] Once again, an integration clause created trouble for Winget. The written promissory notes reflecting the LLC’s debt to Winget were signed after Chase’s right to pursue trust assets was confirmed in the 2015 6th Circuit opinion. Those promissory notes contained an integration clause that the court held prevented it from considering whether the debt was based on any earlier agreement, the effect of such clause being that the debts are deemed to have been incurred the date of the promissory notes regardless of what parol evidence may show.

[15] I note that the court said “the LLCs elected to be ‘pass-though’ entities for federal income-tax purposes.” Citing to S corporation statutes, the court describes the LLC member as being liable for the LLC’s income. This is not entirely correct as the federal income tax treatment of the LLC was default tax treatment. Further, here, the LLC had a single member. Therefore, the LLC was a wholly disregarded entity under Treas. Reg. § 301.7701-2(c)(2). As such, while it does not affect the outcome of the court’s opinion, its discussion is not completely accurate.

[16] See IRC §§ 671-679

[17] IRC § 676(a)

[18] There are, however, any number of other provisions which could have caused Winget to be taxable on the trust’s income including, but not limited to, a power to control beneficial enjoyment under IRC § 674 (assuming Winget had this power given Chase’s potential priority claim to trust assets), certain administrative powers settlor’s of revocable trusts would hold under IRC § 675, and the power to apply the trust’s income for the settlor under IRC § 677 (again, however, perhaps the court would not find this power to exist due to Chase’s rights which exceeded the trust’s assets and the income generated by those assets). It appears that Chase simply lost this issue due to a failure to properly raise the grantor trust rules.

[19] See Mich. Comp. Laws § 566.42

[20] Citing Mickam v. Joseph Louis Palace Tr., 849 F.Supp 516, 523 (E.D. Mich. 1993). The dissent also notes Mich. Comp. Laws §§ 556.128 (under the Powers of Appointment Act of 1967) and 700.7506 (under the Michigan Trust Code) for the proposition that property of a revocable trust is subject to claims of the settlor’s creditors during lifetime (and I note this is the opposite direction of claims at issue here). Also, the 2019 6th Circuit opinion notes that a tax law may note treat revocable trusts as separate entity, “but trust law certainly does,” citing Bogart’s Trusts and Trustees at § 264.5, at 19-20 (rev. 3d ed. 2012) and Restatement (Third) of Trusts § 25 (2003).

[21] Interestingly, referencing Winget’s payment of $79 million of income taxes for the trust, the dissent questions whether Winget may have a claim for a refund based on the majority’s conclusion that the trust was the party responsible for payment of tax on the trust’s income.

[22] In re Brock, 587 F.App’x 485 (10th Cir. 2014).