Using a Special Needs Trust in the Settlement of a Product Liability Lawsuit

(Phil Quaranta, Partner-White Plains also contributed to this blog post).

Product liability cases frequently involve severe and even catastrophic injuries.  As a result, product liability defense counsel and insurance adjusters must be familiar with the prospects for use of a special needs trust as a potential tool in the settlement of severe injury cases. Special needs trusts are frequently proposed as a component of the settlement of severe injury cases.

The purposes of the special needs trust are to allow a severely injured plaintiff to continue to receive social security benefits and to be protected from lien holders. A special needs trust is a trust that is presented to a court for approval.  It is funded with settlement proceeds after costs and attorney fees.  If the special needs trust is approved by a court, then the plaintiff who is the beneficiary of the trust may be allowed to continue to receive social security benefits and the principal of the trust will be protected from creditors − most importantly, lien holders.

The rationale behind the creation of the special needs trust is that a severely injured plaintiff has “special needs.” These “special needs” are related to the expenses for medical treatment and other life care costs that greatly exceed the amounts provided in any current benefits that the plaintiff may be entitled to receive.  The simple idea behind the special needs trust is that the needs of a severely injured plaintiff are so great that the parties and the court want to maximize the amount of the funds available to the plaintiff to ensure that he or she receives adequate care.

The effect that a special needs trust may have on existing insurance and medical liens is a controversial issue.  The criteria for a special needs trust and the effects of a special needs trust vary from state to state.  Special needs trusts have been around for decades. In the early days of special needs trusts, courts in some states approved special needs trusts and the orders of those courts prevented lien holders from enforcing their liens against the principal or benefits paid out of the trust.  But as special needs trusts became more popular, courts began to consider the interests of lien holders more substantially.  As a result, in some jurisdictions the criteria that courts apply to special needs trusts became much more stringent.  In some jurisdictions, existing medical and insurance liens must be satisfied before any special needs trust will be approved.  In other jurisdictions, special needs trusts are rarely approved.

As the criteria for approval of special needs trusts became more stringent, attempts to establish special needs trusts became less popular.  At the same time, Medicare liens and Medicare reporting requirements further complicate the use of special needs trusts.

Of course, substantial liens are an obstacle to settlement in any case.  Counsel should not get the idea that a special needs trust can be used to defeat the interests of lien holders in the absence of any good faith effort to compromise existing liens.  Those jurisdictions that allow special needs trusts will typically require that existing liens must be compromised.  But at the same time, lien holders who have not intervened in the case or who have not provided timely notice of the existence of their liens may have their liens extinguished after a special needs trust is approved.

When there is a Medicare lien, it further complicates the prospects for establishing an effective special needs trust. Nevertheless, in those states that allow special needs trusts,  there are benefits to these trusts after, of course, taking Medicare’s interests into account. When there is a Medicare lien or when the plaintiff is eligible for Medicare, federal regulations require that Medicare’s interests must be taken into account.  Medicare liens must be paid or compromised before any special needs trust is submitted for court approval.  The parties to a settlement should not attempt to rely on a state court order as a basis of sole protection from a Medicare lien.  Federal regulations specifically include a “double payment” provision, which means that Medicare can enforce collection of its lien against any of the parties to a settlement that failed to address a Medicare lien. This provision applies to defendants, their insurers and attorneys for all parties to the settlement.

If there is a Medicare lien, the parties must compromise the Medicare lien using the procedures of the SMART Act. As part of the compromise of a Medicare lien, the CMS will typically require that the parties set aside a specific portion of a settlement in order to take Medicare’s interests into account.  The Medicare set-aside is a specific trust that contemplates the value of any future Medicare benefits that the plaintiff might receive, then discounts them to a present value.  Then, the present value is set aside in an account specifically dedicated to the payment of medical benefits that the plaintiff may incur in the future.  To accomplish this, the parties must use a Medicare benefits consultant to identify the amount of potential future benefits. Then, the parties can use a simple structured settlement annuity purchased from a life insurance company to fund the account. In situations where the settlement requires a Medicare set-aside to satisfy the Medicare lien, the set-aside can be incorporated into a special needs trust, which is the establishment of a “trust within a trust.”  A simple annuity purchased as an account within a special needs trust can be included as an asset in any special needs trust submitted to a court for approval.

In conclusion, special needs trusts are not a method to circumvent liens or Medicare interests. Nevertheless, in those jurisdictions that permit special needs trusts, the special needs trusts may be useful to effectuate a settlement of a lawsuit involving a severely injured plaintiff.

As always, we welcome comments based on any experience that our readers may have.

This blog post was published originally on May 10, 2016.