California Supreme Court Clarifies Bankruptcy Estate's Interests in Spendthrift Trust Distributi
The California Supreme Court decided Carmack v. Reynolds on March 23, 2017. Reynolds filed Chapter 7 one day after his father died. The Reynolds Family Trust provided that after the father's death, Reynolds is entitled to receive $250,000.00 if he survives by 30 days, and $100,000 a year for 10 years then one third of the remainder. All the payments were expected to be made from principal, as the trust assets were not income producing.
The bankruptcy court held that the trustee, as hypothetical lien creditor could only reach 25% of Reynolds's interest in the trust. The Bankruptcy Appellate Panel for the Ninth Circuit affirmed the bankruptcy court decision.The Trustee appealed to the 9th Circuit, who in turn requested the California Supreme Court clarify potentially conflicting Probate Code sections. The Supreme Court does a nice job of parsing out the various Probate Code provisions dealing with the various types of creditor claims against spendthrift trusts, and concludes that the ambiguity or inconsistent limitations set forth in Probate Code sections 15307 & 15306.5 likely resulted from a drafting error when the legislature revised the statutes in 1986. They rejected the trustee's theory that 15306.5 gave creditors automatic access to 25% of the beneficiaries' trust interest, but in exceptional circumstances, general creditors can turn to section 15037 to reach beyond 25%.
The Court held in part:
"after an amount of principal has become due and payable (but has not yet been disbursed), a creditor can petition to have the trustee pay directly to the creditor a sum up to the full amount of that distribution (15301(b)) unless the trust instrument specifies that the distribution is for the beneficiaries' support or education, and the beneficiary needs the distribution for those purposes (15302). If no such distribution is pending or if the distribution is not adequate to satisfy a judgment, a general creditor can petition to levy up to 25% of the payments expected to be made to the beneficiary, reduced by the amount other creditors have already obtained and subject to the support needs of the beneficiary and any dependents. (15306.5)"
The Supreme Court's ruling overturned the bankruptcy court's finding that the Trustee was limited to 25% of any type of distribution notwithstanding that the distribution was from principal, but did not go as far as the Trustee argued for, and confirmed that for future distributions not currently due and payable, the 25% limitation applies.