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In re Cutter

September 4, 2008


Appeal from the United States Bankruptcy Court for the Central District of California. Hon. Kathleen H. Thompson, Bankruptcy Judge, Presiding. Bk. No. SV 05-14744-KT Adv. No. SV 06-01249-KT.

The opinion of the court was delivered by: Montali, Bankruptcy Judge.


Submitted Without Oral Argument on July 25, 2008

Amended: December 3, 2008

Before: MONTALI, DUNN, and KLEIN, Bankruptcy Judges.

These appeals involve a failed asset protection scheme. We publish to call attention to a fundamental fallacy inherent in that scheme. The cornerstone of the scheme is a self-settled trust that identifies only unnamed "surviving" descendants of the trustor as beneficiaries (whose interests vest only after the trustor's death), but leaves in the trustor/trustee the power to deplete the trust of all of its assets for his own benefit.

The bankruptcy court correctly determined by partial summary judgment that where the debtor was in effect a beneficiary of a self-settled spendthrift trust by virtue of the power to use the trust assets for his own benefit, certain real property titled in the debtor as trustee of that trust could be reached by the debtor's creditors under California law and, hence, was property of the estate. The debtor appealed after the court directed entry of judgment against him. The trustee cross-appealed the court's simultaneous denial of partial summary judgment as to a different issue regarding the estate's ownership of other real property. We AFFIRM the partial summary judgment against the debtor but REVERSE and REMAND for entry of summary judgment in favor of the trustee determining that debtor's bankruptcy estate is entitled to recover an additional fractional interest in real property that is part of the trust corpus. We deny leave to appeal and DISMISS as interlocutory the balance of the trustee's cross-appeal.


A. Introduction

Appellant Edward Williams Cutter II ("Debtor") filed for relief under chapter 7*fn2 on July 12, 2005. Appellee David Seror ("Trustee") is the trustee for Debtor's bankruptcy estate.*fn3

As of the petition date, Debtor, as the trustee of The Edward Williams Cutter, 2nd Inter-Vivos Trust dated May 23, 1989 (the "Trust"), held title to the following real property: a condominium on Dickens Street in Sherman Oaks, California (the "Dickens Street Condo"); certain undeveloped property in Los Angeles County (the "Undeveloped Property"); a two-thirds interest in property located on Whipple Street in North Hollywood, California (the "Whipple Street Property"); and property located on Wilkinson Street in North Hollywood, California ("Wilkinson Street Property").

As discussed later, the bankruptcy court found as a matter of undisputed fact that Debtor contributed all of these properties to the Trust, except for a one-third share (the "Ermatinger Third") of the Whipple Street Property that was conveyed to the Trust by John J. Ermatinger ("Ermatinger"). With the exception of the Ermatinger Third, the above-described properties are collectively referred to as the "Trust Properties."*fn4

In addition, as of the petition date, "Edward W. Cutter, A Single Man" held title to property located on Thurston Circle in Los Angeles, California (the "Thurston Circle Property").

On September 6, 2006, Trustee and Vujic (collectively, "Plaintiffs") filed a complaint against Debtor for (1) denial of discharge; (2) revocation of discharge; (3) quiet title; (4) declaratory relief; (5) accounting, turnover and/or damages; and (6) a determination of dischargeability of debt under section 523. Plaintiffs named Debtor as defendant, both individually and in his capacity as trustee for the Trust. Plaintiffs did not assert claims directly against any other party.

On January 24, 2007, John F. Cutter, as Guardian Ad Litem ("Guardian") of Debtor's son, Edward W. Cutter III ("Trip"), filed a complaint in intervention asserting that Trip held actual title to the Thurston Circle Property. Guardian also disputed Trustee's claims that the bankruptcy estate had an ownership interest in the corpus of the Trust.

On March 27, 2007, Plaintiffs filed a motion for summary judgment against Debtor, arguing that, inter alia, title to the Thurston Circle Property and the Trust Properties should be quieted to Trustee pursuant to section 544.*fn5 In particular, Plaintiffs argued that the Trust was a self-settled, irrevocable spendthrift trust designed to benefit Debtor (as settlor/trustor, trustee and unnamed beneficiary) and that Trust Properties were property of the chapter 7 estate under California law and under sections 544 and 541. Plaintiffs also argued that Debtor held title to the Thurston Circle Property.

The bankruptcy court agreed with Plaintiffs that the Trust Properties belonged to the estate and granted partial summary judgment in favor of Trustee. It denied summary judgment as to the Ermatinger Third and as to the Thurston Circle Property, because there were genuine issues of material fact remaining for trial.

B. The Trust Properties

1. The Trust

On May 23, 1989, Debtor as trustor created the Trust. He named himself as trustee of the Trust. Paragraph 2.00 of the Trust Agreement and Declaration of Trust ("Trust Agreement") provides that the "primary beneficiaries of the [T]rust are the surviving issue of the trustor, if any, and the lineal descendants of non-surviving issue of the settlor, if any on the principle of representation."*fn6 If the Debtor had died without surviving lineal descendants, the Trust was to be maintained for the benefit of his mother.

Even though Debtor did not specifically identify himself as a primary beneficiary, Paragraph 5.00 of the Trust Agreement provides that he (as trustee) could make distributions from the trust to benefit himself (as trustor):

No distributions shall be made out of the trust except in the sole discretion of the trustee, in an amount to provide for the health, the education, or the support and maintenance in the customary manner of living of the trustor, prior to the death of the trustor. At the time of the death of the trustor, outright distributions shall be made to the beneficiaries of the trust subject to the limitation in Paragraph 6.*fn7

Paragraph 7.13 additionally grants Debtor (as trustee) authority to invade the Trust property "for emergencies related to the health, education, support and/or maintenance" of Debtor and "other beneficiaries" of the Trust. Notwithstanding the provisions of Paragraphs 5.00 and 7.13, Paragraph 8.00 purports to prohibit Debtor (as trustee) "from exercising any powers vested in him primarily for the benefit of the trustor rather than for the benefit of the beneficiaries."

Paragraph 4.00 of the Trust Agreement provides that the Trust is irrevocable. Paragraph 17.00 contains a spendthrift clause: "No interest in the principal or income of any trust created under this instrument shall be anticipated, assigned, encumbered, or subjected to creditor's claim or legal process before actual receipt by the beneficiary."

Because Paragraph 5.00 permits Debtor as Trustee to make distributions to himself as Trustor (with no limitation on the amount of principal or income that he could use) to maintain Debtor's customary standard of living, the bankruptcy court ruled that the "Debtor is a primary beneficiary of the Trust notwithstanding the absence of a designation as such in the Trust instrument." See page 14 of Findings and Conclusions In Support of Ruling on Plaintiffs' Motion for Partial Summary Adjudication entered on November 5, 2007 ("Findings"). The court further stated:

Because the strictures of Paragraph 8.00 are substantially inconsistent with the provisions of Paragraphs 5.00, 7.00, and 7.13 which expressly allow the Debtor, as trustee, to make distributions for his own benefit, in his sole discretion, the Debtor is a primary beneficiary of the Trust.

Id. The court therefore concluded that the Trust was a self-settled, irrevocable spendthrift trust:

Pursuant to the provisions of the Trust, unlimited distributions can be made to the Debtor in the sole discretion of the trustee for, among other things, the support and maintenance of the Debtor. Access to trust assets for the Debtor's benefit is not restricted to trust income. The trustee also is authorized to invade trust property for emergencies related to the support and maintenance of the Debtor and has the authority and discretion to designate the nature of a "qualifying" emergency. This is enough to make self-settled assets of the Trust vulnerable to the claims of creditors and accessible to the Trustee. In this case, of course, the Debtor himself was the ...

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