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Carmack v. Reynolds

Supreme Court of California

March 23, 2017

JOHN M. CARMACK, as Trustee, etc., et al., Plaintiffs and Respondents,
v.
RICK H. REYNOLDS, Defendant; TODD A. FREALY, as Trustee in Bankruptcy, etc., Claimant and Appellant.

         9th Cir. No. 12-60068, BAP No. CC-11-1433-HPaD, C.D. Cal. Bankr. Nos. 09-14039-MJ, 09-01205-MJ

          Finlayson Toffer Roosevelt & Lilly, Jesse S. Finlayson and Matthew E. Lilly for Claimant and Appellant.

          Law Offices of David W. Meadows and David W. Meadows for Defendant.

          The Eroen Law Firm and Robert C. Eroen for Plaintiffs and Respondents.

          Liu, J.

         Under the terms of a spendthrift trust established by his parents, defendant Rick H. Reynolds is entitled to receive over a million dollars, all to be paid out of trust principal. Reynolds filed for bankruptcy before the trust's first payment, and the bankruptcy trustee seeks to determine what interest the bankruptcy estate has in the trust. The trust is governed by California law, and as the United States Court of Appeals for the Ninth Circuit observed, the relevant statutory provisions are “opaque.” (Frealy v. Reynolds (9th Cir. 2015) 779 F.3d 1028, 1029 (Frealy).) Probate Code section 15306.5 appears to limit the bankruptcy estate to 25 percent of the beneficiary's interest; other provisions of the Probate Code suggest no such limitation. The Ninth Circuit asked us whether the Probate Code limits a bankruptcy estate's access to a spendthrift trust to 25 percent of the beneficiary's interest, where the trust pays the beneficiary entirely out of principal. We hold that the Probate Code does not impose such an absolute limit on a general creditor's access to the trust. With limited exceptions for distributions explicitly intended or actually required for the beneficiary's support, a general creditor may reach a sum up to the full amount of any distributions that are currently due and payable to the beneficiary even though they are still in the trustee's hands, and separately may reach a sum up to 25 percent of any payments that are anticipated to be made to the beneficiary.

         I.

         Reynolds's parents established the Reynolds Family Trust in 2005. The trust contains a spendthrift clause, providing that “no interest in the income or principal of any trust created under this instrument shall be voluntarily or involuntarily anticipated, assigned, encumbered, or subjected to creditor's [sic] claim or legal process before actual receipt by the beneficiary.” Reynolds's mother Patsy died in 2007. Following her death, Reynolds's father Freddie received all the trust's distributions until Freddie died in 2009.

         The trust provides that at Freddie's death, Reynolds is entitled to $250, 000 from the trust if he survives Freddie by 30 days. In addition, Reynolds is entitled to receive $100, 000 a year for 10 years and then one-third of the remainder. All payments are expected to be made from principal; the trust's assets are in undeveloped real estate that do not produce income. Those assets are estimated to be worth several million dollars, although their exact value will not be known until the trust assets are liquidated.

         The day after his father died, Reynolds filed for voluntary bankruptcy under chapter 7 of the United States Bankruptcy Code. The trustees of the Reynolds Family Trust sought a declaratory judgment on the extent of the bankruptcy trustee's interest in the trust. The bankruptcy court held that under the California Probate Code, the bankruptcy trustee standing as a hypothetical lien creditor could reach 25 percent of Reynolds's interest in the trust. The bankruptcy appellate panel affirmed. The bankruptcy trustee appealed to the Ninth Circuit, which asked us to clarify if Probate Code section 15306.5 caps a bankruptcy estate's access to a spendthrift trust at 25 percent of the beneficiary's interest where the trust pays entirely from principal. We granted the Ninth Circuit's request.

         II.

         A spendthrift trust is a trust that provides that the beneficiary's interest cannot be alienated before it is distributed to the beneficiary. Creditors of the beneficiary generally cannot reach trust assets while those assets are in the hands of the trustee, even if they have secured a judgment against the beneficiary. Rather, creditors must wait until the trustee makes distributions to the beneficiary. The law permits such trusts because donors have “the right to choose the object of [their] bounty” and to protect their gifts from the donees' creditors. (Canfield v. Security-First Nat. Bank (1939) 13 Cal.2d 1, 11 (Canfield).) Providing donors some measure of control over their gifts encourages donors to make those gifts, to the benefit of the donor, the beneficiary, and ultimately the beneficiary's creditors.

         Under the Probate Code, spendthrift provisions are generally valid as to both trust income and trust principal. (Prob. Code, §§ 15300 [trust income], 15301, subd. (a) [trust principal]; all statutory references are to the Probate Code unless otherwise noted.) Yet creditors need not always wait for distributions to reach the debtor's hands. Spendthrift provisions are invalid when grantors name themselves beneficiaries. (§ 15304, subd. (a).) When a trust includes a valid spendthrift provision, certain creditors may reach into the trust. Such creditors include those with claims for spousal or child support (§ 15305) and those with restitution judgments (§ 15305.5). In addition, a state or local public entity can reach trust assets when the beneficiary owes money for public support (§ 15306, subd. (a)) unless distributions from the trust are required to care for a disabled beneficiary (§ 15306, subd. (b)).

         Even general creditors, including a bankruptcy trustee standing as a hypothetical lien creditor, have some recourse under three provisions: section 15301, subdivision (b) (section 15301(b)), section 15306.5, and section 15307. The question here is how ...


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