May 18, 2017

Spendthrift Clause - Carmack v. Reynolds

A common provision to include in a trust for a careless beneficiary is a spendthrift provision. This provision provides protection to a beneficiary's inheritance by limiting the ability of a creditor to attach their claim to a beneficiary's interest in the trust. Still, a spendthrift clause does not absolutely insulate a beneficiary's inheritance from creditors. 

Certain types of creditors can attach to the beneficiary's interest regardless of a spendthrift provision, e.g. child support creditors. For general creditors, recovery is typically not as easy. 

A recent California Supreme Court case addressed the issue of how far a bankruptcy trustee can reach into a beneficiary's interest in a trust.

Carmack v. Reynolds (2017) _____ Cal.4th _____

The pertinent facts are as follows:

"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."

The court found that "that a bankruptcy trustee, standing as a hypothetical judgment creditor, can reach a beneficiary's interest in a trust that pays entirely out of principal in two ways. It may reach up to the full amount of any distributions of principal that are currently due and payable to the beneficiary, unless the trust instrument specifies that those distributions are for the beneficiary's support or education and the beneficiary needs those distributions for either purpose. Separately, the bankruptcy trustee can reach up to 25 percent of any anticipated payments made to, or for the benefit of, the beneficiary, reduced to the extent necessary by the support needs of the beneficiary and any dependents."