Bendon v. Reynolds (In re Reynolds), 2012 Bankr.LEXIS 4023 (B.A.P. 9th Cir., Aug. 24, 2012)

In this case, the Bankruptcy Appellate Panel for the Ninth Circuit Court of Appeals affirmed the bankruptcy court order and judgment, holding that the Chapter 7 Trustee was entitled to reach only up to 25% of the Chapter 7 Debtor’s interests in two spendthrift trusts established in California by the debtor’s parents. Spendthrift provisions in a trust are generally permissible in California, as long as that trust is not self-settled. Ordinarily, a beneficiary’s interest in the income and principal of an otherwise valid California spendthrift trust is protected from the claims of creditors as long as the income and/or principal remains in the trust. However, once the income or principal of a spendthrift trust is distributed to a beneficiary, then it may  be reached by creditors. Cal. Prob. Code §§ 15300, 15301. As to be expected, there are a few exceptions to these rules. For instance, Probate Code §15306.5 provides that a judgment creditor may satisfy its judgment out of the payments to which the beneficiary is entitled under the spendthrift trust so long as it does not exceed 25% of the payment that otherwise would be made to the beneficiary. Another exception is found in Probate Code §15307, which provides that, not notwithstanding the spendthrift rules, a creditor may satisfy its judgment out of any amounts that the beneficiary is entitled to receive from the trust which is in excess of the amount that is or will be necessary for the education and support of the beneficiary. The text of Probate Code §15307 seems to suggest that it would permit invasion of the trust income and principal, however the title to the statute references only income. The application of Probate Code §15307 is somewhat unclear, and, unfortunately the interaction of these various statutory exceptions has become muddled in the case law. In this case, the Trustee was permitted to avail himself of the exceptions to the spendthrift rules because the U.S. Bankruptcy Code provides that he holds all of the rights of a hypothetical judgment creditor. Because these particular trusts permitted the Debtor only to receive principal distributions, not income, the majority of the judges on the panel ruled that the 25% cap of Probate Code §15306.5 applied and that Prob. Code §15307  did not apply due to its constraint to mere income payments. The dissent disagreed with the majority’s analysis, arguing that Probate Code §15307 was not so constrained and contending that the judgment creditor should be able to seek additional amounts to satisfy its judgments above and beyond the 25% cap of Probate Code §15306.5 so long as that discretion is exercised reasonably in conformity with the provisions of Probate Code §15307. The dissent is remarkably persuasive, and it should be interesting how this law further develops.