We don’t ordinarily report a decision based on a state’s peculiar law. We make an exception here, though, because the Ninth Circuit and the California Supreme Court ruled on the extent to which a bankruptcy trustee can reach into the assets of a spendthrift trust.
Concluding that some provisions in the California Probate Code were “opaque,” the Ninth Circuit certified a question to the state’s highest court arising from a case where a man filed a chapter 7 petition the day after his father died. The death made the son a beneficiary under the family’s spendthrift trust, entitling him to receive $250,000 immediately, $100,000 a year for 10 years and then one-third of the remainder of the trust’s assets.
In response to a declaratory judgment action initiated by the trustee of the family trust, the bankruptcy court ruled that the bankruptcy trustee, acting as a hypothetical lien creditor, could recover 25% of the debtor’s interest in the trust. The Bankruptcy Appellate Panel affirmed, but the bankruptcy trustee appealed to the Ninth Circuit, where the appeals court certified a question to the California Supreme Court.
The state’s high court characterized a spendthrift trust as precluding creditors from reaching a beneficiary’s interest in a trust while the trust property is in the hands of the trustee of the trust. Generally speaking, California probate law allows creditors to reach 25% of distributions to a beneficiary, to the extent the distribution is not necessary for the beneficiary’s education or support. However, several provisions in the probate law were seemingly in conflict, yielding different results depending on which provision would be controlling.
Answering the certified question, the state Supreme Court identified a “drafting error” in a pivotal provision of the Probate Code. Interpreting that provision literally could have eradicated the 25% limit on a creditor’s recovery from the trust, effectively ending the trust as a spendthrift trust.
Similar to the U.S. Supreme Court’s admonition that courts should follow the plain meaning of a statute so long as the result is not “absurd,” the California Supreme Court concluded that the “Legislature plainly intended general creditors to be limited to 25 percent of distributions from the trust.”
Gleaning what the state’s legislature meant rather than what it said, the state’s high court divined two conclusions from the probate law regarding a bankruptcy trustee’s ability to reach a beneficiary’s interest in a spendthrift trust: (1) The bankruptcy trustee can recover the full amount of currently payable distributions to the extent not necessary for the beneficiary’s education or support; and (2) the bankruptcy trustee can reach 25% of anticipated payments, reduced by the amount necessary for the beneficiary’s support or education.
Applying state law as explicated by the state’s Supreme Court, the Ninth Circuit modified the lower courts’ rulings and remanded with instructions to allow the bankruptcy trustee to recover all distributions that were “due to be paid as of the petition date,” but not “any portion of that money the beneficiary needs for his support or education.” In addition, the bankruptcy trustee could reach “25 percent of expected future payments from the spendthrift trust, reduced by the amount the beneficiary needs to support himself and his dependents.”
For Californians, we recommend reading the state high court’s opinion in full, available in the link below to the Ninth Circuit’s decision.