By: Donald L Swanson
“A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.” 11 U.S.C. § 541(c)(2).
- That is the Bankruptcy Code provision incorporating state laws on spendthrift trusts into bankruptcy.
A primer on spendthrift trusts is provided in a new opinion: Snow Covered Capital, LLC v. Fonfa, Case No. 22-cv-01181 in the U.S. District Court for Nevada (decided August 28, 2024).
Context
Here’s the context for the Snow v. Fonfa primer on spendthrift trusts.
Andrew Fonfa, now deceased, established the Evan Fonfa Trust, which (i) appoints Evan Fonfa (Andrew’s son) as the Trust’s sole trustee and beneficiary, and (ii) contains spendthrift provisions.
Then, fraudulent transfer claims are filed in a lawsuit against the Evan Fonfa Trust. In that lawsuit, the Trust raises a statute of limitations defense, based on its alleged status as a spendthrift trust, because:
- while a four-years statute of limitations normally applies to such claims;
- a two-years statute of limitations applies when the defendant is a valid and enforceable spendthrift trust; and
- the claims at issue in Snow v. Fonfa fall outside the two-years limitation but within the four-years limitation.
Q & A
So, the question in Snow v. Fonfa is this: can the Evan Fonfa Trust qualify as a spendthrift trust under state law?
And, the answer in Snow v. Fonfa is this: No.
Creating a Spendthrift Trust
According to Snow v. Fonfa:
- a spendthrift trust, by its terms, protects the trust’s assets from the claims of the beneficiary’s creditors;
- no specific language is necessary to create a spendthrift trust—instead, a spendthrift trust is created if, by the terms of the writing, the creator manifests an intention to create such a trust; and
- if the spendthrift provision is valid, neither the beneficiary nor the beneficiary’s creditors may reach the property within the trust.
When the Trustee and Beneficiary are the Same Person
The trust beneficiary, Evan, argues that the Evan Fanfa Trust is a valid spendthrift trust, even though he is both its trustee and its beneficiary—because the Trust instrument:
- contains a spendthrift provision; and
- imposes restraints on his ability to make distributions.
Evan, as Trustee and Beneficiary, contends that his position is supported by the ruling in In re Frei Irrevocable Trust, 133 Nev. 50, 390 P.3d 646 (Nev. 2017).
But the In re Frei opinion does not support him, says the Snow v Fonfa court:
- the Frei opinion holds that a spendthrift trust becomes invalid once a beneficiary is entitled to receive a conveyance of the trust principal—the beneficiary does not need to actually exercise the right of distribution, only possess it; and
- a spendthrift trust is not valid when the beneficiary, (i) has the “equivalence of ownership,” and (ii) can demand immediate distribution of the property.
Rationale
The rationale for such In re Frei rules is that a valid spendthrift trust restrains both the voluntary and involuntary attachments or distributions of a trust.
Such rules not only prevent creditors from attaching the beneficiary’s assets, but also restrains the beneficiary from distributing assets as well.
Courts are consistent on valid spendthrift trusts containing restraints on both voluntary and involuntary attachments or distributions of the trust assets. For example:
- a Florida bankruptcy court rules that, if a beneficiary exercises absolute dominion and control over the trust property, the trust can no longer be considered spendthrift; and
- a Minnesota bankruptcy court rules, (i) the purpose of a spendthrift trust is to protect the beneficiary from himself and his creditors, and (ii) the spendthrift trust fails where the beneficiary exercises dominion or control over the property of the trust.
Restraints on Distribution
As to Evan’s argument that the trustee can be the sole beneficiary when there are restraints on the power of distribution, his own motion contradicts his argument.
By inserting his first name, “Evan,” in the place of “trustee” and “beneficiary,” Evan’s own argument reads like this:
- “the Trust endows only [Evan] with the power to make distributions and explicitly precludes Evan, as beneficiary, from demanding that [Evan] make such distributions to him[self].”
Similarly, inserting Evan’s name into the language of the Trust instrument, in place of his “trustee” or “beneficiary” title, makes the language read like this:
- “[Evan] may, but shall not be required to distribute to any one or more of [Evan] and [Evan’s] descendants as much of the net income and principal of the trust as [Evan] may at any time and from time to time determine, in such amounts or proportions as [Evan] may from time to time select for the recipient’s health, education, maintenance or support in his or her accustomed manner of living. . . .”; and
- “Without limiting [Evan’s] discretion, [Evan] may consider the needs of [Evan] as more important than the needs of [Evan’s] descendants or of any other beneficiary.
So, while it may appear that restraints on distribution exist, the restraints are broadly defined and permit distribution for almost any reason. Indeed, the plain language of the Trust allows Evan to distribute funds to himself at “his discretion,” for “his needs,” and “without limitation.”
Further, the Nevada Supreme Court was clear in its Frei opinion:
- “once a beneficiary is entitled to have the trust principal conveyed to him or her . . . any spendthrift protection becomes invalid.”
And that is precisely the situation here.
Accordingly, while the Trust contains a spendthrift provision, it is not a valid spendthrift trust because it gives Evan, as trustee, the right to distribute trust funds to himself, as a beneficiary.
Resolution
Transfers to the Evan Trust in question are not subject to the special two-year statute of limitations because the Trust is not a valid spendthrift trust.
And since all the transfers in question occurred within four-years before the lawsuit was filed, Evan’s argument . . . that the fraudulent transfer claims are time barred by the special two-year statute of limitations for spendthrift trusts . . . must fail.
Conclusion
Good to know!
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