Opinion ID: 2784748
Heading Depth: 3
Heading Rank: 2

Heading: Facts Of Our Case

Text: Appellee Rick Reynolds is a beneficiary of the Reynolds Family Trust, which contains the following spendthrift provision: “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 [a] creditor’s claim or legal process before actual receipt by the beneficiary.” The trust is composed of three subtrusts—the Bypass Trust, the Marital Trust and the Survivor’s Trust. Thirty days after his father’s death in 2009, Reynolds became entitled to $250,000 from the Bypass Trust, $100,000 a year for ten years from the Survivor’s Trust and one-third of the residue of the Survivor’s Trust thereafter. All, or substantially all, of these distributions will be made from trust principal, as the trust assets are not expected to generate income. The day after his father died, Reynolds filed a voluntary Chapter 7 bankruptcy petition. The trust trustee subsequently filed an adversary proceeding asking the bankruptcy court to determine what interest, if any, the bankruptcy estate has. Reynolds filed a motion for partial summary judgment, arguing that section 15306.5 limits the bankruptcy estate to 25 percent of his interest in the spendthrift trust. The FREALY V. REYNOLDS 9 bankruptcy trustee countered that the estate is entitled to more than 25 percent because section 15301(b) gives creditors unrestricted access to distributions of principal “due and payable,” and all of Reynolds’s distributions from the trust were expected to be made from principal. Alternatively, the bankruptcy trustee argued that section 15307 allows the bankruptcy estate to reach any amount of Reynolds’s trust interest not deemed necessary for his education and support. The bankruptcy trustee viewed sections 15306.5, 15301(b) and 15307 as independent routes that a creditor could use in gaining access to a beneficiary’s trust interest. The bankruptcy court ruled in favor of Reynolds and held that section 15306.5 establishes an “absolute maximum cap on what is recoverable by a judgment creditor at 25 percent.” Although it acknowledged that “[t]here may be an exception to [the 25 percent cap] under 15301(b),” the court “cho[]se not to follow that interpretation.” The bankruptcy court also rejected the argument that its reading rendered section 15307 superfluous, explaining that, under section 15307, “[a creditor doesn’t] even necessarily get all of [the 25 percent] if [the trust trustee] can show that [that amount] is necessary for support.” A divided Ninth Circuit Bankruptcy Appellate Panel affirmed the bankruptcy court, though the majority took a different approach. The BAP read section 15301(b) as merely setting forth the procedure that a creditor must follow to satisfy a claim from the principal of a spendthrift trust once such principal is payable but not yet distributed to the beneficiary. It refused to read section 15301(b) as allowing a creditor to reach the entirety of principal due and payable, reasoning that doing so would “effectively eviscerate[] the spendthrift protection recognized by 15301(a).” It also 10 FREALY V. REYNOLDS pointed to the exceptions contained in sections 15304–07 as reflecting a “policy recognition that certain creditors should have greater rights to a beneficiary’s interest in order to satisfy their claims,” and noted that it would run counter to this policy to read section 15301(b) as allowing any creditor to similarly satisfy claims from trust principal. In considering section 15307, the BAP reasoned that, if sections 15307 and 15306.5 were separate avenues for collection, “15306.5 would make no sense: Why would a judgment creditor ever choose to satisfy its claim under 15306.5, which is limited not just by the 25% cap on the beneficiary’s interest but by the needs of the debtor and his or her dependents, when 15307 is only limited by the debtor’s own educational and support needs?” The BAP concluded that section 15307 doesn’t apply to this case because the more plausible reading, and the one most aligned with the legislative intent, is that it only limits a creditor’s access to income, and not principal. The dissent, by contrast, “d[id] not believe the California legislature intended that a debtor, without exception, should have access to potentially large distributions of cash from a trust not needed for his support or education in preference to the legitimate claims of his creditors.” It viewed sections 15301(b) and 15307 as playing a “critical role in protecting creditors’ rights” by allowing “creditors, in some cases, to reach some, or perhaps even all, . . . distributions” for which beneficiaries have “no legitimate need.”