Carmack v. Reynolds

• Citation: 215 Cal.Rptr.3d 749,391 P.3d 625,2 Cal.5th 844
• Decision Date: 23 March 2017
• Docket Number: S224985
• Court: United States State Supreme Court (California)
• Parties: John M. CARMACK, as Trustee, etc., et al., Plaintiffs and Respondents, v. Rick H. REYNOLDS, Defendant; Todd A. Frealy, as Trustee in Bankruptcy, etc., Claimant and Appellant.

2 Cal.5th 844

391 P.3d 625

215 Cal.Rptr.3d 749

John M. CARMACK, as Trustee, etc., et al., Plaintiffs and Respondents,

v.Rick H. REYNOLDS, Defendant;

Todd A. Frealy, as Trustee in Bankruptcy, etc., Claimant and Appellant.

S224985

Supreme Court of California

Filed March 23, 2017

Finlayson Toffer Roosevelt & Lilly, Jesse S. Finlayson and Matthew E. Lilly, Irvine, for Claimant and Appellant.

Law Offices of David W. Meadows and David W. Meadows, Los Angeles, for Defendant.

The Eroen Law Firm and Robert C. Eroen for Plaintiffs and Respondents.

Liu, J.

Under the terms of a spendthrift trust established by his parents, defendant Rick H. Reynolds is entitled to receive over a million dollars, all to be paid out of trust principal. Reynolds filed for bankruptcy before the trust's first payment, and the bankruptcy trustee seeks to determine what interest the bankruptcy estate has in the trust. The trust is governed by California law, and as the United States Court of Appeals for the Ninth Circuit observed, the relevant statutory provisions are "opaque." (Frealy v. Reynolds (9th Cir. 2015) 779 F.3d 1028, 1029 (Frealy ).) Probate Code section 15306.5 appears to limit the bankruptcy estate to 25 percent of the beneficiary's interest; other provisions of the Probate Code suggest no such limitation. The Ninth Circuit asked us whether the Probate Code limits a bankruptcy estate's access to a spendthrift trust to 25 percent of the beneficiary's interest, where the trust pays the beneficiary entirely out of principal. We hold that the Probate Code does not impose such an absolute limit on a general creditor's access to the trust. With limited exceptions for distributions explicitly intended or actually required for the beneficiary's support, a general creditor may reach a sum up to the full amount of any distributions that are currently due and payable to the beneficiary even though they are still in the trustee's hands, and separately may reach a sum up to 25 percent of any payments that are anticipated to be made to the beneficiary.

I.

Reynolds's parents established the Reynolds Family Trust in 2005. The trust contains a spendthrift clause, providing that "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 creditor's [sic ] claim or legal process before actual receipt by the beneficiary." Reynolds's mother Patsy died in 2007. Following her death, Reynolds's father Freddie received all the trust's distributions until Freddie died in 2009.

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.

II.

A spendthrift trust is a trust that provides that the beneficiary's interest cannot be alienated before it is distributed to the beneficiary. Creditors of the beneficiary generally cannot reach trust assets while those assets are in the hands of the trustee, even if they have secured a judgment against the beneficiary. Rather, creditors must wait until the trustee makes distributions to the beneficiary. The law permits such trusts because donors have "the right to choose the object of [their] bounty" and to protect their gifts from the donees' creditors. (Canfield v. Security-First Nat. Bank (1939) 13 Cal.2d 1, 11, 87 P.2d 830 (Canfield ).) Providing donors some measure of control over their gifts encourages donors to make those gifts, to the benefit of the donor, the beneficiary, and ultimately the beneficiary's creditors.

Under the Probate Code, spendthrift provisions are generally valid as to both trust income and trust principal. (Prob. Code, §§ 15300 [trust income], 15301, subd. (a) [trust principal]; all statutory references are to the Probate Code unless otherwise noted.) Yet creditors need not always wait for distributions to reach the debtor's hands. Spendthrift provisions are invalid when grantors name themselves beneficiaries. (§ 15304, subd. (a).) When a trust includes a valid spendthrift provision, certain creditors may reach into the trust. Such creditors include those with claims for spousal or child support (§ 15305) and those with restitution judgments (§ 15305.5). In addition, a state or local public entity can reach trust assets when the beneficiary owes money for public support (§ 15306, subd. (a)) unless distributions from the trust are required to care for a disabled beneficiary (§ 15306, subd. (b)).

Even general creditors, including a bankruptcy trustee standing as a hypothetical lien creditor, have some recourse under three provisions: section 15301, subdivision (b) (section 15301(b) ), section 15306.5, and section 15307. The question here is how much access to trust principal a general creditor has under these provisions.

This is a question of statutory construction. We seek to "ascertain the intent of the lawmakers so as to effectuate the purpose of the statute." (Day v. City of Fontana (2001) 25 Cal.4th 268, 272, 105 Cal.Rptr.2d 457, 19 P.3d 1196.) "[W]e begin by looking to the statutory language. [Citation.] We must give ‘the language its usual, ordinary import and accord[ ] significance, if possible, to every word, phrase and sentence in pursuance of the legislative purpose. A construction making some words surplusage is to be avoided. The words of the statute must be construed in context, keeping in mind the statutory purpose, and statutes or statutory sections relating to the same subject must be harmonized, both internally and with each other, to the extent possible.’ [Citation.] If the statutory language is susceptible of more than one reasonable interpretation, we must look to additional canons of statutory construction to determine the Legislature's purpose. [Citation.] ‘Both the legislative history of the statute and the wider historical circumstances of its enactment may be considered in ascertaining the legislative intent.’ " (McCarther v. Pacific Telesis Group (2010) 48 Cal.4th 104, 110, 105 Cal.Rptr.3d 404, 225 P.3d 538.)

In construing the provisions at issue, we are mindful that the Reynolds Family Trust is distinctive in directing all disbursements to be made from principal. In other trusts, productive assets produce periodic income payments during the life of the trust, and preserving principal is one of the trustee's paramount duties. (See 76 Am.Jur.2d (2016) Trusts, § 429.) It is common for trusts to specify that the principal may not be distributed for many years, and liquidating principal may signal that the trust's purpose has been fulfilled. We are also mindful that this case arises out of a bankruptcy proceeding. Ordinarily, a judgment creditor who is unable to satisfy all of the judgment out of the beneficiary's trust interest may continue to attempt to collect on the balance of the judgment from whatever other assets the beneficiary may have. Here, however, the amount Reynolds's creditors will receive depends on the reach of the bankruptcy trustee. Any remaining debts after the bankruptcy process will be extinguished, and any further distributions will be unencumbered. (11 U.S.C. § 541(c)(2).) That spendthrift provisions can work to beneficiaries' advantage in bankruptcy in this way has long been recognized as a characteristic of such provisions. (See Rest.3d Trusts, § 58, com. a ["An important byproduct of the limited spendthrift protection, however, is the again limited but nevertheless important insulation that may result from a discharge in bankruptcy."].)

A.

We begin with section 15301(b), which provides in pertinent part: "After an amount of principal has become due and payable to the beneficiary under the trust instrument, upon petition to the court under Section 709.010 of the Code of Civil Procedure by a judgment creditor, the court may make an order directing the trustee to satisfy the money judgment out of that principal amount." Section 709.010 of the Code of Civil Procedure (section 709.010 ) sets forth the procedure for a judgment creditor to petition a court to satisfy the judgment out of the debtor's trust interests.

As the Ninth Circuit observed, the statute does not define "due and payable." (Frealy , supra , 779 F.3d at p. 1033.) The phrase is used in other provisions such as section 15305, which provides that creditors with judgments for child or spousal support may petition a court to satisfy their judgments out of disbursements of either income or principal "as they become due and payable, presently or in the future." (§ 15305, subd. (b).) Any disbursement from the trust would appear to be due and payable in the sense the phrase is used in section 15305. But, as the Ninth Circuit recognized, applying such a reading to section 15301(b) could mean that creditors have "immediate access to all of a beneficiary's trust principal," which...