First Northwestern Trust Co. of South Dakota v. I.R.S.

• Decision Date: 03 June 1980
• Docket Number: No. 79-1868,79-1868
• Citation: 622 F.2d 387
• Parties: , Bankr. L. Rep. P 67,465 FIRST NORTHWESTERN TRUST COMPANY OF SOUTH DAKOTA, a corporation and successor in interest to Trust Department of First National Bank of the Black Hills, Appellee, v. INTERNAL REVENUE SERVICE, Department of the Treasury of the United States of America, Appellee, Robert A. Warder, as Trustee of Paul Lex Quarnberg Bankruptcy, Appellant. Paul Lex Quarnberg, Margaret Lorraine Quarnberg, Douglas Allen Quarnberg and Elizabeth Quarnberg, Appellees.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 387

622 F.2d 387

6 Bankr.Ct.Dec. 502, Bankr. L. Rep. P 67,465

FIRST NORTHWESTERN TRUST COMPANY OF SOUTH DAKOTA, a

corporation and successor in interest to Trust

Department of First National Bank of the

Black Hills, Appellee, v. INTERNAL REVENUE SERVICE, Department of the Treasury of the

United States of America, Appellee,

Robert A. Warder, as Trustee of Paul Lex Quarnberg

Bankruptcy, Appellant.

Paul Lex Quarnberg, Margaret Lorraine Quarnberg, Douglas

Allen Quarnberg and Elizabeth Quarnberg, Appellees.

No. 79-1868.

United States Court of Appeals,

Eighth Circuit.

Submitted April 16, 1980.

Decided June 3, 1980.

Wayne F. Gilbert, Gunderson, Farrar, Aldrich, Warder & DeMersseman, Rapid City, S. D., for appellant.

George Beal, Rapid City, S. D., for appellee, First Northwestern Trust Co., etc.

Karl Schmeidler, Atty., Tax Div., Dept. of Justice, Washington, D. C., argued; M. Carr Ferguson, Asst. Atty. Gen., Gilbert E. Andrews, Crombie J. D. Garrett, and Joan I. Oppenheimer, Washington, D. C., and Terry L. Pechota, U. S. Atty., Sioux Falls, S. D., on brief, for appellee, IRS.

Before LAY, Chief Judge, ROSS, Circuit Judge, and LARSON, District Judge. ^*

ROSS, Circuit Judge.

First Northwestern Trust Company of South Dakota, the trustee of the Paul Lex Quarnberg Family Trust, initiated this action for a declaratory judgment of the rights, liabilities, obligations and entitlements of the named party defendants to the income of the trust. In particular, First Northwestern sought judicial determination of the issue of whether the trustee in bankruptcy of one of the beneficiaries of a discretionary spendthrift trust succeeds to that beneficiary's interest in the income of the trust.

The trust agreement in question was executed in 1970 by C. A. Quarnberg. It established an irrevocable trust in the amount of $250,000 to provide for the necessary and ordinary living expenses of the Paul Lex Quarnberg family, and to provide for the educational expenses of the children. The agreement contained a spendthrift clause ¹ and several provisions granting the trustee the authority to distribute the income of the trust in a discretionary fashion.

On May 22, 1973, Paul Lex Quarnberg and his wife, Margaret, entered into two agreements with the Internal Revenue Service, assigning portions of their income payments from the trust to satisfy their federal tax liabilities. On June 29, 1973, upon the petition of the trustee for directions, the South Dakota Circuit Court for the Seventh Judicial Circuit approved the agreements and ordered First Northwestern's predecessor in interest to disburse to the IRS those portions of the trust income which normally would be paid to Paul Lex Quarnberg and Margaret Quarnberg in accordance with the terms of the trust agreement.

On January 31, 1979, Paul Lex Quarnberg filed a voluntary petition in bankruptcy, listing debts of over $400,000 and assets of less than $5,000. Robert A. Warder, the appellant in this action, was named trustee in bankruptcy. On February 28, 1979, Warder requested that First Northwestern pay to him all of the trust income, including that portion assigned to the IRS, for distribution to the creditors of Paul Lex Quarnberg. First Northwestern filed this suit to determine the rights of each of the parties to the trust income. Robert Warder, the IRS and the Quarnbergs, as beneficiaries of the trust, were all named as defendants.

In the district court proceedings, ² Warder claimed that the title to the proceeds of the trust had passed to him, in his capacity as trustee in bankruptcy, pursuant to section 70(a) of the Bankruptcy Act, 11 U.S.C. § 110(a). ³ In its Judgment and Order of August 13, 1979, however, the district court ruled that Warder had succeeded to no rights in the trust income:

It appears to the Court that the above-mentioned trust is a spendthrift trust under which the Plaintiff, as trustee, has control over the disbursement of the trust funds. Furthermore, Defendant Paul Lex Quarnberg, the bankrupt, has no vested right in the trust which allows him to transfer or assign any rights to the trust income. As such, the Defendant Trustee in Bankruptcy has no right to the trust income.

Warder appeals from the final decision of the district court. ⁴

On appeal, Warder again raises the argument that the income disbursements from the trust are "property" of the bankrupt within the meaning of § 110(a)(5) of the Bankruptcy Act, and that the entire interest in that income should have passed to the trustee in bankruptcy in accordance with the terms of the Act. Warder offers three separate theories in support of this contention.

Under the first theory, Warder claims to have succeeded in interest to the proceeds of the trust because assignments of the trust income to the IRS have already been approved and confirmed by the South Dakota Circuit Court. Therefore, according to the argument, the proceeds are property which the bankrupt could "by any means have transferred" within the meaning of § 110(a) (5). Warder further suggests that the holding in that case binds this court to the conclusion that the proceeds of the trust are "assignable" by virtue of the doctrine of res judicata, and that the parties to this law suit are estopped from challenging the validity of that decision because they were participants in the state court proceeding. Second, Warder claims that the South Dakota Supreme Court, which has not in any previous case ruled upon the issue, would not enforce the spendthrift trust provision in the subject trust. Finally, Warder suggests that the same principles which operate to make the proceeds of a spendthrift trust available for the attachment of a federal tax lien apply equally to bankruptcy proceedings.

Warder's first theory is without merit. In arguing that the South Dakota Circuit Court has already determined that the proceeds of the Paul Lex Quarnberg Family Trust are "assignable" and that this court is bound by that decision in the disposition of this appeal, Warder fails to give due consideration to the well established legal principle that the income from a spendthrift trust is not immune from federal tax liens, notwithstanding any state laws or recognized exemptions to the contrary. Leuschner v. First Western Bank and Trust Co., 261 F.2d 705, 707 (9th Cir. 1958); United States v. Dallas National Bank, 152 F.2d 582, 585 (5th Cir. 1945). The same is true even where, as in the present case, the elements of a spendthrift trust are combined with provisions granting discretionary powers of distribution to the trustee:

Whether the trust was created by the taxpayer or by a third party, no spendthrift clause in the instrument itself and no exemption provided by state law can immunize such beneficial rights from the federal tax collector. If the taxpayer's rights are subject to the discretion of the trustee, the tax collector can reach whatever the trustee elects to distribute * * *.

Plumb, Federal Liens and Priorities Agenda for the Next Decade II, 77 Yale L.J. 605, 617 (1968). Accordingly, it is reasonable to conclude that the South Dakota Circuit Court decision affirming the agreements between the Quarnbergs and the IRS was founded upon this narrow legal principle relating to federal tax liens, especially where there is no evidence to indicate that the district court even reached the issue of whether the proceeds of the trust are, for general purposes, "assignable." Warder has thus failed in his burden of proving that the South Dakota decision and the present appeal are based on the same cause of action, and therefore the doctrine of res judicata is in no way binding on this court or the parties before it in the present appeal. Howard v. Green, 555 F.2d 178, 181 (8th Cir. 1977).

This conclusion is supported by our review of the case law involving similar claims of creditors. Most courts which have faced the issue before us have held that "a spendthrift restriction is valid and prevents property subject to the restriction from being alienated or subject to levy." Mickelson v. Detlefsen, 466 F.Supp. 161, 164 (Minn.1979). Therefore, as long as property is held in trust and is subject to the terms of a spendthrift provision, the general rule is that the property may not be reached by the creditors of a beneficiary of that trust. Once the proceeds are distributed to the beneficiaries, of course, they escape the protection of the clause and may be reached by creditors. But the general rule which protects funds held in trust from the creditors of a beneficiary of a spendthrift trust is even applicable in the context of bankruptcy proceedings:

The effect of the trust provision is that upon the bankruptcy of the beneficiary his equitable interest in the income and principal of the trust estate, being non-assignable and immune from judicial process under (state) law, does not pass to the trustee of the bankruptcy estate, under Section 70(a) (5) of the Bankruptcy Act, 11 U.S.C. § 110(a)(5), and title remains in the trustee of the spendthrift trust.

In re Ahlswede, 516 F.2d 784, 786 (9th Cir.), cert. denied, 423 U.S. 913, 96 S.Ct. 218, 46 L.Ed.2d 142 (1975). See Eaton v. Boston Safe Deposit & Trust Company, 240 U.S. 427, 36 S.Ct. 391, 60 L.Ed. 723 (1916). We point out also that the broad discretionary powers of the trustee under the agreement in this case represent to us a further restraint upon the ability of the beneficiaries of this trust to assign or in any manner to alienate the income or the principal of the trust, and represents as well a further immunity from judicial process. See Brownell v. Leutz, 149 F.Supp. 98, 103 (N.D.1957). Consequently, we find it highly unlikely that the South Dakota Circuit Court determined that the proceeds of the Paul Lex Quarnberg Family Trust are "assignable" for any purpose other than to satisfy federal tax liabilities.

The generally accepted rule which favors the enforcement of spendthrift trust provisions is not without...