In re Evans

• Decision Date: 05 August 1988
• Docket Number: Adv. No. 387-0118.,Bankruptcy No. 385-04092
• Citation: 88 BR 813
• Parties: In re Ross EVANS, Debtor. G. Rhea BUCY, Trustee, Plaintiff, v. Ross EVANS, Defendant.
• Court: U.S. Bankruptcy Court — Middle District of Tennessee

88 B.R. 813 (1988)

In re Ross EVANS, Debtor G. Rhea BUCY, Trustee, Plaintiff, v. Ross EVANS, Defendant.

Bankruptcy No. 385-04092, Adv. No. 387-0118.

United States Bankruptcy Court, M.D. Tennessee.

August 5, 1988.

Wallace Dietz, Bass, Berry & Sims, Nashville, Tenn., for defendant.

Linda Knight, Gullett, Sanford, Robinson & Martin, Nashville, Tenn., for plaintiff.

MEMORANDUM

KEITH M. LUNDIN, Bankruptcy Judge.

The question presented is whether the Chapter 7 trustee can use the "strong arm" power in § 544(a)(2) to penetrate a spendthrift trust where Tennessee law would permit the State of Tennessee as a (hypothetical) unsatisfied creditor to reach assets of the trust. The trustee cannot use § 544(a)(2) to assert the special status of the State.

This is a core proceeding. 28 U.S.C. § 157(b)(2)(A), (O). The following are findings of fact and conclusions of law. Bankr.R. 7052.

I.

In 1953, the debtor's father and uncle settled the "Clarendon Properties Trust," naming the debtor beneficiary with the right to trust income. At his death all assets of the trust are to be distributed to the debtor's children.

The debtor filed Chapter 7, and the bankruptcy trustee brought this complaint to capture the trust. The debtor defends that the trust is of the spendthrift variety and is beyond the trustee's reach. The parties disagree whether the formalities of Tennessee law were followed for creation of a spendthrift trust and whether subsequent actions by the debtor or by the bankruptcy trustee affect the validity of the trust.

On the debtor's motion for partial summary judgment, the trustee argues that the State of Tennessee as a hypothetical creditor with an execution returned unsatisfied could invade the debtor's trust, therefore, the bankruptcy trustee can "strong arm" the trust with § 544(a)(2).

II.

The bankruptcy estate includes "all legal or equitable interests of the debtor in property as of the commencement of the case." 11 U.S.C. § 541(a)(1). Section 541(a)(1) is broad and expands estate property beyond the transferability and leviability concepts of the Bankruptcy Act of 1938. United States v. Whiting Pools, 462 U.S. 198, 205, 103 S.Ct. 2309, 2313, 76 L.Ed.2d 515 (1983). See H.R.REP. NO. 595, 95th Cong., 1st Sess. at 367-68 (1977) (all interests of debtor included in estate); S.REP. NO. 989, 95th Cong., 2d Sess. at 82 (1978) U.S.Code Cong. & Admin.News 1978, pp. 5787, 5868, 6323 ("The scope of this paragraph is broad. It includes all kinds of property including tangible or intangible property, causes of action . . . and all other forms of property currently specified in section 70a of the Bankruptcy Act.").

Some legal and equitable interests of the debtor do not become property of the bankruptcy estate. These excluded interests are described in §§ 541(b), (c)(2) and (d). Section 541(c)(2) provides: "A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable non-bankruptcy law is enforceable in a case under this title."

Characterized by prohibitions against using trust income or corpus to satisfy creditors of the beneficiary, spendthrift trusts are "restrictions on the transfer of beneficial interests of debtors in a trust" protected in bankruptcy by § 541(c)(2). In re Daniel, 771 F.2d 1352, 1360 (9th Cir.1985); McLean v. Central State, Southeast and Southwest Areas Pension Fund, 762 F.2d 1204, 1206 (4th Cir.1985) (interests subject to enforceable transfer restrictions are not estate property); In re Lichsterahl, 750 F.2d 1488, 1489-90 (11th Cir.1985); In re Reagan, 741 F.2d 95, 97 (5th Cir.1984) ("spendthrift" restrictions are protected); In re Graham, 726 F.2d 1268, 1272 (8th Cir.1984) (§ 541(c)(2) preserves spendthrift trusts); In re Goff, 706 F.2d 574 (5th Cir. 1983); In re Ridenour, 45 B.R. 72 (E.D. Tenn.1984). See H.R.REP. NO. 595, 95th Cong., 1st Sess. at 369 (1977), U.S.Code Cong. & Admin.News 1978, p. 6325 ("Paragraph (2) of subsection (c), however, preserves restrictions on transfer of a spendthrift trust to the extent that the restriction is enforceable under applicable non-bankruptcy law."); Id. at 176, U.S.Code Cong. & Admin.News 1978, p. 6136 ("The bill . . . continues over from Act the exclusion from the estate of the debtor's interest in a spendthrift trust to the extent the trust is protected from creditors under applicable state law.").

The bankruptcy estate also contains "any interest in property that the trustee recovers under section . . . 550. . . ." 11 U.S.C. § 541(a)(3). Section 550(a) provides:

Except as otherwise provided in this section, to the extent that a transfer is avoided under section 544 . . . of this title, the trustee may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property. . . .

Tracing § 541(a)(3) through § 550 to § 544, the bankruptcy estate includes interests recovered under § 550, which includes property recovered pursuant to the "strong arm" powers in § 544(a).

Section 541(a)(3) states no limitation like the protection of spendthrift trusts in § 541(c)(2). Section 541(a)(3) potentially gathers into the estate property excluded by § 541(c)(2) if the property is recoverable by the trustee with a power listed in § 550. The trustee relies on § 544(a)(2):

The trustee shall have, as of the commencement of the case, . . . the rights and powers of . . .

(2) a creditor that extends credit to the debtor at the time of the commencement of the case, and obtains, at such time and with respect to such credit, an execution against the debtor that is returned unsatisfied at such time, whether or not such a creditor exists.

The trustee reasons that if a creditor with an execution returned unsatisfied could invade the debtor's trust, then the trustee can exercise that power under §§ 544, 550 and 541(a)(3).

The rights of a creditor with an execution returned unsatisfied are determined by state law. McAllester v. Aldridge (In re Anderson), 30 B.R. 995, 1000 (M.D.Tenn.1983). See H.R.DOC. NO. 137, 93d Cong., 1st Sess. pt. 1 at 194 (1973) ("Some reference to state law is still necessary to determine what is property of the debtor, in the absence of a federal law of property.").

III.

Spendthrift trusts are valid in Tennessee by statute but through a quirk of history can be invaded by the State as a creditor of the beneficiary.

In 1831, the Tennessee General Assembly abolished imprisonment for debt, leaving creditors without remedy at law if an execution returned unsatisfied. Creditors sought relief from the equity courts but it was uncertain whether equity had jurisdiction to levy on equitable interests in satisfaction of debt. See Brooks v. Raynolds, 59 F. 923, 939 (6th Cir.1893); McKeldin v. Gouldy, 91 Tenn. 677, 20 S.W. 231 (1892). See also Malone, T.H., "Distinctive Features of the Tennessee Law of Trusts," 16 TENN.L.REV. 33 (1939); Comment, "Spendthrift Trusts in Tennessee," 35 TENN.L.REV. 319 (1978).

In 1832, the General Assembly amended the "1831 Act" to grant equity courts jurisdiction to levy on equitable property interests, excluding the assets of certain kinds of trusts. Presently codified at TENN. CODE ANN. § 26-4-101(a), the "1832 Amendment," states:

The creditor whose execution has been returned unsatisfied, in whole or in part, may file a bill in the chancery court against the defendant in the execution, and any other person or corporation, to compel the discovery of any property, including stocks, choses in action or money due to such defendant, or held in trust for him, except when the trust has been created by, or the property so held has proceeded from some person other than the defendant himself, and the trust is declared by will duly recorded or deed duly registered.

(emphasis added).

Specific spendthrift restrictions are not required to bring a trust within the safe harbor of the "1832 Amendment" — all trusts meeting the appropriate formalities are functionally "spendthrift trusts" in Tennessee. White v. O'Bryan, 148 Tenn. 18, 251 S.W. 785, 791 (1923); First Nat'l Bank v. Nashville Trust Co., 62 S.W. 392, 402 (Tenn.App.1901); Porter v. Lee, 88 Tenn. 782, 14 S.W. 218, 220 (1890); Henson v. Wright, 88 Tenn. 501, 12 S.W. 1035 (1890).

In 1943 the General Assembly amended the "1832 Amendment" to authorize the State of Tennessee to levy on the corpus of a spendthrift trust when the State is a judgment creditor with an execution returned unsatisfied. The 1943 legislation was part of Tennessee's effort to collect a $4,000,000 judgment from a defendant whose only assets were in trusts protected by the 1832 Amendment. State v. Caldwell, 181 Tenn. 74, 178 S.W.2d 624 (1944).¹ This statutory exception to the usual protection of spendthrift trusts reads:

Where the State of Tennessee shall be such a judgment creditor, the Chancery Court shall have jurisdiction to subject such property to the satisfaction of the claims of the state, despite the fact that the trust has been created or the property so held has proceeded from some person other than the defendant himself and the trust declared by will duly recorded or deed duly registered.

TENN.CODE ANN. § 26-4-101(b).

IV.

The scant case law has repelled efforts by bankruptcy trustees to invade spendthrift trusts. On various theories, trustees have been forbidden to exercise rights against spendthrift trusts that are reserved by state law to unique or preferred classes of creditors.

One hundred thirteen years ago, the United States Supreme Court explained the policies served by protecting spendthrift trusts from bankruptcy encroachments. In Nichols v. Eaton, 91 U.S. 716, 23 L.Ed. 254 (1875), the terms of a trust forfeited the beneficiary's right to income upon bankruptcy. The assignee in bankruptcy of the beneficiary argued that the trust was void because it defeated the legitimate claims of the beneficiary's creditors. The Supreme Court disagreed declaring that the settlor of the trust...