April 19, 2017

Mr. Reynolds encountered debt problems at a very inconvenient time. He had inherited a trust with multiple millions of dollars in it from his parents when they died. The very thought of such new found wealth going to pay multiple creditors can leave a bad taste in one’s mouth. Mr. Reynolds was hopeful that he could file for Chapter 7 bankruptcy relief from his debts while still being able to receive sizable distributions from the trust his parents had created for him.

In California, once a trust is required to pay a principal distribution to a beneficiary (regardless of whether it has been distributed), the probate laws allow a creditor to attach 25% of those mandated distribution amounts to the extent they exceed the beneficiary’s support and educational needs. The Supreme Court of California however on March 23, 2017 in the matter of John M. Carmack v. Rick H. Reynolds (C.D. Cal. Bankr. Nos. 09-14039 MJ, 09-1205-MJ), held that the creditor can attach all the required distributions once they are due under the terms of the trust. The reasoning the Court used was that if the trust mandates that certain amounts of principal be distributed currently, the trust must have no longer intended such amounts to be protected.

The above-mentioned 25% limitation on attachment of trust distributions, per the Court, applies only to future distributions that will be due sometime later down the road per the terms of the trust, and then only to the extent such future amounts exceed the beneficiary’s support and educational needs. In essence, the creditor can attach 25% of those anticipated distributions as they are paid out. Of course, once those future payments become currently distributable, the creditor can again petition to court to get the remaining 75% of those-currently-payable distributions.

If this trust had been drafted differently so that the distributions to Mr. Reynolds were more permissive as opposed to being forced out under the trust’s terms, this could have worked out much better for Mr. Reynolds, and could have maximized the asset protection.

 

By Edward D. Brown, Esq., CPA, LLM

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