Imperfect Grafts: Legislative and Judicial Additions to California Probate Code Sections 15300 Et Seq.

• Publication year: 2019
• Author: By L. Paul Ohainle, Esq.

IMPERFECT GRAFTS: LEGISLATIVE AND JUDICIAL ADDITIONS TO CALIFORNIA PROBATE CODE SECTIONS 15300 et seq.

By L. Paul Ohainle, Esq.^*

"The subject of spendthrift trusts makes [people] get red in the face and talk loudly."

Professor Orrin B. Evans (1955)¹

I. INTRODUCTION

A spendthrift trust is intended to prevent both the voluntary and involuntary transfer of a beneficiary's interest in a trust. Jurisdictions across the country struggle with the fundamental question surrounding such trusts: What creditor protections should be afforded to a beneficiary of a spendthrift trust? California permits spendthrift trusts subject to certain limitations as set forth in California Probate Code sections 15300, et seq. Spendthrift trust law underwent a number of statutory changes in the 1980's as the answer to the fundamental question changed and spendthrift protections were relaxed in a number of ways. The fallout from the changes—and attempted corrections—in the 1980's eventually garnered the attention of the Bankruptcy Appellate Panel ("BAP"), of the Ninth Circuit Court of Appeals ("Ninth Circuit"), and the Supreme Court of California when spendthrift trust beneficiary Rick Reynolds filed for bankruptcy in 2009. The decisions in the Reynolds case demonstrate the problem that was created with the Legislature's addition of Probate Code section 153 06.5² in 1986 without reconciling it with Probate Code section 15307.³

The contradiction in the law came to light in 2012 when the BAP examined Probate Code sections 15301,⁴ 15306.5, and 15307 to determine whether a general creditor of a trust beneficiary could reach future principal distributions from a spendthrift trust in In Re Reynolds ("Reynolds").⁵ The BAP had difficulty determining how Probate Code section 15306.5, with its broader beneficiary support protections and additional 25% cap, could co-exist with Probate Code section 15307, with its narrower beneficiary support protection and no cap. Probate Code section 15306.5 appeared to be too favorable for beneficiaries, and too limiting for creditors, thereby rendering it useless. The BAP reconciled these two sections by remaining true to the history of long-standing spendthrift trust principles embodied in Probate Code section 15307 and in the predecessor statute by concluding that Probate Code section 15307 did not apply to principal distributions and that Probate Code section 15306.5 applied to distributions of income and principal. An appeal was made to the Ninth Circuit which, in turn, certified the question to the Supreme Court of California, stating:

A substantial sum of money hangs in the balance, as the beneficiary stands to lose—and the bankruptcy estate stands to gain—the entirety of his trust interest. Their fate, and the fates of future beneficiaries and their creditors, hinges on the interpretation of opaque sections of the Probate Code. Because the resolution of this appeal could transform the terrain of California trust law, we respectfully request that the California Supreme Court exercise its discretion to accept and decide the certified question below.⁶

The Supreme Court of California did not reconcile Probate Code sections 15306.5 and 15307. Instead, the Supreme Court of California concluded that the enactment of Probate Code section 15307 in its present form was "inadvertent."⁷ In doing so, the Court overturned long-standing spendthrift trust principles that had been maintained, uninterrupted, for over one hundred years.⁸

This article has three parts. Part one summarizes spendthrift trust law in California, with special attention to the turbulent 1980's, as it relates to Probate Code sections 15301, 15306.5, 15307 and their predecessor statutes. Part two discusses the Reynolds's facts and the above-referenced decisions. Part three attempts to accomplish what the courts failed to do—reconcile Probate Code sections 15306.5 and 15307. This reconciliation, however, only supports the call for a legislative solution to a legislatively created problem and the corresponding judicial (over) reaction.

II. PART ONE: SUMMARY OF SPENDTHRIFT TRUST LAW IN CALIFORNIA

For over one hundred years, former California Civil Code section 867⁹ permitted limited "spendthrift" trusts. The limitations were imposed by former Civil Code section 859. Under Civil Code section 859, a creditor was permitted to reach the income of a spendthrift trust that was distributed to a debtor/beneficiary that exceeded the support and education needs of the beneficiary and those dependent on the beneficiary.¹⁰ While excess income was clearly subject to a creditor's claim, the law relating to principal during this time was "unclear."¹¹ Accordingly, prior to 1984, at least the income of a spendthrift trust was protected for a beneficiary's (and those dependent on the beneficiary) education and support needs.

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In 1982, the California legislature enacted a comprehensive statute concerning the enforcement of judgments. Newly added Code of Civil Procedure section 709.010 set forth the mechanism for enforcing a judgment against a debtor/ beneficiary's interest in a trust. As originally enacted, Code of Civil Procedure section 709.010 did not alter the protections previously afforded a beneficiary of a spendthrift trust. Instead, Code of Civil Procedure section 709.010 merely referred to Civil Code section 859 and a spendthrift trust beneficiary's (and the beneficiary's dependents) support and education needs remained protected.¹²

The spendthrift trust beneficiary's protections that existed under Civil Code section 859 were weakened and the rights of general creditors strengthened by a 1984 amendment to Code of Civil Procedure section 709.010. The reason for the change in the law is stated in the Law Revision Commission Report: "To provide more protection from creditors for beneficiaries of inherited wealth than is provided for wage earners is a discrimination that can no longer be tolerated."¹³

Code of Civil Procedure section 709.010, as amended in 1984, eroded the protections afforded a beneficiary of a spendthrift trust by giving a creditor access to distributions that were based on wage garnishment law, instead of Civil Code section 859.¹⁴ The wage garnishment law included preferences for spousal and child support creditors ("support creditors"). In addition, the wage garnishment law, at that time, permitted a general creditor to reach monthly payment amounts that were over $435.50, up to $580.66; and one-fourth (or 25%) of the amount payable where monthly payments exceed $580.66.¹⁵

The 1984 version of Code of Civil Procedure section 709.010 made no distinction between income and principal. Instead, the section used the term "periodic payments." As noted previously, the law relating to creditor's rights with respect to distributions of principal from spendthrift trusts was "unclear." With the 1984 amendment, spendthrift trusts no longer completely protected a beneficiary's education and support, and principal "payments" were subject to creditor's claims.

The following examples demonstrate how the 1984 version of Code of Civil Procedure section 709.010 (the predecessor to Probate Code section 15306.5) and Civil Code section 859 (the predecessor to Probate Code section 15307) could co-exist.

Example #1. Assume that a trust's terms state that it pays as much income to the beneficiary as is necessary for the beneficiary's support. There are to be no distributions in excess of the beneficiary's support and any excess income is accumulated and added to principal.

In a departure from the past, under the 1984 version of Code of Civil Procedure section 709.010, the creditor could now reach an amount determined under the wage garnishment law, even if this meant that the beneficiary's support and educational needs were not entirely met. If the creditor sought recovery under Civil Code section 859, the creditor could not attach the distributions because they were limited under the terms of the trust to the beneficiary's support. In summary, Code of Civil Procedure section 709.010 provided a limited recovery to a general creditor when Civil Code section 859 provided no recovery.

Example #2. Assume that the trust provides that it pays the beneficiary all the net income of the trust and assume that such income greatly exceeds the beneficiary's support needs.

Under the former law, a creditor would seek relief under Civil Code section 859 and recover the income distributed to the beneficiary that greatly exceeded the beneficiary's support needs. This would be preferred to seeking relief under Code of Civil Procedure section 709.010 that included a limit of no more than 25% of the distribution. In summary, a creditor, like any creditor from the preceding hundred years, would prefer to seek recovery under Civil Code section 859 as the excess income is more than the amount determined under Code of Civil Procedure section 709.010's wage garnishment calculation.

In 1985, it appeared that the significant change brought on by Code of Civil Procedure section 709.010 would be temporary. The California Law Review Commission ("Commission") had already undertaken the task of revising the Probate Code, including the law regarding spendthrift trusts. The Commission recommended a new statute that provided explicit spendthrift protection to principal, endowed support creditors with preferred rights as set forth in current Probate Code sections 15304, 15305, and 15306,¹⁶ and returned general creditors to their status under the pre-1984 law where a beneficiary's support and education needs were protected, among other things.¹⁷ Pre-1984 law included Civil Code section 859 that afforded general creditors access to income distributions that exceeded the beneficiary's (and the beneficiary's dependents) support and education needs.

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Probate Code sections 15300 et seq., as proposed in 1985, included Probate Code section 15307, but not Probate Code section 15306.5. Accordingly, as proposed, a...