Spendthrift Trust Corpus Not Part of Bankruptcy Estate, Testamentary Spendthrift Trust Income Disbursements Made More Than 180 Days After Date of Petition Not Part of Bankruptcy Estate — By Dan Lake

Massillon v. Riley (In re Massillon), No. MB 10-024, 2011 Bankr. LEXIS 83 (B.A.P. 1st Cir. Jan. 11, 2011)

In an unpublished decision, the United States Bankruptcy Appellate Panel for the First Circuit reversed a Bankruptcy Court decision, which ordered that post-petition disbursements of trust income become part of the debtor’s estate.  At issue was whether a debtor’s interests in a testamentary spendthrift trust created under New York law could become property of the bankruptcy estate.  The BAP held that income disbursements from a testamentary spendthrift trust received by the debtor within 180 days after the date of petition became part of the estate, while exempting a spendthrift trust’s corpus and all other post-petition testamentary spendthrift trust income disbursements.

The BAP first determined that the corpus of the spendthrift trust was not part of the debtor’s estate.  Under Section 541(c)(2) of the Bankruptcy Code, the inalienability of a debtor’s interest in a spendthrift trust is fully enforceable in a bankruptcy proceeding.  Accordingly, if the BAP found that the trust at issue was a spendthrift trust, the panel would exclude the debtor’s interest in the corpus from the estate.  Under New York law, all express trusts are spendthrift, unless the settlor provides otherwise.  Because the settlor of the trust did not expressly provide otherwise, the BAP agreed with the Bankruptcy Court’s determination of a spendthrift trust and excluded the corpus from the debtor’s estate.

The second issue was whether distributions of income from the testamentary spendthrift trust would become property of the debtor’s estate.  Section 541(a)(5)(A) of the Bankruptcy Code provides that any interest that the debtor acquires by bequest, devise, or inheritance within 180 days after the date of filing becomes part of the estate.  Therefore, the BAP held that any distributions of income by a testamentary spendthrift trust within 180 days after filing became property of the debtor’s estate. 

The BAP also held that distributions of testamentary spendthrift trust income after the 180 day period are not part of the bankruptcy estate.  A New York statute, N.Y. C.P.L.R. 5205(d)(1), provides that a creditor can receive only ten percent of a judgment debtor’s trust income distributions to satisfy a money judgment.  The bankruptcy court found this statute to be an exemption statute because it restricts creditors but not a debtor’s ability to alienate.  The trustee argued that the debtor could not take advantage of the state exemption, as the debtor had already applied for federal exemptions.  The bankruptcy court agreed with the trustee and held that future trust income distributions would be part of the estate because the debtor could not stack exemptions.  The bankruptcy court failed to address Section 541(a)(5)(A), however, because the court held that the debtor’s right to trust distributions became fixed pre-petition and that all future distributions were therefore part of the estate under Section 541(a)(1).  On appeal, the BAP noted that courts in three cases had applied N.Y. C.P.L.R. 5205(d)(1) in a bankruptcy context.  These cases held that ten percent of all future disbursements of trust income became part of the debtor’s estate.  However, none of the case law considered the New York statute in light of Section 541(a)(5)(A).  Congress only enacted one provision that brought a post-petition entitlement into a debtor’s estate, and holding that future trust distributions are part of the estate under Section 541(a)(1) would make Section 541(a)(5)(A) superfluous.  The BAP did not address the exemption stacking argument because the debtor did not claim an exemption under N.Y. C.P.L.R. 5205(d)(1).

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