IN RE: BERTHA C. WRIGHT CASE NO. 93-50224

UNITED STATES BANKRUPTCY COURT 

FOR THE EASTERN DISTRICT OF KENTUCKY

LEXINGTON DIVISION

IN RE:

BERTHA C. WRIGHT CASE NO. 93-50224

DEBTOR

MEMORANDUM OPINION

The issue before the court is to what extent the debtor's interest in the Warren Wright, Jr. Testamentary Trust is property of the estate.

FINDINGS OF FACT:

Counsel for the trustee and the debtor have filed a stipulation of facts as follows:

1. Warren Wright, Sr. ("Wright Senior") died on December 28, 1950, leaving a surviving spouse, Lucille Parker Wright (later Markey) and a son, Warren Wright, Jr. ("Wright Junior"). A true copy of the Last Will of Warren Wright, Sr. is attached and agreed upon as Joint Exhibit 'A.'

2. In his will, Wright Senior established two trusts, an Income Trust and a Residuary Trust, of which Wright Junior was a beneficiary. In Wright Senior's will, Wright Junior was given a special testamentary power of appointment over 3/5 of the remainder of the Income Trust and 1/2 of the remainder of the Residuary Trust, which power of appointment was exercisable in favor of a limited class composed of Wright Junior's widow and surviving descendants.

3. Wright Junior was married to Bertha C. Wright and had four children: Warren III, Thomas, Lucille (Cindy) Lundy, and Courtney Wright Lancaster. Wright Junior died testate, a resident of Lexington, Kentucky on May 19, 1978, leaving his spouse, children and grandchildren as descendants. A true copy of the Last Will of Warren Wright, Jr. is attached and agreed upon as Joint Exhibit 'B.' In that Will, Wright Junior appointed his remainder interests in the Income and Residuary Trusts to a trust created in Article V of Wright Junior's Will ("Article V Trust").

4. Upon Wright Junior's death in May 1978, his power of appointment as to the property in both the Income and Residuary Trusts was exercised. Pursuant to this exercise, the Chicago bank which was Executor/Trustee of the Estate of Wright Senior transferred funds from the Income Trust to Second National Bank, a Trustee under the Will of Warren Wright, Jr., in the approximate sum of $449,888.00, which sum was used to fund the Article V Trust.

5. Lucille Parker Wright Markey survived her son and died a resident of Florida on July 24, 1982. Upon her death, the power of appointment which Wright Junior had exercised in his will with respect to the Residuary Trust became effective. Pursuant thereto, in 1983, Second National Bank, as Trustee under the Will of Warren Wright, Jr., received oil an gas assets from the Residuary Trust then worth approximately $40 million. These assets were used to fund the Article V Trust.

6. Under the terms of the Article V Trust, Bertha C. Wright is to receive the net income derived from the Article V Trust until her death. Upon her death, the remainder of the Article V Trust is to be distributed among Wright Junior's children and grandchildren "in such shares and interests among those selected as my wife shall by her Last Will and Testament provide." The parties agree that this is a special testamentary power of appointment limited to a class of Wright Junior's children and grandchildren.

7. Mrs. Wright's income from the Warren Wright, Jr. Trust in 1992 was approximately $673,279.00.

8. In litigation initiated in September 1985 in the Fayette Circuit Court, Third Division, both Second National Bank and the Debtor and her children agreed the trust was a spendthrift trust under Kentucky law. In that litigation, Judge Armand Angelutcci [sic] held, on a motion for summary judgment, that the Warren Wright, Jr. Testamentary Trust could not be terminated under Kentucky law. A true copy of his Opinion and Order dated August 5, 1987 is attached as Joint Exhibit 'C'.

9. Pursuant to an interim agreement, the income payments from the Article V Trust becoming payable during the next twelve (12) months following the filing of the petition are presently being allocated between the debtor and the Chapter 7 Trustee, fifty percent of such payments to each, without prejudice to either's right to seek reimbursement in accordance with this Court's ruling on the section 541 questions of law herein."

Stipulations, August 16, 1993.

The court makes the following additional findings of fact.

The Last Will and Testament of Warren Wright, Sr. established two trusts: an income trust and a residuary trust.

Section FIFTH paragraph (b) of the Last Will and Testament of Warren Wright, Sr. provided for the creation of an income trust and further provided that on the death of Warren Wright, Jr. up to but not in excess of three-fifths (3/5) of the income trust estate shall go to the surviving widow of Warren Wright, Jr. (Bertha Wright) or to any of Warren Wright, Jr.'s surviving descendants "upon such terms, outright or in trust, and in such shares and interests among those selected, as my son, WARREN WRIGHT, JR., shall in and by his Last Will and Testament provide." (emphasis added).

Section EIGHTH of the Last Will and Testament of Warren Wright, Sr. established a residuary trust. The net income from the trust was payable during her life to the widow of Warren Wright, Sr., Lucille Parker Wright (later Markey). Section EIGHTH paragraph (d) provided that if Warren Wright, Jr. predeceased Lucille Parker Wright then upon the death of Lucille Parker Wright up to one-half (1/2) of the remainder of the Residuary Trust shall go to the surviving widow of Warren Wright, Jr. (Bertha Wright) or to any of Warren Wright, Jr.'s surviving descendants "upon such terms, outright or in trust, and in such shares and interests among those selected, as my son, WARREN WRIGHT, JR., whether he survives me or my wife or not, shall by his Last Will and Testament provide." (emphasis added).

Warren Wright, Jr. died testate in 1978. By ARTICLE V of his Last Will and Testament he established a trust into which he poured the assets of the Income Trust and the Residuary Trust estates created by the will of his father, assets over which he had been granted a power of appointment by the will of his father. The Last Will and Testament of Warren Wright, Jr. provides that the net income derived from the thus invigorated ARTICLE V Trust shall be paid to Bertha Wright during her life. Upon her death, the remaining assets of the trust "shall go and be distributed among my children and grandchildren and upon such terms outright or in trust and in such shares and interests among those selected as my wife shall by her Last Will and Testament provide." In the event Bertha Wright does not effectively dispose of all or any part of the trust estate by her Will, all or any part of the trust which was not disposed of shall go and be distributed in equal shares, per stirpes and not per capita, to the living descendants of Warren Wright, Jr.

ARTICLE XV of the Last Will and Testament of Warren Wright, Jr. provides: "No beneficiary of any trust hereby established shall have any right to alienate, encumber, or hypothecate his or her interest in the principal or income of the trust estate in any manner, nor shall such interest of any beneficiary be subject to claims of his or her creditors or liable to attachment, execution or other process of law or in any manner subject to the control of the spouse of any beneficiary."

In 1985 Bertha Wright and the four children born of her marriage to Warren Wright, Jr., presented to Second National Bank and Trust Company of Lexington, a predecessor in interest to National City Bank as trustee of the trust created by the will of Warren Wright, Jr., an agreement which they had all signed terminating the trust and authorizing distribution of the corpus of the trust to Bertha Wright. The bank filed a declaratory judgment action in the Fayette Circuit Court asking the court to determine whether the bank could terminate the trust in accordance with the agreement.

On August 5, 1987, the Fayette Circuit Court entered an opinion and order noting that the parties conceded the trust to be a spendthrift trust under Kentucky law. The court found: (1) the grandchildren, great-grandchildren, and unborn issue of Warren Wright, Jr. are parties in interest who have not agreed or consented to the termination of the trust; (2) the language of Article XV of the Last Will and Testament of Warren Wright, Jr. expressly prohibits termination of the trust or at least necessarily implies that the trust is not to be terminated; and (3) the attempted termination of the trust by agreement of Bertha Wright and her children would defeat the purpose of the trust which is to provide to Bertha Wright only the income from the trust for the duration of her life with the corpus to be distributed to the children and grandchildren of Warren Wright, Jr. upon the death of Bertha Wright.

The trust remained in effect when Bertha Wright filed a petition for relief under chapter 7, title 11 United States Code on February 12, 1993. Her bankruptcy resulted from the financial demise of Calumet Farm, Inc. and her exposure as a co-maker or guarantor of a substantial portion of the indebtedness of Calumet Farm. The debtor scheduled assets in the amount of $307,282.24 and liabilities in the amount of $69,401,526.43.

In the statement of financial affairs accompanying her petition the debtor reported income from the trust and royalties for the first 43 days of 1993 of $73,176; in 1992, she received income in the approximate amount of $600,000 from the trust, royalties and sale of furnishings; and in 1991, her income was reported to be $220,541 ("taxable amount") from the trust, royalties and dividends.

In Schedule C accompanying her petition the debtor claimed as exempt her entire interest as life income beneficiary of the Warren Wright, Jr. Trust pursuant to 11 U.S.C. 541(c)(2) and KRS 427.110.

The trustee made claim in behalf of the estate to all income the debtor receives from the trust during the six-month period immediately following bankruptcy.

On April 8, 1993, the debtor and the bankruptcy trustee executed an agreed order which provided that until such time that the debtor and the bankruptcy trustee reach a final settlement, or the court makes a final determination, concerning the estate's interest, if any, in the Testamentary Trust under the Will of Warren Wright, Jr., the debtor and the bankruptcy trustee shall each receive 50% of each monthly income payment distributable by Commerce National Bank, Trustee under the Will of Warren Wright, Jr., for the months commencing March 1993 and following, not to exceed twelve months. The order further required the debtor to procure at her expense a prepaid $500,000 term life insurance policy on her life with the bankruptcy trustee as primary beneficiary to insure payment to the trustee of the trust income for six months and any amounts of trust income paid to the debtor and subsequently determined to be recoverable by the bankruptcy trustee. The insurance policy was to remain in effect through March 1, 1994, or until further orders of the court.

On April 13, 1993, the bankruptcy trustee filed an objection to the exemption claimed by the debtor of her interest as a life income beneficiary of the Warren Wright, Jr. Testamentary Trust.

On August 3, 1993, the bankruptcy trustee and the debtor entered into an agreed order which sustained the objection of the trustee to the exemption claimed by the debtor in her interest as life income beneficiary of the Warren Wright, Jr. trust, established a briefing schedule, and authorized resolution as a contested matter issues of (1) whether the Warren Wright, Jr. Testamentary Trust is a spendthrift trust within the purview of 11 U.S.C. 541(c)(2); and (2) whether subsections (a)(5) and (c) of 11 U.S.C. 541 should be construed to include as or exclude from property of the estate the debtor's entire interest in the trust including her postpetition income as life income beneficiary for 180 days after the date of the filing of the debtor's chapter 7 petition.

CONCLUSIONS OF LAW:

Title 11 U.S.C. 541 provides in pertinent part as follows:

(a) The commencement of a case . . . creates an estate. Such estate is comprised of all the following property, wherever located and by whomever held:

(1) Except as provided in subsection . . .(c)(2) of this section, all legal or equitable interests of the debtor in property as of the commencement of the case.

. . . .

(5) Any interest in property that would have been property of the estate if such interest had been an interest of the debtor on the date of the filing of the petition and that the debtor acquires or becomes entitled to acquire within 180 days after such date -

(A) by bequest, devise, or inheritance;

. . . .

 

(c) (1) Except as provided in paragraph (2) of this subsection, an interest of the debtor in property becomes property of the estate under subsection (a)(1) . . . or (a)(5) of this section notwithstanding any provision in an agreement, transfer instrument, or applicable nonbankruptcy law -

(A) that restricts or conditions transfer of such interest by the debtor;

. . . .

(2) A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.

The applicable Kentucky statute provides:

(1) Estates of every kind held or possessed in trust shall be subject to the debts and charges of the beneficiaries thereof the same as if the beneficiaries also owned the similar legal interest in the property, unless the trust is a spendthrift trust.

(2) As used herein, unless the context otherwise requires, "spendthrift trust" means a trust in which by the terms of the instrument creating it a valid restraint on the voluntary and involuntary alienation of the interest of a beneficiary is imposed.

(3) Specific language shall not be necessary to create a spendthrift trust and it shall be sufficient if the instrument creating the trust manifests an intention to create a spendthrift trust.

(4) If an instrument creating a trust provides that a beneficiary is entitled to receive income of the trust and that his interest shall not be subject to alienation by operation of law or legal process, the restraint on the voluntary and involuntary alienation of his right to income due and to accrue shall be valid.

(5) If an instrument creating a trust provides that a beneficiary is entitled to receive principal of the trust at a future time and that his interest shall not be alienable by him and shall not be subject to alienation by operation of law or legal process, the restraint on the voluntary and involuntary alienation of his right to principal shall be valid.

(6) Although a trust is a spendthrift trust, the interest of the beneficiary shall be subject to the satisfaction of an enforceable claim against the beneficiary:

(a) By the spouse or child of the beneficiary for support, or by the spouse for maintenance;

(b) If the trust is not a trust described in subsection (7)(b) of this section by providers of necessary services rendered to the beneficiary or necessary supplies furnished to him; and

(c) By the United States or the Commonwealth of Kentucky for taxes due from him on account of his interest in the trust or the income therefrom.

. . . .

KRS 381.180.

The issues as stated by the parties and their arguments with respect thereto will be discussed in turn.

1. Is the debtor's interest as beneficiary of the trust created by ARTICLE V of the Will of Warren Wright, Jr. property of the estate?

The court has no doubt that the testamentary trust created by the will of Warren Wright, Jr. qualifies as a spendthrift trust under Kentucky statutory and case law. Article XV of the Last Will and Testament of Warren Wright, Jr. contains an anti-alienation provision which is valid under KRS 381.180. As noted in paragraph 8 of the Stipulation of Facts filed herein, the debtor, her children, and the bank administering the trust all agreed in prior litigation in the Fayette Circuit Court that the trust in question is a spendthrift trust. While the trustee in bankruptcy was not a party to that action, the decision of the state court holding that the trust could not be terminated by the parties because it is a spendthrift trust is persuasive. The court is satisfied that the debtor's interest as life income beneficiary of the trust is excluded from property of the debtor's estate by 11 U.S.C. 541(c)(2).

2. Are disbursements of income from the trust to the debtor during the 180-day period following the date on which the debtor filed bankruptcy recoverable by the trustee as property of the estate?

The trustee argues that because disbursements from a spendthrift trust are not protected from the reach of creditors once in the hands of the debtor, all distributions of income received by the debtor from the trust within 180 days following bankruptcy are property of the estate pursuant to 11 U.S.C. 541(a)(5). While acknowledging that the debtor's interest as income beneficiary of the trust vested upon the death of her husband, Warren Wright, Jr., some fifteen years prior to the debtor's bankruptcy, the trustee contends each distribution of trust income to the debtor during the 180-day period following bankruptcy should be categorized as an interest in property acquired by the debtor by bequest during that period within the meaning of subsection 541(a)(5)(A).

The debtor argues that she "acquired" her interest in the trust--that is, her right to receive the income from the trust for her lifetime--by bequest when Warren Wright, Jr. died in May 1978, and that she does not "acquire" by bequest each distribution of income made within 180 days after the intervention of bankruptcy. The debtor also asserts that even assuming arguendo that each postpetition distribution of income from the spendthrift trust is a separate bequest, the debtor's interest in the distributions is excepted from property of the estate under subsections 541(c)(1) and (c)(2) because subsection 541(c)(2) operates to except from subsection 541(a)(5)(A) (the "180-day" provision) any interest of the debtor emanating from a spendthrift trust. 11 U.S.C. 541(c)(1) ("Except as provided in paragraph (2) of this subsection, an interest of the debtor in property becomes property of the estate under . . . subsection (a)(5) . . . .") (emphasis added).

In In re Lonstein, 950 F.2d 77 (1st Cir. 1991), the debtor had been bequeathed an unrestricted ten percent interest in the decedent's estate under a will probated more than a decade before the commencement of the debtor's chapter 7 bankruptcy case. The debtor's share of the estate had not been distributed prior to bankruptcy nor was it distributed during the 180-day period after bankruptcy. It was distributed approximately one year after bankruptcy. It was contended that the debtor's interest in the inheritance did not become property of the estate under subsection 541(a)(5)(A) because it was not distributed during the 180-day period following bankruptcy.

The court rejected this contention, pointing out that subsections 541(a)(1) and 541(a)(5)(A) focus on mutually exclusive time periods. Under subsection 541(a)(1) any legal or equitable interest of a chapter 7 debtor as of the commencement of a case is property of the estate. On the other hand subsection 541(a)(5)(A) is not implicated unless "the debtor acquires or becomes entitled to acquire" an "interest in property" "by bequest" within 180 days after the commencement of the case. Since the debtor's interest under the decedent's will vested long before the commencement of the case, subsection 541(a)(5)(A) was never activated.

The court noted that the operative term in both subsections 541(a)(1) and 541(a)(5)(A) is "interest in property." The court observed that the inference that neither subsection is operative until the debtor acquires possession of the property is foreclosed by the prefatory language of subsection 541(a) which brings into the estate an interest in property "wherever located and by whomever held" which modifies both subsections 541(a)(1) and 541(a)(5)(A).

The fact situation in this case is analogous to that in Lonstein. Upon the death of her husband in 1978 the debtor became entitled to acquire and did acquire by bequest the stream of income from the trust established by her late husband's will. This was long before the commencement of her chapter 7 bankruptcy case on February 12, 1993. The stream of income which she was receiving when bankruptcy intervened clearly would have been property of her bankruptcy estate were it not for the provision of subsection 541(c)(2) which preserves for her benefit any restrictions on transfer of a spendthrift trust to the extent such restriction is enforceable under applicable nonbankruptcy law. The latter provision together with subsection 541(a)(1) and Kentucky law operate to exclude from property of her estate the debtor's interest in the spendthrift trust.

This court agrees that on these facts subsection 541(a)(5)(A) is not implicated because the debtor became entitled to acquire and acquired her "interest" in the spendthrift trust before bankruptcy and not during the 180-day period after bankruptcy. As in Lonstein this court rejects the inference that for purposes of subsection 541(a)(5)(A) a new bequest occurs when the debtor actually receives a disbursement of income from the trust. It is not when she receives a disbursement from the trust but rather when she acquired an interest in and the right to receive disbursements from the trust that is controlling.

Even if the debtor's husband had died during the 180-day period following bankruptcy her interest in the spendthrift trust would be protected because in order for an interest acquired by a debtor by bequest during that period to be property of the estate under subsection 541(a)(5)(A) it must be an interest in property that would have been property of the estate if such interest had been an interest of the debtor on the date of the commencement of the chapter 7 bankruptcy case. This language makes the spendthrift trust protection provided by subsection 541(c)(2) applicable to postpetition bequests as well.

Courts have circumvented the applicability of subsection 541(c)(2) to income from a spendthrift trust received by a debtor during the 180-day period following bankruptcy by viewing each disbursement of income as a separate or independent bequest. They rationalize that if such income had been received by the debtor prior to bankruptcy and had been in the possession of the debtor when bankruptcy intervened it would not have enjoyed on that date the protection provided by state statutory or case law for spendthrift trust property and therefore is an interest in property that would have been property of the debtor's estate on the date of bankruptcy. In re Moody, 837 F.2d 719, 722-23 (5th Cir. 1988); In re Hecht (Togurt v. Hecht), 54 B.R. 379, 384 (Bankr. S.D.N.Y. 1985), aff'd, 69 B.R. 290, 291 (S.D.N.Y. 1987).

This court finds the Lonstein case provides a more correct analysis of the applicable statutory provisions and therefore rejects the reasoning of the Hecht and Moody cases. Specifically, the court declines to hold that the disbursements of income from the spendthrift trust to Mrs. Wright postpetition are separate bequests which activate subsection 541(a)(5)(A). Thus, the trustee cannot rely on that subsection as grounds for sequestering such disbursements as property of the estate.

Subsection 541(a)(1) which encompasses and applies retrospectively from the date of bankruptcy and subsection 541(a)(5) which applies prospectively for 180 days from the date of bankruptcy provide identical tests for determining whether an interest in property which a debtor becomes entitled to acquire or acquires by bequest during either period is property of the estate. The protection provided by subsection 541(c)(2) for the interest of a debtor in a spendthrift trust is applicable with equal force to both subsections. These provisions should not be circumvented by viewing a grant of the right to the income from a spendthrift trust and actual disbursements of that income as separate bequests. The ultimate fact here is that the postpetition income received by the debtor is the product of a bequest acquired by the debtor prior to bankruptcy; the status of the income is governed by subsection 541(a)(1), and it is excluded from property of the estate by subsection 541(c)(2).

3. Are payments from the trust which the debtor acquires after 180 days following the date of the petition subject to claims of creditors holding nondischargeable debts or whose debts arise postpetition?

The answer to the above question is yes, of course. However, this is not a ground for holding that income from a spendthrift trust which the debtor receives beyond the 180-day period is property of the estate or is subject to administration by the trustee for the benefit of creditors holding such claims. There is no statutory authority for the trustee to stand in the shoes of creditors holding nondischargeable claims or claims that arise postpetition or to pursue collection of such claims in behalf of such creditors. This was not what the court held in In re Moody, 837 F.2d 719 (5th Cir. 1988).

In the Moody case the court, relying on the Hecht cases above cited and In re Kragness, 58 B.R. 939 (Bankr. D. Or. 1986), held that income payments from a spendthrift trust which the beneficiary is entitled to receive or does receive within the 180-day period after the filing of the bankruptcy petition qualify as bequests under 11 U.S.C. 541(a)(5)(A) and are brought into the bankruptcy estate by the provisions of that subsection. According to that court this result is consistent with the theory of the spendthrift trust because once trust income is paid to the beneficiary the income so paid is no longer subject to the protection of the spendthrift trust provisions contained in the trust. As previously indicated this conclusion is based on a misreading of the provisions of section 541 of the Code. It is when the debtor becomes entitled to acquire or acquires an interest in property and not when the debtor acquires possession of the property that determines whether the property is property of the estate. In re Lonstein, 950 F.2d 77 (1st Cir. 1991).

Based on the conclusions of law which it reached the court in the Moody case gave the trustee a judgment for the amount of income payments from a spendthrift trust received by the debtor during the 180-day period following bankruptcy. The judgment included prejudgment interest and costs.

The court then determined that the judgment was not collectible by the trustee from income from the trust escrowed at the direction of the court because the escrowed funds, not having been distributed to the debtor, were still under the protection of the provisions of the spendthrift trust.

The question then arose as to whether the trustee could collect the judgment from income distributions from the trust made to the debtor after expiration of the 180-day period. The court recognized that such payments to the debtor would not become property of the estate. The court held that such payments once received by the debtor were subject to sequestration for payment of the judgment of the trustee. The court justified this conclusion on the ground that such payments were subject to seizure for satisfaction of claims of creditors holding nondischargeable debts or creditors whose claims arose postpetition. Thus, these distributions were subject to sequestration for collection of the trustee's judgment for money that had been determined to be property of the estate even though such future distributions were not property of the estate.

The trustee in this case does not have a money judgment against the debtor. Thus, the fact that a creditor holding a nondischargeable debt or postpetition creditors may be able to reach future income distributions to the debtor from the trust is immaterial in this case. As noted in the Moody case such future income distributions are not property of the estate.

Dated:

 

By the court -

 

 

 

 

Chief Judge

 

Copies to:

 

Suzanne Jett Trowbridge

Lucinda Masterson Hall

Gene Lynn Humphreys