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Keywords

trustbankruptcydeclaratory judgment
appealtrustbankruptcy

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First Northwestern Trust Co. of South Dakota v. Internal Revenue Service, 622 F.2d 387, 23 C.B.C. 257, 6 Bankr.Ct.Dec. 502, Bankr. L. Rep. P 67,465

Facts

First Northwestern Trust Company of South Dakota sought a declaratory judgment regarding the rights of the parties to the income of the Paul Lex Quarnberg Family Trust. The trust, established in 1970, included a spendthrift clause and allowed the trustee to distribute income at their discretion. After Paul Lex Quarnberg filed for bankruptcy, the trustee in bankruptcy, Robert A. Warder, claimed rights to the trust income, leading to this legal dispute.

The trust agreement in question was executed in 1970 by C. A. Quarnberg. It established an irrevocable trust in the amount of $250,000 to provide for the necessary and ordinary living expenses of the Paul Lex Quarnberg family, and to provide for the educational expenses of the children.

Issue

Did the trustee in bankruptcy of a beneficiary of a discretionary spendthrift trust succeed to that beneficiary's interest in the income of the trust?

The Court of Appeals, Ross, Circuit Judge, held that enforcement of spendthrift provision of trust did not remove from beneficiary's creditors property which otherwise would be available.

Rule

The enforcement of a spendthrift provision in a trust does not remove property from the creditors of the beneficiaries, as the beneficiaries have no vested rights in the trust income until it is distributed.

Thus, under South Dakota law, trustee in bankruptcy had no right to trust income.

Analysis

The court analyzed the trust agreement and determined that the beneficiaries had no present interest in the income of the trust until it was actually distributed by the trustee. The spendthrift provision and the discretionary powers of the trustee limited the beneficiaries' rights, making the income non-assignable and immune from creditors until distributed. The court concluded that the trustee in bankruptcy could not claim the income as property of the bankrupt.

The effect of the trust provision is that upon the bankruptcy of the beneficiary his equitable interest in the income and principal of the trust estate, being non-assignable and immune from judicial process under (state) law, does not pass to the trustee of the bankruptcy estate.

Conclusion

The court affirmed the district court's decision, ruling that the trustee in bankruptcy had no rights to the income of the Paul Lex Quarnberg Family Trust.

Accordingly, the decision of the district court denying the trustee in bankruptcy's claims to the income of the Paul Lex Quarnberg Family Trust is hereby affirmed.

Who won?

First Northwestern Trust Company of South Dakota prevailed because the court found that the spendthrift provision protected the trust income from the claims of the trustee in bankruptcy.

First Northwestern sought judicial determination of the issue of whether the trustee in bankruptcy of one of the beneficiaries of a discretionary spendthrift trust succeeds to that beneficiary's interest in the income of the trust.

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