Todd Frealy v. Rick Reynolds , 779 F.3d 1028 ( 2015 )

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
TODD A. FREALY, Attorney, No. 12-60068
Chapter 7 Trustee of Estate of
Rick Reynolds, BAP No.
Appellant, 11-1433
v.
ORDER
RICK H. REYNOLDS; JOHN M. CERTIFYING A
CARMACK, Co-Trustee of the QUESTION TO
Reynolds Family Trust and Co- THE CALIFORNIA
Trustee of The Reynolds Family SUPREME COURT
Trust - Survivor’s Trust, as
amended; JOHN MORRIS, Co-
Trustee of the Reynolds Family
Trust and Co-Trustee of The
Reynolds Family Trust -
Survivor’s Trust, as amended,
Appellees.
Filed March 9, 2015
Before: Alex Kozinski and Susan P. Graber, Circuit
Judges, and Charles R. Breyer, Senior District Judge.*
Per Curiam Order
*
The Honorable Charles R. Breyer, Senior District Judge for the U.S.
District Court for the Northern District of California, sitting by
designation.
2 FREALY V. REYNOLDS
SUMMARY**
Bankruptcy
The panel certified to the California Supreme Court the
following question:
Does section 15306.5 of the California
Probate Code impose an absolute cap of 25
percent on a bankruptcy estate’s access to a
beneficiary’s interest in a spendthrift trust that
consists entirely of payments from principal,
or may the bankruptcy estate reach more than
25 percent under other sections of the Probate
Code?
COUNSEL
Jesse S. Finlayson (argued), Finlayson Toffer Roosevelt &
Lilly LLP, Irvine, California, for Appellant.
David W. Meadows (argued), Law Offices of David W.
Meadows, Los Angeles, California, for Appellees.
**
This summary constitutes no part of the opinion of the court. It has
been prepared by court staff for the convenience of the reader.
FREALY V. REYNOLDS 3
ORDER
PER CURIAM:
This appeal requires us to determine the extent to which
a bankruptcy estate may reach a beneficiary’s interest in a
spendthrift trust under the California Probate Code. The
beneficiary claims that California Probate Code section
15306.5 caps the bankruptcy estate’s access at 25 percent of
his trust interest, which consists entirely of payments from
principal. The bankruptcy trustee, on the other hand, seeks to
reach more than 25 percent of the beneficiary’s interest under
Probate Code sections 15301(b) and 15307, which it reads as
not subject to the section 15306.5 cap.
We find no controlling precedent in the decisions of the
California Supreme Court or Courts of Appeal. See Cal. R.
Ct. 8.548(a)(2) (permitting certification where there is “no
controlling precedent” from the state court); Sullivan v.
Oracle Corp., 557 F.3d 979, 983 (9th Cir. 2009) (order)
(looking to decisions of California appellate courts). Nor has
our court considered the interplay between section 15306.5
and other Probate Code sections governing creditors’ access
to spendthrift trusts. We held in Neuton v. Danning (In re
Neuton), 922 F.2d 1379, 1383 (9th Cir. 1990), that section
15306.5 allows a bankruptcy estate to reach 25 percent of a
spendthrift trust. But, unlike in the present case, the
beneficiary in Neuton had argued that all of his interest in the
spendthrift trust was protected from the bankruptcy estate,
while the bankruptcy estate claimed only 25 percent under
section 15306.5. Id. We therefore had no occasion to
examine whether a bankruptcy estate could access more than
25 percent under other Probate Code sections.
4 FREALY V. REYNOLDS
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.
I. Question Certified
Pursuant to Rule 8.548 of the California Rules of Court,
we request that the California Supreme Court answer the
following question:
Does section 15306.5 of the California
Probate Code impose an absolute cap of 25
percent on a bankruptcy estate’s access to a
beneficiary’s interest in a spendthrift trust that
consists entirely of payments from principal,
or may the bankruptcy estate reach more than
25 percent under other sections of the Probate
Code?
We understand that the Court may reformulate our question,
and we agree to accept and follow the Court’s decision.
II. Background
A. Applicable California Statutes
The California Probate Code recognizes the validity of
spendthrift provisions that restrict transfer of a beneficiary’s
FREALY V. REYNOLDS 5
interest in income and principal, so long as that interest hasn’t
yet been paid to the beneficiary. See Cal. Prob. Code
§§ 15300, 15301(a). Section 15301(a) permits the restraint
against transfer of trust principal, subject to certain
exceptions set forth in sections 15301(b) and 15304–07:
Except as provided in subdivision (b) and in
Sections 15304 to 15307, inclusive, if the trust
instrument provides that a beneficiary’s
interest in principal is not subject to voluntary
or involuntary transfer, the beneficiary’s
interest in principal may not be transferred
and is not subject to enforcement of a money
judgment until paid to the beneficiary.
Cal. Prob. Code § 15301(a).
One of these exceptions, section 15306.5(a), allows
general creditors to satisfy money judgments out of payments
to which the beneficiary is entitled. The section provides:
Notwithstanding a restraint on transfer of the
beneficiary’s interest in the trust under
Section 15300 or 15301, and subject to the
limitations of this section, upon a judgment
creditor’s petition under Section 709.010 of
the Code of Civil Procedure, the court may
make an order directing the trustee to satisfy
all or part of the judgment out of the payments
to which the beneficiary is entitled under the
trust instrument or that the trustee, in the
exercise of the trustee’s discretion, has
determined or determines in the future to pay
to the beneficiary.
6 FREALY V. REYNOLDS
Cal. Prob. Code § 15306.5(a). Creditors, upon petition to the
court, may thus reach payments to which the beneficiary is
entitled subject to “the limitations of this section.” Id.
One of the limitations states as follows:
An order under this section may not require
that the trustee pay in satisfaction of the
judgment an amount exceeding 25 percent of
the payment that otherwise would be made to,
or for the benefit of, the beneficiary.
Cal. Prob. Code § 15306.5(b). Along the same lines, section
15306.5(f) specifies that “the aggregate of all orders for
satisfaction of money judgments against the beneficiary’s
interest in the trust may not exceed 25 percent of the payment
that otherwise would be made to, or for the benefit of, the
beneficiary.” Cal. Prob. Code § 15306.5(f). Section
15306.5(c) further restricts creditors’ access, stating that “[a]n
order under this section may not require that the trustee pay
in satisfaction of the judgment any amount that the court
determines is necessary for the support of the beneficiary and
all the persons the beneficiary is required to support.” Cal.
Prob. Code § 15306.5(c).
Section 15301(b) contains another exception to the
general rule against transfer of a spendthrift trust
beneficiary’s interest in principal:
After an amount of principal has become due
and payable to the beneficiary under the trust
instrument, upon petition to the court under
Section 709.010 of the Code of Civil
Procedure by a judgment creditor, the court
FREALY V. REYNOLDS 7
may make an order directing the trustee to
satisfy the money judgment out of that
principal amount.
Cal. Prob. Code § 15301(b).
And section 15307, titled “Income in excess of amount
for education and support; application to creditors’ claim,”
states:
Notwithstanding a restraint on transfer of a
beneficiary’s interest in the trust under
Section 15300 or 15301, any amount to which
the beneficiary is entitled under the trust
instrument or that the trustee, in the exercise
of the trustee’s discretion, has determined to
pay to the beneficiary in excess of the amount
that is or will be necessary for the education
and support of the beneficiary may be applied
to the satisfaction of a money judgment
against the beneficiary. Upon the judgment
creditor’s petition under Section 709.010 of
the Code of Civil Procedure, the court may
make an order directing the trustee to satisfy
all or part of the judgment out of the
beneficiary’s interest in the trust.
Cal. Prob. Code § 15307.
Unlike sections 15306.5, 15301(b) and 15307, which
apply to general creditors, the remaining exceptions pertain
to either preferred creditors or the unique situation in which
the settlor of the trust is also a beneficiary. See Cal. Prob.
Code § 15304 (invalidating the restraint against transfer
8 FREALY V. REYNOLDS
where the beneficiary is also the settlor); id. § 15305 (court
may order the trust to satisfy a money judgment for support
of the beneficiary’s spouse, former spouse or minor child); id.
§ 15305.5 (same, where there is a judgment against the
beneficiary awarding restitution for the commission of a
felony); id. § 15306 (same, where the beneficiary is liable for
reimbursement to the state of California for public support
furnished to him or his spouse or minor child).
B. Facts Of Our Case
Appellee Rick Reynolds is a beneficiary of the Reynolds
Family Trust, which contains the following spendthrift
provision: “No interest in the income or principal of any trust
created under this instrument shall be voluntarily or
involuntarily anticipated, assigned, encumbered, or subjected
to [a] creditor’s claim or legal process before actual receipt
by the beneficiary.” The trust is composed of three sub-
trusts—the Bypass Trust, the Marital Trust and the Survivor’s
Trust. Thirty days after his father’s death in 2009, Reynolds
became entitled to $250,000 from the Bypass Trust, $100,000
a year for ten years from the Survivor’s Trust and one-third
of the residue of the Survivor’s Trust thereafter. All, or
substantially all, of these distributions will be made from trust
principal, as the trust assets are not expected to generate
income.
The day after his father died, Reynolds filed a voluntary
Chapter 7 bankruptcy petition. The trust trustee subsequently
filed an adversary proceeding asking the bankruptcy court to
determine what interest, if any, the bankruptcy estate has.
Reynolds filed a motion for partial summary judgment,
arguing that section 15306.5 limits the bankruptcy estate to
25 percent of his interest in the spendthrift trust. The
FREALY V. REYNOLDS 9
bankruptcy trustee countered that the estate is entitled to more
than 25 percent because section 15301(b) gives creditors
unrestricted access to distributions of principal “due and
payable,” and all of Reynolds’s distributions from the trust
were expected to be made from principal. Alternatively, the
bankruptcy trustee argued that section 15307 allows the
bankruptcy estate to reach any amount of Reynolds’s trust
interest not deemed necessary for his education and support.
The bankruptcy trustee viewed sections 15306.5, 15301(b)
and 15307 as independent routes that a creditor could use in
gaining access to a beneficiary’s trust interest.
The bankruptcy court ruled in favor of Reynolds and held
that section 15306.5 establishes an “absolute maximum cap
on what is recoverable by a judgment creditor at 25 percent.”
Although it acknowledged that “[t]here may be an exception
to [the 25 percent cap] under 15301(b),” the court “cho[]se
not to follow that interpretation.” The bankruptcy court also
rejected the argument that its reading rendered section 15307
superfluous, explaining that, under section 15307, “[a creditor
doesn’t] even necessarily get all of [the 25 percent] if [the
trust trustee] can show that [that amount] is necessary for
support.”
A divided Ninth Circuit Bankruptcy Appellate Panel
affirmed the bankruptcy court, though the majority took a
different approach. The BAP read section 15301(b) as
merely setting forth the procedure that a creditor must follow
to satisfy a claim from the principal of a spendthrift trust once
such principal is payable but not yet distributed to the
beneficiary. It refused to read section 15301(b) as allowing
a creditor to reach the entirety of principal due and payable,
reasoning that doing so would “effectively eviscerate[] the
spendthrift protection recognized by 15301(a).” It also
10 FREALY V. REYNOLDS
pointed to the exceptions contained in sections 15304–07 as
reflecting a “policy recognition that certain creditors should
have greater rights to a beneficiary’s interest in order to
satisfy their claims,” and noted that it would run counter to
this policy to read section 15301(b) as allowing any creditor
to similarly satisfy claims from trust principal.
In considering section 15307, the BAP reasoned that, if
sections 15307 and 15306.5 were separate avenues for
collection, “15306.5 would make no sense: Why would a
judgment creditor ever choose to satisfy its claim under
15306.5, which is limited not just by the 25% cap on the
beneficiary’s interest but by the needs of the debtor and his
or her dependents, when 15307 is only limited by the debtor’s
own educational and support needs?” The BAP concluded
that section 15307 doesn’t apply to this case because the more
plausible reading, and the one most aligned with the
legislative intent, is that it only limits a creditor’s access to
income, and not principal.
The dissent, by contrast, “d[id] not believe the California
legislature intended that a debtor, without exception, should
have access to potentially large distributions of cash from a
trust not needed for his support or education in preference to
the legitimate claims of his creditors.” It viewed sections
15301(b) and 15307 as playing a “critical role in protecting
creditors’ rights” by allowing “creditors, in some cases, to
reach some, or perhaps even all, . . . distributions” for which
beneficiaries have “no legitimate need.”
III. Explanation of Certification
The bankruptcy judge in this case was correct in
observing that “[t]he Probate Code of the state of California
FREALY V. REYNOLDS 11
is anything other than crystal clear.” It’s no surprise that both
the bankruptcy court and the BAP struggled to make sense of
the statutory scheme, with little to rely on but their own
conceptions of the proper balance between the rights of a
spendthrift trust beneficiary and those of his creditors.
As reflected in the assorted theories advanced by the
debtor, the bankruptcy trustee, the bankruptcy court and the
BAP majority and dissent, there is no obvious way to
harmonize section 15306.5 with sections 15301(b) and
15307. Below, we identify aspects of these sections that have
proved challenging for us to decipher, and for which we seek
authoritative guidance.
1. Recall that section 15301(a) permits the restraint
against transfer of trust principal, subject to exceptions
“provided in subdivision (b) and in Sections 15304 to 15307.”
Cal. Prob. Code § 15301(b). Section 15306.5 is one of these
exceptions, but it’s not clear from its text whether the 25
percent cap on a creditor’s access to “payment[s] that
otherwise would be made to, or for the benefit of, the
beneficiary” also applies to orders under other sections of the
Probate Code. Cal. Prob. Code § 15306.5(b).
Section 15306.5(b) suggests, for example, that the 25
percent cap is limited to orders issued under section 15306.5,
as it states that “[a]n order under this section may not require
that the trustee pay in satisfaction of the judgment an amount
exceeding 25 percent of the payment that otherwise would be
made to, or for the benefit of, the beneficiary.” Cal. Prob.
Code § 15306.5(b) (emphasis added). But the “under this
section” phrasing is missing from subsection (f), which
provides that “the aggregate of all orders for satisfaction of
money judgments against the beneficiary’s interest in the
12 FREALY V. REYNOLDS
trust may not exceed 25 percent of the payment that otherwise
would be made to, or for the benefit of, the beneficiary.” Cal.
Prob. Code § 15306.5(f). Nor do the Law Revision
Commission’s comments elaborate when explaining that
“[s]ubdivision (f) limits the aggregate amount of the
beneficiary’s interest in one trust that is subject to
enforcement where several creditors have obtained orders.”
Cal. Prob. Code § 15306.5 Law Revision Commission
comments.
2. A broader ambiguity exists with respect to section
15301(b). Its plain wording does not specify a limit on the
amount of principal “due and payable” that a creditor may
reach. It simply states that, “[a]fter an amount of principal
has become due and payable to the beneficiary . . . , the court
may make an order directing the trustee to satisfy the money
judgment out of that principal amount.” Cal. Prob. Code
§ 15301(b) (emphasis added). Reading section 15301(b)
literally, without any limitations on creditors’ access, raises
a host of difficult questions.
At the outset, section 15301(b) specifies that creditors
may access those principal amounts held within the trust only
after they become “due and payable” to the beneficiary. Cal.
Prob. Code § 15301(b). But nowhere in the Probate Code is
there a definition of “due and payable.” One interpretation
of “due and payable” is that it encompasses all disbursements
of principal owed to the beneficiary, regardless of the timing
of disbursement. Section 15301(b) would therefore give
creditors immediate access to all of a beneficiary’s trust
principal. Another theory is that an amount becomes “due
and payable” at the time the beneficiary is owed a
disbursement—that is, when the only remaining step is for the
trust to write a check or otherwise effect the transfer of funds
FREALY V. REYNOLDS 13
to the beneficiary. So construed, in Reynolds’s case, where
he is entitled to annual payments of principal continuing over
the next decade, a creditor would be unable to use section
15301(b) to reach the totality of his trust interest at one time;
instead, the creditor would have to wait until certain amounts
were ready for disbursement to petition the court for access.
Under any definition of “due and payable,” a literal
reading of section 15301(b) could give a judgment creditor
access to all trust principal, notwithstanding the limitations
set forth in section 15306.5 or section 15307. And perhaps
that makes sense—after all, it is, in essence, what already
happens: a spendthrift provision protects the beneficiary’s
income and principal interests only so “long as the income or
principal is properly held” in the trust. Chatard v. Oveross,
101 Cal. Rptr. 3d 883, 889 (Ct. App. 2009). After the amount
is paid to the beneficiary, creditors may reach it. Kelly v.
Kelly, 79 P.2d 1059, 1063 (Cal. 1938); see also Cal. Prob.
Code §§ 15300, 15301(a).
That reading, when viewed in light of the absence of a
similar provision in section 15300, also renders the Probate
Code’s treatment of principal different from that of income:
distributions of income are protected by the spendthrift
provision until they reach the beneficiary, while distributions
of principal become fair game as soon as they are “due and
payable.” And that distinction also may make sense—
distributions of principal, for example, are more likely to be
associated with the winding-down of a trust, as the
beneficiary transitions to self-sufficiency. Distributions of
income, by contrast, are intended to keep the beneficiary
going from year to year and therefore may be designed to
ensure that the beneficiary’s most immediate needs are met.
14 FREALY V. REYNOLDS
When considered in context, however, reading section
15301(b) as an independent means of accessing all principal
as it becomes due and payable creates some puzzling
consequences. For example, what purpose would section
15306.5 serve? On one hand, section 15306.5 uses the all-
encompassing word “payments,” so it could also be read as
applying to principal due and payable. See Cal. Prob. Code
§ 15306.5(a), (b), (f). Why, then, would the California
legislature craft a 25 percent cap and emphasize that it applies
in the aggregate, if creditors could bypass this protection by
using section 15301(b) to access the entirety of principal due
and payable? It’s also unclear, under that reading, why the
legislature would specify that creditors may not access
amounts “necessary for the support of the beneficiary and all
the persons the beneficiary is required to support,” see Cal.
Prob. Code § 15306.5(c), if creditors could turn to section
15301(b) to potentially drain the entirety of a beneficiary’s
trust interest, when that interest consists of principal due and
payable. On the other hand, section 15306.5 refers to all
payments, current and future, of principal and income. Thus,
perhaps section 15306.5 exists not as a cap on payments of
principal otherwise accessible through section 15301(b), but
instead as a limit on a creditor’s ability to obtain a standing,
general percentage share of the beneficiary’s trust payments,
current and future.
Similarly, if section 15301(b) permits general creditors to
access all principal due and payable, what becomes of the
exceptions in sections 15304–07 giving access to preferred
creditors? Could the bankruptcy trustee or any unsecured
creditor deplete the entirety of the trust interest when it
consists of principal due and payable, leaving none for the
preferred creditors contemplated in sections 15305, 15305.5
and 15306? Section 15301(b) states that “[a]fter an amount
FREALY V. REYNOLDS 15
of principal has become due and payable . . . , upon petition
to the court . . . , the court may make an order directing the
trustee to satisfy the money judgment out of that principal
amount.” Cal. Prob. Code § 15301(b) (emphasis added). By
contrast, sections 15305, 15305.5 and 15306 don’t contain
any language requiring preferred creditors to wait until a
certain time to petition the court for an order. Thus, if the
sequence in which a court order is issued determines the
timing of payments—an assumption lacking clear support
from the Probate Code—preferred creditors may retain
priority over a section 15301(b) creditor in accessing
principal due and payable.
3. The final ambiguity arises under section 15307, which
can be read as applying either to both income and principal,
or only to income. Its title, “Income in excess of amount for
education and support; application to creditors’ claim,”
suggests the latter. The legislative history also supports this
interpretation. See, e.g., Cal. Prob. Code § 15307 Law
Revision Commission comments (explaining that “[s]ection
15307 permits an ordinary creditor to reach income under
limited circumstances” and further discussing “the creditor’s
attempt to reach the excess income under this section”). In
addition, California Civil Code section 859, which was
repealed and replaced by California Probate Code section
15307, exclusively governed income. See United Cal. Bank
v. Lawrence (In re Estate of Lawrence), 72 Cal. Rptr. 851,
854–55 (Ct. App. 1968). However, the text of section 15307
does not mention income and instead refers generally to “any
amount to which the beneficiary is entitled.” Cal. Prob. Code
§ 15307. Also, the first sentence begins, “Notwithstanding a
restraint on transfer of a beneficiary’s interest in the trust
under Section 15300 [governing income] or 15301
16 FREALY V. REYNOLDS
[governing principal],” which supports applying section
15307 to both income and principal. Id.
If section 15307 pertains only to income, then it has no
application in this case. But if it extends to principal, many
of the same questions raised above arise. Section 15307, like
section 15301(b), does not explicitly refer to section 15306.5
or any of the other exceptions listed in section 15301(a), and
it could be read literally to give a creditor access to the
entirety of a beneficiary’s trust interest so long as none of it
is deemed necessary for his education and support. What
purpose, then, would sections 15301(b) and 15306.5 serve?
Section 15307 would be duplicative of a creditor’s right to
petition for distributions of principal under section 15301(b).
And, depending on the meaning of section 15306.5 (which
remains unclear), section 15307 could directly conflict
with—and create an end-run around—the 25 percent cap set
forth in section 15306.5. Is the Probate Code meant to
function as a menu from which creditors may select the
sections they want to invoke in order to reach the maximum
amount of a beneficiary’s interest in a spendthrift trust? And,
if so, what would remain of the protections afforded to the
beneficiary?
The answers to these questions have significant
ramifications, not just for the immediate parties, but for the
administration of all spendthrift trusts in California. As it
currently stands, the Probate Code is subject to two vastly
different readings: one giving creditors unfettered access to
a beneficiary’s interest in the trust, and another restricting
creditors’ access to 25 percent. We are reluctant to decide
which reading prevails without the authoritative guidance of
the California Supreme Court. We therefore ask the Court to
FREALY V. REYNOLDS 17
exercise its discretion and decide the appropriate degree to
which creditors may access spendthrift trusts.
IV. Administrative Information
The names and addresses of counsel for the parties are as
follows:
Counsel for Appellant Todd A. Frealy:
Jesse Sequoia Finlayson
Matthew E. Lilly
Finlayson Toffer Roosevelt & Lilly LLP
15615 Alton Parkway
Irvine, CA 92618
Counsel for Appellees Rick H. Reynolds, John M.
Carmack and John Morris:
David Meadows, Attorney
Law Offices of David W. Meadows
1801 Century Park East
Los Angeles, CA 90067
Joseph A. Eisenberg
Thomas M. Geher
Jeffer Mangels Butler & Marmaro LLP
1900 Avenue of the Stars
Los Angeles, CA 90067
Frealy should be deemed the petitioner if the California
Supreme Court accepts this request. Cal. R. Ct. 8.548(b)(1).
18 FREALY V. REYNOLDS
The Clerk of this court shall submit copies of all relevant
briefs and an original and ten copies of this Order to the
California Supreme Court with a certificate of service on the
parties. See Cal. R. Ct. 8.548(c), (d). All further proceedings
before us are stayed pending receipt of the California
Supreme Court’s decision. The parties shall notify the Clerk
of this court within one week after the California Supreme
Court accepts or declines this request, and again within one
week after it renders its decision.
IT IS SO ORDERED.