[UPDATE 4/30/2015 -- Bankruptcy Court's decision reversed by the U.S. District Court, see http://goo.gl/5iahmc -- See my Update Article at http://onforb.es/1Fzw7ej ]
In 1997, Faith Campbell created a Living Trust for the benefit of her four children.
In general, a Living Trust is a relatively simple form of trust, but by far the most common encountered in the United States. It is a form of trust that may be revoked by its Settlor (here, Faith) until her death, after which the right to revoke dies with the Settlor, and it becomes an irrevocable trust as to its surviving beneficiaries.
Faith's Living Trust was unremarkable -- it was a relatively simple trust as trusts go -- and it had (as most such trusts do) a Spendthrift Provision, the purpose of which is to give the Trustee the discretion whether to make payments to a beneficiary that is in financial distress. There is nothing like a uniform Spendthrift Provision, but rather this language is left to the whim of whatever attorney drafts particular trusts. The Spendthrift Provision in this case provided:
If any beneficiary should attempt to alienate, encumber, or dispose of all or any part of the income or principal of this [Living] Trust before it has been delivered by the [Spendthrift] Trustee, or if by reason of bankruptcy or insolvency or any attempted execution, levy, attachment, or seizure of any assets remaining in the hands of the [Spendthrift] Trustee under claims of creditors or otherwise, all or any part of the income or principal might fail to be enjoyed by any beneficiary or might vest in or be enjoyed by some other person, then the interest of that beneficiary shall immediately terminate Thereafter, the [Spendthrift] Trustee shall pay to or for the benefit of that beneficiary only those amounts that the [Spendthrift] Trustee, in its sole and absolute discretion, deems advisable for the education and support of that beneficiary until the death of the beneficiary or the maximum period permissible under the South Carolina rule against perpetuities, whichever first occurs.
Otherwise, Faith's Living Trust left the trust assets to her four children in equal shares.
Faith died in 2011, and later that year her Trust's assets were valued at about $1.8 million, plus a cabin in Wisconsin. By the terms of the Trust, Bank of America was appointed the new Trustee, but refused the appointment. Thus, as per the terms of the Trust, the four children were allowed to, and did, name the husband of one of Faith's grandchildren -- the Debtor's nephew, Mr. J.T. Del Alcazar (whom I'll refer to as "J.T.") -- as the new Trustee.
As to three of Faith's children, everything was fine, and apparently distributions from the Living Trust to them proceeded as normal. But one of the children, Linda Castellano, and her husband were having severe financial problems.
On October 5, 2011, Linda's attorney wrote to the J.T.'s attorney, and advised that Linda was insolvent. Further:
I am writing to you in relation to section 10.03 of the [Living] [T]trust [the Spendthrift Provision], to advise you that my client [the Debtor] and her husband have experienced insolvency due to the recession. They have closed their business and are filing for bankruptcy protection. [The Debtor] considers that it is the [Spendthrift] [T]rustee's obligation to exercise his authority consistent with the provisions of the [Living] [T]trust identified above [i.e., sec. 10.03].
This letter was later known as the "Insolvency Letter". After receiving the Letter, J.T. set up a new Merrill Lynch account, into which J.T. deposited Linda's 1/4th share of the Trust assets. Although technically not a trust, J.T. and Linda referred to this account quite loosely and unfortunately as the "Spendthrift Trust".
The truth is that things get pretty fuzzy as to whether Faith's trust still existed or not. Under the terms of the trust:
Section 8.01 of the Living Trust further stated that, "[u]pon the death of Faith F. Campbell and upon settlement of her estate, this [Living] Trust shall terminate."
Well, Faith had obviously died, but whether the Estate had been settled -- thus causing final termination of the Living Trust -- turns out to be a critical issue.
A little over a month after the Insolvency Letter was written, on November 18, 2011, Linda filed her voluntary petition for Chapter 7 bankruptcy. In her schedules required to be filed with the Petition, Linda identified herself as the "[b]eneficiary of deceased mother's trust protected by spendthrift provision" in the amount of $400,000.
Three days later, on November 21, 2011, Linda executed a document entitled "Receipt, Approval of Accounting, Release and Discharge of Trustee", which everybody later called the "Receipt". In the Receipt, Linda stated that her status as a named beneficiary of Faith's Trust had terminated, and that she was now simply a limited beneficiary whose rights to assets were subject to the J.T.'s sole discretion.
Linda further stated in the Receipt:
I acknowledge that pursuant to the attached Schedule of Assets Distributed I will individually receive no distribution from the Living Trust and that the Spendthrift Trust shall receive my lifetime, limited beneficial interest. This is in full satisfaction of my rights and interests under the Living Trust, however reserving my beneficial interests pursuant to the Spendthrift Trust, I approve the Schedule of Assets Distributed.
The Chapter 7 Trustee for Linda's bankruptcy case then sued Linda and J.T. for fraudulent transfers under 11 U.S.C. § 548(e)(1), and also for a turnover of Linda's share of the Trust's assets under §§ 543 and 550.
Section 548(e)(1) provides in full:
(e)(1) [T]he trustee may avoid any transfer of an interest of the debtor in property that was made on or within 10 years before the date of the filing of the petition, if—
(A) such transfer was made to a self-settled trust or similar device;
(B) such transfer was by the debtor;
(C) the debtor is a beneficiary of such trust or similar device; and
(D) the debtor made such transfer with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that the transfer was made, indebted.
Before the Bankruptcy Court embarked on its analysis of 548(e)(1) against these facts, it made the following general comment about that section:
Section 548(e) has received little attention in the case law. However, there appears to be no dispute that Congress enacted sec. 548(e) in order to avoid the deleterious results of certain state laws that permitted debtors to shelter their assets from their creditors by placing them into self-settled spendthrift trusts (or similar devices) shortly before filing for bankruptcy. [] By permitting the bankruptcy trustee to seize these assets for the benefit of creditors, sec. 548(e) restored the common-law rule allowing creditors to avoid pre-bankruptcy spendthrift trusts designed to shield assets from creditors of an insolvent debtor. []
[Citations omitted]
Linda made a very straightforward argument, that she didn't transfer anything to the Trust. Moreover, the Trust gave the Trustee the complete and sole discretion to make or not make distributions, totally independent of what Linda wanted or not -- maybe, since the alternative explanation is that Linda's 1/4th interest irrevocably vested at Linda's death, and thereupon the Trustee lost that discretion.
The Bankruptcy Trustee countered that there certainly was a transfer of assets, from the Trust's main account to the new Merrill Lynch account, which transferred occurred because of the family relationship between the debtor and her nephew, the Trustee.
The Bankruptcy Court agreed with the Bankruptcy Trustee:
The Court finds that the Debtor voluntarily effectuated an indirect, conditional parting with an interest in property-her share of the Living Trust assets. Rather than accepting direct receipt of those assets and then transferring them into a self-settled trust or the like, she recruited the Spendthrift Trustee to accomplish the equivalent result, schooling him, in the Insolvency Letter, in his "obligation to exercise his authority consistent with the provisions of the [Living Trust, i.e., sec. 10.03]."
What happened, according to the Bankruptcy Court, was that the Spendthrift Trustee followed Linda's suggestions that he not make any distributions to her directly, but instead set up the new Merrill Lynch account, into which he placed Linda's share. Linda then had the use of the moneys in that account, subject only to the discretion of her nephew, the Spendthrift Trustee.
The Court then turned back to 548(e)(1) and focused on the language "self-settled trust or similar device", and commented:
A self-settled trust has been defined as "[a] trust in which the settlor is also the person who is to receive the benefits from the trust, usually set up in an attempt to protect the trust assets from creditors." [] In determining the scope of the "similar device" language of the statute, the Court agrees with the court's conclusion in Porco that Congress's intent in enacting sec. 548(e) was to have the "similar device" provision interpreted broadly:
Collier on Bankruptcy notes that the congressional decision to leave undefined the terms used in sec. 548(e), such as "similar device," indicates an intent for courts to interpret the statute broadly so as to effectuate its aims, noting that, "even if crafty lawyers draft devices not technically "self-settled trust[s]," court[s] will have the power to scrutinize them under the "similar device" provision.
[Citations omitted]
Linda argued that since the "Spendthrift Trust" (a/k/a the Merrill Lynch account) was created by the Spendthrift Trustee, she (Linda) was not the Settlor, and thus the Trust was not self-settled for purposes of 548(e)(1).
The Bankruptcy Court disagreed, finding that Linda effectively caused J.T. to set up the Spendthrift Trust by way of Linda's insolvency letter. Moreover:
Thereafter, the Debtor confirmed in the Receipt that the effect of her coaching of the Spendthrift Trustee in the Insolvency Letter was to ensure that her share of the Living Trust assets would be distributed not to her individually but into the newly-created Spendthrift Trust. Read together, the Insolvency Letter and the Receipt provide strong evidence that the Spendthrift Trustee invoked the Spendthrift Provision and created the Spendthrift Trust in direct response to the Debtor's express wishes. By its own terms, the intent of the Spendthrift Provision is to shield a beneficiary's interest in the Living Trust from his or her creditors, and the Debtor is, by her own written admission in the Receipt, clearly a beneficiary of the Spendthrift Trust created thereunder.
The Bankruptcy Court also couldn't get away from the fact that Linda was related to J.T., who was acting as the Spendthrift Trustee, and that with the Spendthrift Trust being fully discretionary, it was Linda who was really in control:
Further, the Court cannot ignore the family relationship between the Debtor and the Spendthrift Trustee, as well as the total absence of any court supervision or control over the Spendthrift Trustee's decisions concerning disposition of the assets of the Spendthrift Trust. Family ties militate against any trustee exercising completely unfettered, independent discretion in administering a spendthrift trust. Lack of judicial oversight exacerbates the risk that the Spendthrift Trustee's independent judgment will be compromised by family entanglements. The Debtor had reason to assume that despite the creation of the Spendthrift Trust she would have every opportunity to influence, if not simply instruct, the Spendthrift Trustee to disburse funds according to her own discretion. Whether the Spendthrift Trust was a self-settled trust or similar device, the practical effect is the same—the Debtor can justifiably expect to exercise a significant degree of control over its assets.
But then the Bankruptcy Court shifted direction away from whether the Spendthrift Trust was a self-settled trust, and instead focused on whether it was a "similar device" to a self-settled trust. In doing so, the Bankruptcy Court identified four factors that it held brought the Spendthrift Trust into the "similar device" language of 548(e)(1):
1. Like a self-settled trust, the Spendthrift Trust was created in part to shield the Debtor's assets from her creditors: The Spendthrift Trustee and the Debtor candidly admitted that the purpose of setting up the Spendthrift Trust was to shield assets from the Debtor's creditors. Indeed, the fact that the Spendthrift Trust was not created until after the Debtor had made a written declaration of insolvency and her written mandate to the Spendthrift Trustee "to exercise his authority consistent with the provisions of [the Spendthrift Provision] of the [Living Trust]" make it impossible to reach any other conclusion about the purpose of the parties in setting up the Spendthrift Trust.
2. Like a self-settled trust, the Spendthrift Trust was created to preserve the right of the Debtor to receive future distributions from the Living Trust: Both the Debtor and the Spendthrift Trustee also conceded that another important purpose of the Spendthrift Trust was to provide for the Debtor's education and support needs under sec. 10.03 of the Living Trust and that the Debtor's nephew, the Spendthrift Trustee, had complete and unfettered discretion to make sure that this occurred.
3. Although not directly created by the Debtor, the Debtor indirectly caused the creation of the Spendthrift Trust via the instructions she conveyed to the Spendthrift Trustee in the Insolvency Letter: While it is true that the Debtor did not personally set up the Spendthrift Trust, there is no dispute that the Spendthrift Trustee did so in response to her request that he "exercise his authority consistent with the [Spendthrift Provision]" of the Living Trust. The Court concludes that the Debtor satisfied the "self-settled" aspect of sec. 548(e) by using the Spendthrift Trustee as her cat's paw to create the Spendthrift Trust, rather than setting it up directly.
4. It is irrelevant for purposes of sec. 548(e) whether the formal requirements for establishing a trust under South Carolina law were satisfied: Finally, the Court finds that, under the "similar device" language of sec. 548(e), the Chapter 7 Trustee need not establish that a formal trust was established according to South Carolina law; an account that was directly or indirectly created by the Debtor to shield her assets from her creditors while retaining a right to receive the assets from that account suffices to meet the requirements of the statute. Any more restrictive interpretation than that would have the effect of reading the "or-similar-device" language out of sec. 548(e).
The Bankruptcy Court thus found that a transfer had indeed been made to a "similar device" to a self-settled trust.
Linda next argued that she was not a beneficiary of the Spendthrift Trust. The problem was that Linda was obviously a beneficiary, both before and after the Merrill Lynch account was created. But, regardless of what the documents said, the Court turned again to the close relationship between Linda as the beneficiary, and her nephew J.T. as the Trustee, and that he had total discretion to do whatever he wanted:
At trial, [J.T.] candidly admitted that, because he is not subject to any court oversight, it is within his sole discretion to distribute spendthrift funds for the Debtor's support and maintenance in any way he sees fit. By way of example, he could justify giving the entire amount in the Spendthrift Trust to the Debtor as a "support" distribution designed to alleviate the emotional anxiety she presumably feels as a result of her bankruptcy. This is not an entirely facetious analogy, given the family relationship between the two and the complete lack of court supervision over the Spendthrift Trustee's exercise of his discretion.
All this brings us to the whether the Debtor had the actual intent to transfer assets so as to hinder, delay, or defraud her creditors. Here, the Court simply looked to the timing of Linda's advising J.T. that she was in financial difficulty, and that the Spendthrift Provision of the Living Trust should apply. Here, the Court held that Linda intended to use the Spendthrift Provision to defeat her creditors:
Along with the Debtor's testimony that the purpose of the Spendthrift Trust was to prevent creditors from reaching her interest, the Court finds that these facts establish that the Debtor and the Spendthrift Trustee at a minimum contemplated using the Spendthrift Trust device as a mechanism to avoid the Debtor's creditors. Indeed, they suggest that the Debtor and the Spendthrift Trustee actively planned and structured the creation of the Spendthrift Trust with the explicit purpose of shielding those assets from creditors—the precise action that sec. 548(e) was created to avoid. Even now, the Spendthrift Trustee continues to maintain that account subject to his sole discretion to distribute funds for the Debtor's support or education.
In summary, the transfer of funds was not timed in accordance with the terms of the Living Trust or even with the onset of the Debtor's financial need. It was delayed until an instrumentality had been created to deny the Debtor's creditors access to these assets while making them available for the Debtor's benefit.
Second, the Debtor testified at trial that her understanding was that the Spendthrift Trust was created to prevent her creditors from reaching her one-quarter share of the assets. The Spendthrift Trustee was equally candid, testifying that the purpose in setting up the Spendthrift Trust was to shield assets from the Debtor's creditors. This testimony, coupled with the timing of the events outlined above, make it impossible to characterize the purpose of the parties in setting up the Spendthrift Trust as anything other than to thwart the Debtor's creditors. Therefore, the Court finds that the Debtor intended to hinder, delay, or defraud her creditors in making the transfer.
Finally, in Footnote 5, we find the Court's final rationale for its decision that 548(e) applies to set aside the transfer in this case -- a very surprising rationale: When Faith Campbell set up her Living Trust, that trust was a self-settled trust to her, and thus 548(e) applies even though Linda did not settle the trust, i.e., a settlor's self-settled status may be applied to beneficiaries.
Footnote 5. There is an alternative analysis which leads to the same result. It is undisputed that the Living Trust set up by Ms. Campbell was a "self-settled" trust, since it was directly created by Ms. Campbell. All that sec. 548(e) requires is that the avoidable transfer be made within ten years of the bankruptcy filing by a debtor beneficiary. Even if the Court were to ignore the Spendthrift Trust and look solely at the Living Trust, the Debtor's actions taken in the Insolvency Letter and the Receipt would still have accomplished a "transfer" into a "self-settled trust or similar device," i.e., the Living Trust created by Ms. Campbell, that would be avoidable under sec. 548(e).
In the end, the Court ruled against Linda on every issue, determined that Linda and J.T. had committed a fraudulent transfer under 548(e)(1), and also found that the turnover order for Linda's share of the Living Trust assets should be issued. This was all embodied in the recommendation made by the Bankruptcy Court to the U.S. District Court for the Northern District of Illinois, who now must decide whether to affirm or reject the Bankruptcy Court's recommendations.
ANALYSIS
This Opinion turns on the single most critical issue of whether the Living Trust terminated or not, upon or shortly after Faith's death. If the Living Trust did not terminate, but J.T. as the Trustee could continue to hold the assets for Linda's benefit, then this Opinion is troublesome in many ways. If the Living Trust did terminate soon after Faith's death, such that Linda had a vested right to the assets by the time she declared bankruptcy, then it makes more sense -- although the rationale of the Opinion is still troublesome.
So, let's go right to the money question, did Faith's Living Trust terminate?
According to Section 8.01 of the Living Trust document, it terminated upon Faith's death "and upon settlement of her estate."
So what does "settlement" mean? Whatever it means, the Bankruptcy Court took a very restricted view of the term, and -- with only the most superficial analysis and no legal authority -- deemed "settlement" in this context to essentially mean that once the Trustee had substantially administered the Estate and paid out the rest of its assets, then "settlement" was achieved.
In other words, the Bankruptcy Court shot-from-the-hip in the singularly most important issue in the case, and didn't even make an attempt to consider the alternative interpretation of the term, which was that the Living Trust could not be considered to be settled until all of its assets had been paid out; further, because of the Spendthrift Clause, the Trust could not in fact be settled because Linda as one of the beneficiaries had financial problems and thus the Trustee could not make the final distributions to her.
The parties did in fact extensively brief the common law Doctrine of Cessor in their Joint Pre-Trial Statement. That Doctrine posits that if a creditor attempts to subject the interests of a beneficiary in property to collection, the beneficiary's interest immediately ceases to exist and instead vests in another beneficiary. South Carolina law, which applied to Faith's Living Trust, follows the Doctrine of Cessor. So, in the worst case, meaning that for whatever reason the Spendthrift Provision failed, Linda's interest would simply have terminated, and her three siblings would have received greater shares from the Trust.
But the Bankruptcy Court ignored this too, and instead the Court gives us an analysis of 548(e)(1) that has ramifications far beyond what most planners would have suspected. We'll get to these in a second.
A plausible characterization of what happened is this: Faith properly created and funded a Trust that was revocable as to her in 1997, at a time when she had no creditors (or at least no creditors who timely challenged the funding of the Trust). When Faith died in 2011, three-fourths of the Trust immediately passed to three of Faith's children. The remaining one-fourth of the Trust could not be distributed because that beneficiary (Linda) had financial problems that prevented the distribution according to the Trust's terms. There was never anything like two trusts, but simply the one original Trust -- the Merrill Lynch account for the benefit of Linda was simply the Trustee's quite proper method of segregating those remaining Trust assets from the balance.
Alternatively, Linda's beneficial interest ceased to exist when it was time for the Trustee to make a distribution to her, both according to the terms of the Trust document, and South Carolina's Doctrine of Cessor. If anything, then, Linda's share should have passed to the remaining beneficiaries.
But the Court didn't see it anything like that. Instead, the Court held that Faith's Trust effectively was terminated immediately upon her death, and at that time Linda became unchangeably vested in her one-fourth interest. Thus, according to the Court, when J.T. as the Trustee did not make the distribution to Linda of her one-fourth interest, but instead placed those moneys into the Merrill Lynch account, a fraudulent transfer occurred under section 548. As to the Spendthrift Clause, the Court essentially held that because Linda became vested in her interest at the time of Faith's death, and the Trust then immediately terminated, the Spendthrift Clause was inapplicable.
The Court's conclusion as to the non-applicability of the Spendthrift Clause is, and should be, quite shocking to planners who presume that a trust survives if payments to a beneficiary cannot be made because of that clause. However, the fix is easy: A trust document should (now) have language that the trust will not terminate if there is a remaining beneficiary who cannot immediately take because of existing creditors.
Moreover, this Opinion again illustrates the perils of fixed, mandatory distributions where asset protection is anything like a serious concern. This mess would likely not have happened if, by contrast, the trust document had provided that all trust distributions to all beneficiaries where wholly within the sole and unfettered discretion of the Trustee, and the Settlor had instead (1) given the Trustee a "Letter of Wishes" as to how distributions ought (but are not required) to be made, and (2) the trust had a "trust protector" who had the ability to fire a Trustee who did not act in good faith to fulfill the wishes of the Settlor.
Or, maybe this mess would still have occurred, per the Court's quite expansive (to be kind) reading of section 548, as discussed more further below. We can only do so much with drafting, and drafting is often no barrier if a particular judicial officer goes off the technical legal reservation.
Nonetheless, the Court's rationale is followed in future cases, this means that probably millions (literally, millions) of existing trusts may be defective as to the operation of their Spendthrift Clause, if the Trust may be deemed to terminate immediately upon the death of the Settlor. These trusts probably need to be fixed, and quickly -- it is a good opportunity for planners to meet with their past clients and update their documents.
The Court apparently followed the same rationale in regard to whether Linda's beneficial interest ceased to exist because she had existing creditors, i.e., the Trust terminated (and Linda's right to Trust assets vested) immediately upon Faith's death, and so there was never an opportunity for Linda's beneficial interest to cease to exist. Here, the fix is the same: Trust documents should be clear that the Trust survives until all distributions have been made, including distributions that would have been made if a beneficiary's interest ceases for whatever reason to exist.
A problem with this case is that both Linda and J.T. referred to the new Merrill Lynch account as a "Spendthrift Trust", when it seemed to be no more than just a new account opened by J.T. to fulfill his duties under Faith's Living Trust. This lead the Court to apparently presume that there were two trusts, one of which was formed after Linda had creditor problems, instead of just the one Living Trust.
Now let's turn to the 548(e) issues. Fasten your seatbelt, and pull it tight, as this is going to be a wild ride.
In 2005, Congress passed the Bankruptcy Abuse Prevent and Consumer Protection Act ("BAPCPA"). Personally, I'm still trying to find the consumer that was "protected" by the Act, but I digress. The BAPCPA gave us a new addition to section 548, which is bankruptcy law's fraudulent transfer provision. That addition is 548(e), which, as set forth above, operates to set aside transfers to "self-settled trusts and similar devices".
According to the Congressional record, and as recognized by the Courts, the stated purpose of 548(e) was to eviscerate in bankruptcy the protections afforded by the so-called Domestic Asset Protection Trusts. Here, the Bankruptcy Court noted:
Footnote 4. At the time sec. 548(e) was added to the Bankruptcy Code, five states (Alaska, Delaware, Nevada, Rhode Island, and Utah) had enacted statutes permitting debtors to shield their assets from creditors by transferring them to self-settled spendthrift trusts. Quality Meat Prods., LLC. v. Porco, Inc. (In re Porco, Inc.), 447 B.R. 590, 595 (Bankr.S.D.Ill.2011).
Section 548(e) is the reason why not just a few asset protection planners believe that, whatever else DAPTs do or don't accomplish, they are at best a very weak asset protection device since they don't work in bankruptcy, at least within the first 10 years after a transfer was made to such a trust (which 10 years is the Statute of Limitations given in 548(e)).
While it is perfectly clear that DAPTs will not work in bankruptcy, at least as to the settlor/beneficiary, Congress' inclusion of the language "or similar device" raises substantial questions about just how far 548(e) will be interpreted in bringing other, non-DAPT, trusts within its orbit.
One would think that this language would be limited to DAPTs and their close variants, such as so-called Power of Attorney Trusts and Hybrids Trusts, but we found out in the Thomas case than an IRA is a form of self-settled trust within the orbit of 548(e), see In re Thomas, 2012 WL 2792348 (Bkrtcy.D.Idaho, Slip Copy, July 9, 2012) (full Opinion at http://goo.gl/4x01T) and my article on that opinion, "Thomas: Pre-Bankruptcy Exemption Planning Survives And An IRA Is A Self-Settled Trust Or Similar Device" http://goo.gl/ZU0Q4
Here, the Court tells us once again that the "similar device" language of 548(e) is to be interpreted broadly" so that "even if crafty lawyers draft devices not technically "self-settled trust[s]," court[s] will have the power to scrutinize them under the 'similar device' provision." In other words, if something starts to smell like an asset protection trust, then 548(e) potentially becomes implicated. This creates very dangerous ground from the outset for clients and planners alike who are considering asset protection planning using trusts.
Optics play a huge role in trials; if enough things look bad, then everything is evaluated in a cynical light. Here, the bad optics were found in making the Debtor's nephew, J.T., the Trustee.
Since a Trustee is fundamentally somebody that the Settlor trusts, and since folks naturally tend to give greater trust to long-known family members, an explanation of why appointing the Debtor's nephew amounted to bad optics.
The problem was, from the Court's perspective, that not only was the Trustee so closely related to the Debtor that the line between a true Trustee and a mere Nominee became blurred, but the problem was exacerbated by the fact that the Trustee had been given complete discretion by the Trust document to do whatever he wanted in regard to the Debtor as a beneficiary (and, yes, many if not the majority of modern trusts are drafted just this way). While there was no actual evidence of J.T. being influenced by Linda, the optics were bad, and the Court ended up almost presuming that Linda was the de facto puppet master of J.T.
It also rubbed the Court wrong that J.T. apparently set up the Merrill Lynch account on the indirect urging of Linda, or as the Court put it, "using the Spendthrift Trustee as her cat's paw to create the Spendthrift Trust, rather than setting it up directly." Of course, this presumes that the Merrill Lynch account rose to the dignity of a "Spendthrift Trust", which isn't exactly clear as previously discussed. But the takeaway is this -- Linda acted, J.T. reacted, and together they appeared to be working in concert, and this belied that J.T. was a true independent Trustee instead of simply Linda's nominee.
So was a second Trust, called the "Spendthrift Trust" created? The Court implicitly admits that it was not formally created, but then goes on to say that under 548(e), setting up the Merrill Lynch account was a "similar device" under 548(e), and therefore just as good as a self-settled trust for fraudulent transfer purposes.
Wow -- think about that one for a minute! If a Trustee sets up a new investment account, that could be a "similar device" under this Court's interpretation of 548(e). Presumably, if the Trustee set up a sub-trust to hold assets, that would also be a "similar device". What about if the Trustee decants the existing Trust assets to a new Trust? If this Opinion stands up, I can hear the ice cracking.
But there are flaws in the Court's thinking. Setting up a new account for an existing trust doesn't mean that the beneficiary of the existing trust ipso facto becomes a beneficiary of the new trust, but more likely that the old trust is the beneficiary of the new account -- not the debtor. The Court glosses over this issue.
Similarly, I think that simply wrong is the Court's position that because Faith created a Trust that was self-settled as to herself, it also meant the Trust was self-settled as to Linda as a beneficiary. In the context of trust law generally, that sort of reasoning doesn't rise to the level of respectable nonsense. In the context of this case in particular, the argument is a non-starter because Faith created and funded the Trust well more than 10 years before Linda filed for bankruptcy, and thus was barred by the Statute of Limitations. In other words, at best Footnote 5 to this effect is dicta, and highly dubious dicta at that.
Which is to say that even if this Opinion stands, I don't expect the full breadth of its amazingly liberal interpretation of 548(e), and playing fast-and-loose with the facts, to be adopted as a majority position by other Courts. Like most other things, section 548(e) is going to shake out somewhere in the middle -- not as broadly construed as creditors hope, and not as tightly construed as debtors hope -- and we may well later mark this Opinion as an extreme example of a liberal interpretation of the statute.
But we'll have to wait and see where the Courts go with this. Often, the first opinions on a subject are given more weight that they ordinarily would be due, and thus swing the law disproportionately to the merits of their reasoning.
The bottom line is that 548(e) is a fearsome part of the Bankruptcy Code, which not only neuters DAPTs in bankruptcy, but also has the tremendous potential to eviscerate asset protection strategies which are somewhat like DAPTs, and maybe even some things that aren't like DAPTs at all.
Personally, my guess is that this Opinion will be reversed or at least significantly cut back upon review by the U.S. District Court, or on appeal to the Seventh Circuit. But there is probably about an equal probability that this Opinion will survive in major part.
The only thing that we know for sure is that heartburn and ulcers are imminent. So stay tuned.
CITE AS
In re Castellano, 2014 WL 3881338 (Bk.N.D.Ill., Aug. 6, 2014). http://goo.gl/4Ue5Dn
The Trustee's Adversary Complaint is found at http://www.assetprotectionbook.com/casedocs/castellano/01_Adversary_Complaint_25oct13.pdf
The Trust Document is found at http://www.assetprotectionbook.com/casedocs/castellano/01-A_Campbell_Trust.pdf
The parties' Joint Pre-Trial Statement is worth reading, and found at http://www.assetprotectionbook.com/casedocs/castellano/38_Joint_PreTrial_Statement.pdf
This article at http://onforb.es/1rj37ij and http://goo.gl/FRqBXE
