Friday, November 27, 2009

Whom do you trust when interpreting a trust?

Update: On June 15, 2011, the Fifth Circuit entered a ruling finding that the Trustee was entitled to 50% of the corpus of the trust. Roberts v. McConnell, No. 10-50462 (5th Cir. 6/15/11). You can read the Fifth Circuit opinion here.

Trusts are interesting things. They are a way to transfer property without completely letting go. One reason to transfer property in trust is to see that the beneficiary receives the benefit of the trust property instead of his creditors. Of course, the bankruptcy trustee has just the opposite incentive. The trustee would like to bust the trust and distribute the proceeds to creditors. When trust provisions are unclear, it can make for an interesting exercise as Judge Craig Gargotta discovered in Roberts v. McConnell, Adv. No. 09-1011 (Bankr. W.D. Tex. 11/3/09).

In this case, Mary McConnell set up a trust for her grandson. The trust allowed the beneficiary to withdraw funds from the trust according to a graduated schedule based on the beneficiary's age, but only if "the Settlor of this Trust (or each Settlor, if more than one) is then deceased." The grandmother passed away in September 1997. At that time, the grandson could have withdrawn 33% of the trust. However, several months later, his mother made a contribution to the trust which she repeated during six additional years.

The debtor filed for bankruptcy in 2004. At that time, he was 37 years old. At that time, he would have been entitled to one-half of the trust if the Settlor (or Settlors if more than one) were deceased. In 2009, the bankruptcy trustee brought suit against the trustee of the trust seeking to recover the entire corpus for the benefit of the bankruptcy estate. The trustee of the trust moved to dismiss.

The issues that the court faced were:

1) Was the term settlor limited to the person who initially created the trust or did it extend to the mother as well?
2) If the mother was deemed to be a settlor, could the trustee at least recover the funds which the debtor was entitled to withdraw for a brief period prior to his mother's initial contribution?

Under the Texas Property Code, the term settlor is defined as the person who creates the trust. However, the Trust defined settlor as anyone who contributed property to the trust. Under the Texas Property Code, the specific language of the trust controlled over the definition of settlor contained within the Property Code. The parenthetical language (or each Settlor if more than one) suggested that there could be additional settlors. Thus, the trustee could not recover the full amount of the trust, since there was still a settlor alive.

However, this gave rise to a second question: could the mother, by becoming a settlor, unvest the debtor's right to make a withdrawal? Recall that when the debtor's grandmother passed away, she was the sole settlor of the trust and he could withdraw one-third of the value of the trust at that time. Had bankruptcy not intervened, one could imagine the unpleasant conversation which might transpire when the son learned that his legacy was now out of reach due to this mother's decision to add to the trust. In this case, the bankruptcy trustee was just making the argument which the son would likely have made, namely, it's not fair.

In trying to determine the intent of the settlor, the court found it significant that the trust imposed two different requirements for withdrawing funds from the trust: reaching a specified age and the prior death of all settlors. The court found an intent for both benchmarks to be present at any time that a withdrawal was requested.

The court's result seems to be a natural reading of the language of the trust. However, it is not hard to imagine how these provisions could be used to reach a twisted result. Imagine that the grandmother had two grandsons, one of whom always wrote his thank you notes timely and never forgot his grandmother's birthday. The other grandson was an ungracious lout who stole spare change from his grandmother's purse and never had a kind word, let alone a thank you. The grandmother decides to create a trust for one of the grandsons but not the other. The grandmother passes on and the ungrateful grandchild learns that he has been passed over. Upon learning of the trust provision, he contributes $10 to his brother's trust so that he can never access the trust funds. In this scenario, could the ungrateful grandson keep his favored brother from ever accessing the trust? Would the likelihood that the sinister grandson would encounter an unfortunate accident go up? These would make for good law school exam questions. Fortunately Judge Gargotta didn't have to reach these questions. (Congratulations to new law clerk Sarah Darnell on her first opinion).

Update #1: Eric Taube advises that this opinion is being appealed.

Update #2: Alert grammarians Pat Autry and Fay Gillham pointed out that my headline should have read "Whom do you trust when interpreting a trust?" instead of the original "Who do you trust when interpreting a trust?" I did some research and found out that they were correct.

According to wikiHow, who is used as the subject of a sentence or phrase while whom is used as the object of a verb. This still left me scratching my head, so I read further on. If the answer to the question is he, then who is correct, while if the answer to the question is him, then it is whom. Thus, the answer to the question would be "I trust him to interpret a trust" indicating that whom was the correct way to begin the sentence.

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