Fifth Circuit Trusts (Chapter 7) Trustee's Interpretation of Trust

In an interesting ruling that has more to do with trust law than bankruptcy, the Fifth Circuit has ruled that a bankruptcy court incorrectly held that a trust was not property of the estate. Roberts v. McConnell, No. 10-50462 (5th Cir. 6/15/11). You can find the opinion here.

Mary McConnell ("Mary") created a trust for her grandson Terry Hoff ("Terry"). The trust listed her as the Settlor. She contributed $100 to the trust. Terry's mom, Peggy McConnell ("Peggy"), on the other hand, contributed $70,000. The Trust provided that once the Settlor died, Terry would have the right to withdraw increasing amounts from the trust at age 30, age 35 and age 40.

Terry filed for chapter 7 bankruptcy when he was 37. Mary was deceased at this time, but Peggy was not. The critical question was whether Terry had the right to withdraw funds from the trust. If Mary was the sole settlor, then Terry would have the right to withdraw funds. On the other hand, if Peggy (who actually contributed 99% of the money to the trust) was a settlor, then Terry could not.

The Bankruptcy Court quite sensibly ruled that because Peggy had contributed funds to the trust and because she was not deceased that the trust funds were not property of the estate. I wrote about the Bankruptcy Court's opinion here.

The Fifth Circuit relied on both the language of the trust and the version of the Texas Trust Code then in effect to hold that Mary was the sole settlor of the trust. The Court shrugged off cases such as In re Bradley, 501 F.3d 421 (5th Cir. 2007) with the comment that they referred to self-settled trusts. Apparently persons other than the stated settlor can be settlors for a self-settled trust. The decision is of limited importance due to a change in the Texas Trust Code. Under the current version of the law, a settlor is "a person who creates a trust or contributes property to a trustee of a trust." Tex. Prop. Code Sec. 111.004(14). Unfortunately, this legislation was enacted after the debtor filed bankruptcy. As a result, it did not determine that Peggy was an additional settlor.

Because the trust designated Mary as the settlor and because she was deceased at the time that Terry filed bankruptcy, Terry's trustee was entitled to 50% of the trust. The only real take-away from this case is that prior to 2007 when the law was changed, the definition of a settlor under a Texas trust depended on whether the trust was self-settled or not. However, under current law, anyone who contributes property to a trust is a settlor.