Removal of Trust Contingency Benefits Estate

Posted by NCBRC - January 2, 2023

Removal of a contingency in a Trust did not create a new asset such that the resulting increase in value to the debtor/beneficiary would be considered a post-petition asset. In re Wright, No. 19-21544 (Bankr. D. Kans. Dec. 7, 2022).

The Wrights filed for chapter 13 bankruptcy with unsecured debts totaling $14,196.53. They confirmed a three-year plan that provided little to no distribution to unsecured creditors. When they filed for bankruptcy, Ms. Wright and her siblings were the beneficiaries of an irrevocable Trust consisting of 40 acres of real property. The Trust had a contingency that one of Ms. Wright’s siblings, Ronnie True, would receive the Trust income and continue to live on the Trust property for the remainder of his life. Upon Mr. True’s death, the Trustee could then either deed or sell the property for the benefit of the remaining siblings, including Ms. Wright.

The Wrights did not list the Trust on their bankruptcy schedules. Mr. True died shortly after Ms. Wright and her husband filed for bankruptcy at which time Ms. Wright’s interest in the Trust grew to $49,442. The debtors moved the bankruptcy court for “retention of distribution from a trust.” The chapter 13 trustee objected and sought Ms. Wright’s interest in the Trust for the benefit of the bankruptcy estate.

The court began with the finding that property of the estate under section 541 is broadly defined and comprises contingent interests such as the one here. The court rejected the Wrights’ argument that because the Trust had no value to Ms. Wright when they filed their petition, it did not become property of the estate. The court noted that the debtors’ argument as to the value of the Trust was based entirely on its contingent status. It found further that the mere fact that the value of an asset is difficult to assign, does not mean it is without value. Therefore, Ms. Wright’s interest in the Trust, albeit contingent, became part of the bankruptcy estate when the debtors filed their petition.

The debtors next argued that the Trust fell under section 541(c)(2) which excludes spendthrift trusts from the bankruptcy estate. Though agreeing that the Trust itself did not include a spendthrift provision, the debtors argued that Oklahoma law made it a spendthrift trust. Specifically, the debtors relied on 60 Okla. Stat. Ann. § 175.25(E)-(F) which provides:

  1. The right of any beneficiary of a trust to receive the principal of the trust or any part of it, presently or in the future, shall not be alienable and shall not be subject to the claims of his creditors.
  2. Where the interest of the beneficiary of a trust is subject to the exercise of discretion by the trustee or by another, the provisions of this act as to the rights of creditors and assignees shall apply with respect to any sums which the trustee or such other person determines shall be paid to or for the beneficiary.

The court found that, when read in the context of the entire Oklahoma statute, paragraph (E) “extends the spendthrift protection to the entire principal of the trust containing an express spendthrift limitation and therefore has no bearing on Ms. Wright’s interest.” As to paragraph (F), the court found the debtors’ reliance to be likewise misplaced. It found that the Trustee’s discretion with respect to this Trust was limited to whether to deed or sell the property for the benefit of the beneficiaries. The Trustee did not have any discretion with respect to the beneficiaries’ interest after the contingency was removed by Mr. True’s death.

The chapter 13 trustee argued that the debtors’ plan should be modified to include the increase in Ms. Wright’s assets. The debtors countered that the asset was post-petition property that did not enter the estate.

The court found that the contingent interest was part of the estate upon filing and that the chapter 13 plan specified that estate property did not revest in the debtors upon plan confirmation. The court rejected the debtors’ argument that removal of the contingency created a new, post-petition, asset.

Because the property of the estate was the entire asset, rather than its value at the time of the petition, the removal of the contingency increased the value of the asset for the benefit of creditors. The court distinguished Rodriguez v. Barrera (In re Barrera), 22 F.4th 1217 (10th Cir. 2022), where the Tenth Circuit held that the proceeds from the post-petition sale of real property, did not become part of the debtor’s chapter 7 estate upon conversion because the asset as listed on the chapter 13 petition no longer existed. Unlike that case, the court here found that the removal of the contingency was not a sale or other event that removed the asset from the estate.

The court concluded that the debtors were not entitled to retention of the Trust distribution.

The court turned to the Trustee’s motion to modify the chapter 13 plan under section 1329 to distribute the Trust funds in satisfaction of section 1325’s “best interest of creditors” test as required for modification. The “best interest of creditors” test compares the distribution the creditors can expect to receive under the applicable chapter 13 plan, and the amount they would receive were the estate to be liquidated under a hypothetical chapter 7 case. The property in the hypothetical chapter 7 liquidation consists of the property included in the original chapter 13 petition that is still in the debtor’s possession.

Again, the court found the Trust was part of the original chapter 13 estate and that its increase in value was captured by the estate. It therefore found the value of the Trust as calculated on the date of the proposed modified plan was properly included in the hypothetical chapter 7 case. Using that value, the court found the creditors in a chapter 7 liquidation would receive more than the creditors under the debtors’ actual chapter 13 plan.

Finally, the court found that the trustee’s motion to modify was timely filed even though the debtors completed their plan payments before the court had ruled on the motion. The trustee filed the motion before the plan payments were complete as required by section 1329(a).

The court denied the debtors’ motion to retain the funds, and granted the trustee’s motion to modify.

Wright Bankr D Kans Dec 2022

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