In re Castellano: A Strike at Third Party Spendthrift Trusts

By Mary E. Vandenack.

In In re Castellano,  a Bankruptcy Court in Illinois applied Section 548(e) of the  Bankruptcy Code to disregard a third party trust containing spendthrift provisions and conclude that the spendthrift trust was a device similar to a self-settled trust and that the assets of the trust were subject to seizure by the creditors of a trust beneficiary who filed bankruptcy.

Faith Campbell created the Faith M. Campbell Living Trust (“LT”) on February 18, 1997 in South Carolina, where she was a resident. The LT provided that upon Faith’s death, its assets would be divided equally among her children. The LT stated that “[upon] the death of Faith F. Campbell and upon settlement of her estate, this Living Trust shall terminate”.  The LT contained a spendthrift clause as follows:

“If any beneficiary should attempt to alienate, encumber, or dispose of all or any part of the income or principal of this trust before it has been delivered by the Trustee, of if by reason of bankruptcy or insolvency or any attempted execution, levy, attachment, or seizure of any assets remaining in the hands of the 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, the interest of that beneficiary shall immediately terminate…Thereafter, the Trustee shall pay to or for the benefit of that beneficiary only those amounts that the 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.”

Faith died on February 11, 2011, survived by all four of her children, including Linda Castellano (“D”), who was a debtor in the case. Bank of America declined to accept its appointment as trustee and in March 2011 Faith’s children, including D, named the husband of one of Faith’s grandchildren (a nephew by marriage) as trustee.

D filed bankruptcy on November 18, 2011. Prior to filing, D’s counsel sent a letter to the trustee of LT indicating that D was insolvent and directing the trustee to set aside and retain any assets that might otherwise be distributed to D in a spendthrift trust. On October 31, 2011, D signed a receipt acknowledging she would receive no distribution from LT.

The court applied Section 548(e)(1) of the Bankruptcy Code to conclude that the assets in the spendthrift trust were subject to seizure by D’s  creditors. The court concluded that D had made a transfer as a result of the combined effect of the letter from her counsel to the trustee, her signature on the receipt, release and refunding agreement and a “familial” Trustee.

 The court concluded that the transfer by D  was to a device similar to a self-settled trust because the trust was created to shield D from creditors and to preserve the rights of D to future distributions from the trust. The court indicated that D had indirectly created the trust by refusing to take a distribution of assets from LT and instead engaging in a course of action that resulted in setting aside her share of LT in the spendthrift trust.

The court’s decision in this case seems flawed. It is our understanding that counsel for D is considering an appeal.

© 2014 Parsonage Vandenack Williams LLC

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