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Danning v. Lederer

April 11, 1956

SARAH B. DANNING, AS TRUSTEE IN BANKRUPTCY OF THE ESTATE OF RUTH LEDERER JOSLIN, ALSO KNOWN AS RUTH L. JOSLIN, ALSO KNOWN AS MRS. BERNARD JOSLIN, BANKRUPT, PLAINTIFF-APPELLANT,
v.
HAROLD LEDERER, ALSO KNOWN AS HAROLD S. LEDERER; LEO LEDERER, ALSO KNOWN AS LEO M. LEDERER, ALSO KNOWN AS LEON LEDERER; AND MORRIS GLASSER; INDIVIDUALLY AND AS TRUSTEES OF CERTAIN TRUSTS AND AS EXECUTORS OF THE ESTATE OF ELLEN LEDERER BURNSTINE, DECEASED, DEFENDANTS-APPELLEES.



Author: Swaim

Before FINNEGAN, SWAIM and SCHNACKENBERG, Circuit Judges.

SWAIM, Circuit Judge.

This is a plenary suit brought by a trustee in bankruptcy to recover property to which she claims title under Section 70, sub. a(5) of the Bankruptcy Act, 11 U.S.C.A. § 110, sub. a(5). The voluntary petition in bankruptcy was filed in the Southern District of California, but the property involved is located in Illinois.

The property to which the trustee claims title consists of four trusts in which the bankrupt has an equitable interest as one of the beneficiaries. Three of the four trusts were established by the bankrupt's father: two inter vivos, referred to as the Leon Lederer and Harold Lederer Trusts, and one by his Last Will and Testament, referred to as the Testamentary Trust. The fourth trust was established by the bankrupt's brother and is referred to as the Atlantic Brewing Trust since it consists of all the stock of the Atlantic Brewing Company. Each of the trusts contains a "spend-thrift" clause providing that none of the beneficiaries can transfer, pledge, assign or in any manner anticipate, charge, encumber or make liable for the debts, contracts or engagements of the beneficiaries any money or property distributable thereunder while such property or money is in the possession of the trustees.

Section 70, sub. a of the Bankruptcy Act, under which the trustee claims title, provides that the trustee in bankruptcy shall obtain title to all property that the bankrupt could have transferred:

"(a) The trustee of the estate of a bankrupt and his successor or successors, if any, upon his or their appointment and qualification, shall in turn be vested by operation of law with the title of the bankrupt as of the date of the filing of the petition initiating a proceeding under this title, except insofar as it is to property which is held to be exempt, to all of the following kinds of property wherever located * * * (5) property, including rights of action, which prior to the filing of the petition he could by any means have transferred or which might have been levied upon and sold under judicial process against him, or otherwise seized, impounded, or sequestered * * *." 11 U.S.C.A. § 110, sub. a.

The plaintiff filed her complaint claiming title to the bankrupt's interest in the trusts. The defendant trustees moved to dismiss the complaint arguing that because they are all "spendthrift" trusts the bankrupt did not have the power to "transfer" her interest in them and therefore the requirements of Section 70, sub. a(5) of the Bankruptcy Act had not been met. The District Court dismissed the complaint, for failure to state a cause of action, and from that judgment this appeal is prosecuted.

In such an appeal we must consider all the allegations of the complaint as true. The basic question is whether or not the bankrupt at the time she filed her petition in bankruptcy could have in any manner transferred her interest in any of the four trusts. If she could, her title in the trusts passed to the trustee under Section 70, sub. a(5) of the Act. The appellant trustee argues that the spend-thrift provisions in these trusts are invalid and that the bankrupt could have assigned her interest in them. The trustee argues that the spendthrift clauses of all the trusts are invalid because they attempt to restrain alienation of the corpus of the trusts as well as the income. She makes the further point that the bankrupt has a vested interest in the trusts and restraints upon the alienation of such an interest are against public policy. These two arguments are actually the same in this case since the bankrupt's vested interest is in the corpus of the trust which the "spendthrift" clause attempts to protect from creditors.

In determining the question of the bankrupt's right to transfer under these trusts we must follow Illinois law because they were made in Illinois by Illinois residents and involve Illinois property. In Hopkinson v. Swaim, 284 Ill. 11, 25-26, 119 N.E. 985, 989, the Supreme Court of Illinois in passing upon the effect of a "spendthrift" trust said:

"It is argued that the attempted restraint on alienation is void because the children of William Swaim took a vested legal estate in fee under the will of James Swaim and the entire legal interest under the supposed trust for their lives, and that James Swaim, having devised the property in fee to his grandchildren, was powerless to impose any restraint on its alienation. It is true that as a general rule any limitation restraining an owner in fee simple from selling his land is bad, but it is said in Johnson v. Preston, 226 Ill. 447, 80 N.E. 1001, 10 L.R.A.,N.S., 564, which is cited by appellant's counsel, that there is an apparent exception to this rule where what is known as a spendthrift trust is created. The devise in that case was stated to bear no resemblance to a spendthrift trust, and it was therefore not decided there whether cases of that character were an exception to the general rule. In this case, however, active duties were imposed upon the trustees and the trust is a spendthrift trust. We have already seen that such trusts will be sustained and the restriction upon alienation enforced during the life of a devisee for life. There is no reason for such a rule in the case of a life estate which does not apply equally to a fee during the life of the owner."

The Appellate Courts of Illinois have specifically held that a spendthrift clause may protect the corpus of a trust as well as the income. Von Kesler v. Scully, 267 Ill.App. 495.

The case of Potter v. Couch, 141 U.S. 296, 11 S. Ct. 1005, 35 L. Ed. 721, upon which plaintiff relies, has no bearing on the present situation because it was decided in 1891, before spendthrift clauses had been accepted as a valid restraint on the alienation of an equitable interest in the corpus of a trust in Illinois. In the case of Steib v. Whitehead, 111 Ill. 247, only the payment of the net rents and income to the beneficiary was involved, and the court held that a spendthrift provision in the trust protected such funds while in the hands of the trustee against garnishment by a creditor of the beneficiary.

Likewise, plaintiff's argument that we must follow federal rather than state authority on this question is untenable. Section 70, sub. a of the Bankruptcy Act makes the trustee's title to the beneficial interest in the trusts dependent upon the bankrupt's power to alienate that interest, but the Act does not define that power to alienate. The definition of such power is left to the courts of the several states. By making the trustee's title dependent upon the alienability of property, the Act has made it dependent upon state law where that law has determined the question of alienability. See Eaton v. Boston Safe Deposit & Trust Co., 240 U.S. 427, 36 S. Ct. 391, 60 L. Ed. 723. The Supreme Court in that case said, 240 U.S. at page 429, 36 S. Ct. at page 392:

"The policy of the bankruptcy act is to respect state exemptions, and until the Massachusetts decisions shall have gone farther than they yet have we are not prepared to say that the present ...


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