If You Are A Spendthrift (Trust), Go To Hawaii

On behalf of Macdonald Fernandez LLP on Friday, December 5, 2014.

A valid spendthrift trust is entitled to certain protections in bankruptcy, especially in Hawaii. In In re Zukerkorn, 500 B.R. 598 (9th Cir. BAP 2013), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit (the "BAP") upheld the decision of California Bankruptcy Judge Alan Jaroslovsky ruling that a Hawaii spendthrift trust was valid and entitled to full protection under Hawaii law.A spendthrift trust is used to transfer the beneficial interest in assets, often to children or grandchildren, with restrictions on spending. Because the beneficiary's use of funds is restricted, the trust is entitled to certain protections from execution by creditors. For example, in California, creditors generally can reach only 25% of distributions to the target beneficiary under California Probate Code Section 15306.5. Under Hawaii law, by contrast, the distributions are fully protected.In Zukerkorn, the debtor and his mother lived in Hawaii, and the mother held assets in Hawaii. The debtor's mother set up a spendthrift trust, with a Hawaii choice of law clause, for the benefit of her two sons. After the death of his mother and brother, the debtor became the trustee and moved to California with his two children, also beneficiaries under the trust.The debtor filed bankruptcy in California. The bankruptcy trustee sought turnover of 25% of the debtor's future distributions and raised traditional choice of law arguments, including that California has a more substantial interest in the matter and Hawaii's full protection of spendthrift trusts violates a fundamental policy of California law.The bankruptcy court ruled that the trust was governed by Hawaii law and fully protected. The trustee appealed, and the BAP affirmed.The BAP held that Hawaii has a substantial relationship to the dispute. Moreover, the BAP held that Hawaii's full protection for spendthrift trusts does not violate a fundamental policy of California law. Accordingly, the BAP held that Hawaii law applies.It will be interesting to see whether this opinion encourages foreign choice of law provisions in spendthrift trusts in California and throughout the Ninth Circuit. The fact that there was a clear, concrete connection to Hawaii in this case, and the fact that this is a decision of the BAP and not the Ninth Circuit, may discourage a mass migration toward foreign choice of law provisions.