Mennen v. Fiduciary Trust Int’l of Del.
The Delaware Supreme Court decided a case this week that is of great importance to Delaware trust law involving the enforceability of a spendthrift provision and the protection of trust assets against the claims of a beneficiary’s creditors relating to breaches of fiduciary duties by the beneficiary which arose in a separate but related action. This opinion is notable because it is a strong confirmation of the protections available to beneficiaries of third-party spendthrift trusts in Delaware under Section 3536 of Title 12 of the Delaware Code (“Section 3536”). Importantly, the Delaware Supreme Court has affirmed the narrow application of the Garretson case and, in doing so, we are provided with helpful analysis as to the rationale of the holding in Garretson and related cases. The Court refused to create a public policy exception to Section 3536 for a tort claimant who was a family member of the plaintiffs and who allegedly persistently engaged in a course of conduct that breached his fiduciary duties resulting in millions of dollars of damages for plaintiffs. This opinion will likely have importance around the country considering the paucity of case law on the subject and the relevance of the Delaware Supreme Court. While we previously summarized the substantive analysis of this case when the Draft Master’s Report of the Delaware Court of Chancery was issued in 2014, the long history of this case and the weight of its importance warrants additional presentation of its analysis. The procedural history of this case is somewhat long and complicated, but is also notable for its exemplary judicial process and expediency.
On January 17, 2014, the Honorable Abigail M. LeGrow (now a Superior Court judge in Delaware), then serving as a Master in Chancery (in that capacity referred to herein as “Master LeGrow”) issued a draft report (the “Draft Report”) granting a motion for summary judgment upholding the enforceability of a spendthrift clause under Delaware’s spendthrift statute, Section 3536. Exceptions to the Draft Report were filed with the Court of Chancery and, on April 25, 2015, Master LeGrow issued a Master’s Final Report (the “Final Report”). The Final Report contained substantively the same analysis and conclusion as the Draft Report. Exceptions were taken to the Final Report. On June 10, 2015, the Delaware Court of Chancery entered an order holding that the plaintiff’s exceptions to the Final Report were untimely (the “Strike Order”) and entered an order on August 18, 2015 adopting the Final Report as a decision of the Court of Chancery. The plaintiffs appealed this decision to the Delaware Supreme Court and, by opinion dated October 11, 2016, the Delaware Supreme Court reversed the Strike Order and remanded the matter, instructing the Court of Chancery to reconsider the exceptions taken on their merits. On February 27, 2017, Vice Chancellor J. Travis Laster issued an opinion affirming the Final Report in its entirety, concluding “I would like to think that I could improve on then-Master LeGrow’s decision, but I know that I cannot.” This decision was appealed to the Delaware Supreme Court and, on May 17, 2017, Justice Collin J. Seitz, Jr. entered an order that the final judgment of the Court of Chancery is affirmed, based on Master LeGrow’s well-reasoned April 24, 2015 Final Report. With such a long procedural history, all of which points back to, and gives such strong affirmation and even approbation to Master LeGrow’s Final Report, we reprise our analysis of that opinion below.
On November 25, 1970 George S. Mennen (the “Settlor”) created four trusts, one for each of his children and their issue (collectively the “1970 Trusts”). One of the 1970 Trusts (“John’s Trust”) was created for the Settlor’s son, John H. Mennen (“John”) and one of the 1970 Trusts (“Jeff’s Trust”) was created for the Settlor’s son, George Jeff Mennen (“Jeff ”). In March 2013, the beneficiaries (“Beneficiaries”) of John’s Trust filed a complaint against Wilmington Trust Company (“WTC”), the corporate trustee of John’s Trust, and Jeff, the individual trustee of John’s Trust (Jeff and WTC are collectively the “Co-Trustees”). The Beneficiaries alleged that the Co-Trustees of John’s Trust breached their fiduciary duties and claimed damages exceeding $100 million. Under the terms of John’s Trust, Jeff has the power, as individual co-trustee, to direct the corporate co-trustee to exercise certain investment powers. The individual trustee of Jeff’s Trust, Owen Roberts (“Owen”), was also named as a defendant.
The crux of the allegations made by the Beneficiaries were that the Co-Trustees of John’s Trust breached their fiduciary duties related to a series of poor investment decisions made by Jeff, as the individual trustee of John’s Trust. In particular, the Beneficiaries claimed that Jeff utilized assets of John’s Trust to invest in and make loans to several start-up companies (“Jeff’s Investments”), including several that Jeff served as a board member on, and because Jeff’s Investments drained the value of the Trust to nearly zero, Jeff’s Investments were imprudent and self-interested. Jeff had no authority to invest the assets of Jeff’s Trust and, as a whole, the investment of Jeff’s Trust had been successful. The Beneficiaries alleged that if their claims against Jeff as Co-Trustee of John’s Trust are successful, equity would require that the assets of Jeff’s Trust should be available to satisfy any judgment against Jeff. Ultimately, Master LeGrow issued a Master’s Final Report in the breach of fiduciary duties case against Jeff relating to John’s Trust, entering a judgment against Jeff in the amount of $96,978,299.93 plus prejudgment interest of 7.75% compounded quarterly.
Owen moved for summary judgment against Jeff’s trust on the basis that, even if the Beneficiaries prevailed against Jeff at trial, the spendthrift provision in Jeff’s Trust and Section 3536 of Title 12 of the Delaware Code precluded those assets from being subject to the claims of the Beneficiaries’ judgment creditors. The Beneficiaries argued alternatively that (i) the spendthrift provision is not enforceable against them because they are not “creditors” for purposes of the spendthrift provision or for purposes of Section 3536, or (ii) if the spendthrift provision and Section 3536 applies to them, then Delaware should recognize a public policy exception for tort claimants who are “persistent wrongdoers” that would allow them to recover from Jeff’s Trust, or (iii) they should be able to impound Jeff’s interest in Jeff’s Trust because the 1970 Trusts are essentially sub-trusts of a larger trust created by the Settlor. Master LeGrow held that the trustee of Jeff’s Trust was entitled to summary judgment because none of the theories advanced by the Beneficiaries presented a legal argument entitling them to defeat the spendthrift provision in Jeff’s Trust if their claims against Jeff at trial were ultimately successful.
Master LeGrow began her analysis by recognizing that the merit of the Beneficiaries’ claims turned on the application of Subsection (a) of Section 3536, which provides that creditors of beneficiaries only have rights with respect to a beneficiary’s interest in the trust as granted in the express terms of the trust instrument or by Delaware law. The import of Subsection (a) of Section 3536 is that a spendthrift provision in a trust instrument will be enforceable subject only to the statutory limitations provided for in Section 3536. To circumvent the application of Section 3536, the Beneficiaries argued that they are not “creditors” for purposes of Section 3536 and, even if they are, the common law regarding spendthrift trusts and public policy in Delaware should permit the Beneficiaries to access the assets in Jeff’s Trust under the factual circumstances of this case.
The Beneficiaries are “Creditors” Under Section 3536
The Court disagreed with the first contention of the Beneficiaries and concluded that they would be “creditors” under Section 3536 if they obtained a judgment against Jeff at trial. The essence of the Beneficiaries unsuccessful argument was that they were a special class of tort claimants entitled to pierce Jeff’s Trust because of the “especially egregious and specific” allegations against Jeff. To summarize the Beneficiaries argument, they contended, that “family member victims of fiduciary misconduct are entitled to pierce the spendthrift trust of the faithless fiduciary co-family member to satisfy a judgment in equity.”
The Court noted that Delaware courts have been asked to discuss the rights of tort claimants against third-party spendthrift trusts in the past. In the Delaware Supreme Court ruling in Garretson v. Garretson, 302 A.2d 737 (Del. 1973), the Supreme Court held that a wife, seeking maintenance and support from her husband, is not a “creditor” within the meaning of Section 3536 because such action was merely compelling performance of a duty of support imposed on the spouse who was a beneficiary and was not an action to collect on a debt. Central to the Supreme Court’s holding in Garretson was the nearly universally recognized policy that a beneficiary of a spendthrift trust should not be permitted to enjoy his interest in the trust while neglecting to support his dependents. Master LeGrow read Garretson as creating a narrow exception for familial support obligations that cannot be extended to create other exceptions to Section 3536. The limited application of Garretson was confirmed in two later cases, namely Gibson v. Speegle, C.A. No. 124 (Del. Ch. May 30, 1984), and Parsons v. Mumford, 1989 WL 63899 (Del. Ch. June 14, 1989), where the Court held that, in general, a tort claimant is a “creditor” for purposes of Section 3536. Notably, the Court in both Gibson and Parsons rejected recognizing a public policy exception in the case of a creditor of the beneficiary of a third-party spendthrift trust where the beneficiary was alleged to have committed as a tort with respect to the creditor.
The Beneficiaries argued that the rationale of Garretson should be extended and their case should be an exception to the principles of Section 3536 and the tort claimant rulings in Gibson and Parsons. According to the Beneficiaries, the fact that their claim was made against the trust of a family member of the Beneficiaries who committed alleged fiduciary misconduct with respect to John’s Trust warranted that they not be treated as “creditors” for purposes of Section 3536.
The Court rejected this argument for two principal reasons. First, the exception recognized in Garretson was of a totally different nature than the claims made by the Beneficiary. In Garretson, the beneficiary of a third-party spendthrift trust owed a support obligation to his spouse (who was his current spouse at the time) and dependents, which he had a legal duty to pay separate from any judgment entered by a court. Here, if the Beneficiaries succeeded against Jeff at trial they would hold a judgment liability, a debt similar to any other successful tort claim. Second, the only similarity the Beneficiaries identified between their case and Garretson was that it involved disputes between family members. The Court implied that this similarity was legally insignificant for the Beneficiaries to avoid being treated as “creditors” under Section 3536.
As an aside, it is notable that many commentators observe that in Garretson, the Court of Chancery issued an order of sequestration with respect to the trust income to obtain personal jurisdiction over Mr. Garretson, who was no longer a resident of Delaware, and the Delaware Supreme Court appears to have simply upheld the Court of Chancery’s sequestration of the trust income merely to compel the husband to appear in court, not as a judgment piercing the trust in favor of the wife. It is also notable that the court in Garretson said: “It of course remains to be seen, if the husband appears generally in this litigation and subjects himself to the jurisdiction of the Court of Chancery, whether, on final hearing, his contentions with regard to his Mexican divorce will be ultimately upheld in which event we assume that the wife would lose her status as wife, and there may be an entirely different situation…” Garretson, 306 A.2d at 742. Lastly, Delaware’s spendthrift statute has been substantially revised since the Garretson decision and, thus, the state of the law is much different now than it was then.
No Common Law or Public Policy Exception Support the Beneficiaries’ Claims
The Court also rejected the Beneficiaries’ contention that a limited variety of tort claimants, as “involuntary creditors”, should be recognized as a common law or public policy exception to Section 3536. The Court noted that this exact argument was considered and rejected for the tort claimants in Gibson and Parsons. The Court further reasoned that, although Section 3536 did not replace the common law regarding spendthrift trusts in Delaware, the Beneficiaries were unable to identify a common law exception that applies in that case. Absent such an exception, the Court reasoned that the General Assembly, in enacting Section 3536, did not give the Court carte blanche authority to develop new, non- statutory exceptions to Section 3536 as fairness and justice might dictate in the absence of an ambiguous statute.
The Beneficiaries claimed that Delaware law should recognize a “persistent wrongdoer” exception of the kind identified in the Restatement (Third) of Trusts (the “Restatement”). More specifically, the Beneficiaries pointed out that comment a(2) to Section 59 of the Restatement provides authority for the piercing of a third-party spendthrift trust where there is a “nature or pattern of tortious conduct by a beneficiary… especially one whose willful or fraudulent conduct or persistently reckless behavior causes serious harm to others”, such as the alleged fiduciary misconduct exhibited by Jeff with respect to the investment of John’s Trust.
The Court rejected the Beneficiaries’ argument for two reasons. First, the Court noted that the Restatement did not identify a single case adopting this type of exception. Second, and more importantly, the Court noted that again the Beneficiaries failed to identify any common law principal recognizing this exception in Delaware before Section 3536 was enacted and, “in the absence of ambiguity in the statute, this Court cannot resort to public policy to engraft an exception into the statute.” Although the Court admitted that the Beneficiaries’ argument was “compelling from the standpoint of fairness”, recognizing a common law exception in this case would be “inconsistent with the role of the judiciary” when Section 3536 is an unambiguous statute. Master LeGrow stated this strongly, with the following commentary: “Although I have sympathy for the Beneficiaries’ argument that the Court should not permit Jeff to escape his willful misconduct without consequence, I do not believe the Court can or should adopt the exception the Beneficiaries seek in the name of ‘public policy’ and in contravention of an unambiguous statute. The type of ‘results-based’ judicial reasoning the Beneficiaries advocate may seem desirable to meet their ends, but it rarely creates the type of coherent or predictable body of law on which our judicial system is based.”
The Beneficiaries Are Not Entitled to Pierce Jeff’s Trust Based on Impoundment
Finally, the Court rejected the Beneficiaries’ argument that they should be able to impound Jeff’s Trust. The theory of impoundment applies when the trustee of a trust who is also a beneficiary of that same trust commits a breach of trust that harms the other beneficiaries. The Beneficiaries argued that John’s Trust and Jeff’s Trust were essentially sub-trusts of a larger trust created by the Settlor in 1970 and, accordingly, Jeff’s alleged wrongdoing with respect to John’s Trust permitted them to impound his interest in Jeff’s Trust.
In rejecting the Beneficiaries’ argument, the Court concluded that, even if impoundment was a remedy available under Delaware law, it applies only where the trustee and wronged beneficiaries share an interest in the same trust. The Beneficiaries’ argument that the 1970 Trusts were really subtrusts because they were created on the same day by the same settlor and easily could have been drafted as sub-trusts under the same trust was not persuasive to the Court because the Beneficiaries could point to no case that espoused this theory.
Moreover, the Court reasoned that, even assuming the theory was available in this case, the nature of Jeff’s Trust would require the Court to order relief expressly forbidden by Section 3536. Central to this holding was that Jeff was not the only current beneficiary of Jeff’s Trust and was not entitled to any specific distribution from Jeff’s Trust. Because the trustees of Jeff’s Trust had discretionary authority to sprinkle income and principal of the Trust between one or more of the beneficiaries as the trustee deems appropriate, there was no relief to which the Beneficiaries were entitled that is permissible under Section 3536. The Beneficiaries’ proposed relief (that the trustees are enjoined from making distributions to Jeff until he satisfies his obligations to the Beneficiaries and require distributions to immediately be sent to the Beneficiaries) was, in the Court’s view, clearly prohibited by Section 3536.
Mennen provides significant insight into the application of Section 3536 and the Delaware Court’s unwillingness to graft exceptions onto the statute based on public policy or other non-statutory exceptions that did not exist in common law at the time Section 3536 was enacted and which were not addressed by Section 3536. Under the Court’s reading of the statute, Section 3536(a) applies to third-party spendthrift trusts unless a specific exception can be identified under Delaware law. Even where, as here, the allegations against a fiduciary are particularly egregious and damages caused by the fiduciary are substantial, the Court appears unwilling to undermine Section 3536 unless a specific exception in Delaware common law can be identified.
Additionally, the Court affirmed the limited application of Garretson and in doing so provided helpful analysis as to the rationale of the holding in Garretson, Parsons, and Gibson. Importantly, the Court reads Garretson narrowly, emphasizing that the claim in Garretson was a support obligation for a current spouse that existed outside of a judgment in litigation. The Court concluded that Garretson did not extend beyond familial support obligations. The essence of what the Court held was that the claims of the Beneficiaries, though compelling from a standpoint of fairness and justice, were simply tort claims and, accordingly, fell within the umbrella of the Parsons and Gibson.
Because Delaware has such a thorough and strongly-worded spendthrift statute that affords a great deal of clarity and protection, we have included the current version of Section 3526 below:
§ 3536 Rights of creditors and assignees of beneficiary of trust
- Except as expressly provided in subsections (c) and (d) of this section, a creditor of a beneficiary of a trust shall have only such rights against or with respect to such beneficiary’s interest in the trust or the property of the trust as shall be expressly granted to such creditor by the terms of the instrument that creates or defines the trust or by the laws of this State. The provisions of this subsection shall be effective regardless of the nature or extent of the beneficiary’s interest, whether or not such interest is subject to an exercise of discretion by the trustee or other fiduciary, and shall be effective regardless of any action taken or that might be taken by the beneficiary. Every interest in a trust or in trust property or the income there from that shall not be subject to the rights of creditors of such beneficiary as expressly provided in this section shall be exempt from execution, attachment, distress for rent, foreclosure, garnishment and from all other legal or equitable process or remedies instituted by or on behalf of any creditor, including, without limitation, actions at law or in equity against a trustee or beneficiary that seeks a remedy that directly or indirectly affects a beneficiary’s interest such as, by way of illustration and not of limitation, an order, whether such order be at the request of a creditor or on the court’s own motion or other action, that would:
- Compel the trustee or any other fiduciary or any beneficiary to notify the creditor of a distribution made or to be made from the trust;
- Compel the trustee or beneficiary to make a distribution from the trust whether or not distributions from the trust are subject to the exercise of discretion by a trustee or other fiduciary;
- Prohibit a trustee from making a distribution from the trust to or for the benefit of the beneficiary whether or not distributions from the trust are subject to the exercise of discretion by a trustee or other fiduciary; or
- Compel the beneficiary to exercise a power of appointment or power of revocation over the trust.
- Every direct or indirect assignment, or act having the effect of an assignment, whether voluntary or involuntary, by a beneficiary of a trust of the beneficiary’s interest in the trust or the trust property or the income or other distribution therefrom that is unassignable by the terms of the instrument that creates or defines the trust is void. No beneficiary may waive the application of this subsection (a). For purposes of this subsection (a), the creditors of a beneficiary shall include, but not be limited to, any person that has a claim against the beneficiary, the beneficiary’s estate, or the beneficiary’s property by reason of any forced heirship, legitime, marital elective share, or similar rights. The provisions of this subsection shall apply to the interest of a trust beneficiary until the actual distribution of trust property to the beneficiary. Regardless of whether a beneficiary has any outstanding creditor, a trustee may make direct payment of any expense on behalf of such beneficiary to the extent permitted by the instrument that creates or defines the trust and may exhaust the income and principal of the trust for the benefit of such beneficiary. A trustee shall not be liable to any creditor of a beneficiary for paying the expenses of a beneficiary.
- Notwithstanding subsection (a) of this section, a beneficiary entitled to receive all or a part of the income of a trust shall have the right to assign gratuitously in writing, at any time or from time to time, a stated fraction or percentage of the beneficiary’s entire remaining income interest in such trust to the State or to any corporation, church, community chest, fund, or foundation authorized as a deduction pursuant to §§ 1107, 1108, and 1109 of Title 30 and such assignment shall be valid and binding on all parties irrespective of any restrictions on assignment contained in the instrument creating or defining the trust; provided, however, that this subsection shall not authorize a beneficiary of such a trust to reduce any part of the beneficiary’s income interest which is subject to such restrictions on assignment below 50% of what such interest would be if no assignments were made under this subsection. Any interest assigned under this subsection, together with a corresponding portion of the corpus of the trust, shall be treated as a separate share and thereafter no provision of the trust permitting invasion of corpus for the benefit of the assignor shall be exercisable with respect to such share.
- Except as provided in subchapter VI of this Chapter 35, if the trustor is also a beneficiary of a trust, a provision that restrains the voluntary or involuntary transfer of the trustor’s beneficial interest shall not prevent such trustor’s creditors from satisfying their respective claims from the trustor’s interest in the trust to the extent that such interest is attributable to the trustor’s contributions to the trust; provided, however, that the trustor shall not be considered a beneficiary for purposes of this section merely because the trustor may be named as an additional trust beneficiary or is a proper object of the exercise of a power of appointment over trust property held by someone other than the trustor. A trustor’s creditors may satisfy their respective claims from the trustor’s interest in the trust to the extent provided in the preceding sentence except where the trustor has not retained any beneficial interest in the trust other than either or both:
- A beneficial interest that is contingent upon surviving the trustor’s spouse such as, but not limited to, an interest in an inter vivos marital deduction trust in which the interest of the trustor’s spouse is treated as qualified terminable interest property under § 2523(f) of the Internal Revenue Code of 1986 (26 U.S.C. § 2523(f)), as amended, an interest in an inter vivos marital deduction trust that is treated as a general power of appointment trust for which a marital deduction would be allowed under § 2523(a) and (e) of the Internal Revenue Code of 1986 (26 U.S.C. § 2523(a) and (e), as amended, and an interest in an inter vivos trust commonly known as a “credit shelter trust’’ that used all or a portion of the trustor’s unified credit under § 2505 of the Internal Revenue Code (26 U.S.C. § 2505), as amended; and
- A right to receive discretionary distributions to reimburse the trustor’s income tax liability attributable to the trust.
- Further, a beneficiary of a trust shall not be considered a trustor of the trust merely because of a lapse, waiver, or release of the beneficiary’s right to withdraw all or a part of the trust property.
- For purposes of subsection (a) of this section, a creditor shall have no right against the interest of a beneficiary of a trust or against the beneficiary or trustee of the trust with respect to such interest unless:
- The beneficiary has a power to appoint all or part of the trust property to the beneficiary, the beneficiary’s estate, the beneficiary’s creditors, or the creditors of the beneficiary’s estate by will or other instrument such that the appointment would take effect only upon the beneficiary’s death and the beneficiary actually exercises such power in favor of the beneficiary, the beneficiary’s creditors, the beneficiary’s estate, or the creditors of the beneficiary’s estate but then only to the extent of such exercise.
- The beneficiary has a power to appoint all or part of the trust property to the beneficiary, the beneficiary’s creditors, the beneficiary’s estate, or the creditors of the beneficiary’s estate during the beneficiary’s lifetime and the beneficiary actually exercises such power in favor of the beneficiary, the beneficiary’s creditors, the beneficiary’s estate, or the creditors of the beneficiary’s estate but then only to the extent of such exercise.
- The beneficiary has the power to revoke the trust in whole or in part during the beneficiary’s lifetime and, upon such revocation, the trust or the part thereof so revoked would be possessed by the beneficiary. This paragraph shall have no application to any part of the trust that may not be so revoked by the beneficiary.
- Notwithstanding subsection (a) of this section, a beneficiary of a charitable-remainder unitrust or charitable-remainder annuity trust as such terms are defined in § 664 of the Internal Revenue Code of 1986 (26 U.S.C. § 664) and any successor provision thereto, shall have the right, at any time and from time to time, by written instrument delivered to trustee, to release such beneficiary’s retained interest in such a trust, in whole or in part, to a charitable organization that has or charitable organizations that have a succeeding beneficial interest in such trust. Notwithstanding subsection (a) of this section, a beneficiary may also disclaim an interest in a trust pursuant to Chapter 6 of this title.
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