IN RE JOHNSON, (Bankr.W.D.N.Y. 2000)

Michael J. Kaplan, U.S.B.J.

Following closely on the heels of this Court's decision in In re Lowe, 252 B.R. 614 (Bankr. W.D.N.Y. 2000), holding a particular profit sharing fund non-exempt, comes another exemption question that appears to be, like Lowe, a matter of first impression. The Court is asked whether funds that many thousands of people have in trust under the "Deferred Compensation Plan for Employees of the State of New York and Other Participating Public Jurisdictions" are exempt property in a bankruptcy case of one such person. Debtor's counsel believes that 20% of all municipal, county and state employees in this state are enrolled in plans identical to this "Deferred Compensation Plan." And this Court is aware that such public servants are not immune from some of the woes that lead debtors to our doors.

The analysis of New York State Exemption Law as set forth in Lowe is here reaffirmed. The Court sustains the Chapter 7 Trustee's objection to the claim of exemptions. The $4000 that this Debtor has in her trust account under this plan is not exempt and the Trustee has greater rights to those funds than the Debtor has, as discussed herein.

THE "DEFERRED COMPENSATION PLAN" AND ITS STATUTORY BASES

The Plan is 43 pages long. Its various sections may be summarized as follows, for purposes of this Decision:

The statement of "Purpose" that begins the plan recites: "The purpose of the Plan is to encourage Employees to make and continue careers with the State by providing eligible employees with a convenient way to save on a regular and long-term basis and thereby provide for their retirement as set forth herein. Other Public Employers in the State can elect to provide their eligible Employees with such a savings mechanism by adopting the Plan. . . . The Plan and the Trust Agreement are intended to satisfy the requirements for an `eligible deferred compensation plan' under Section 457 of the [Internal Revenue] Code."

26 U.S.C. § 457 permits state and local governments and tax exempt organizations to establish and maintain a plan under which their employees may defer limited amounts of their compensation and not have to pay income taxes thereon until they receive the compensation so deferred. That will happen, typically, when the participant attains age 70 1/2, or when she separates from service with the employer, or "when the participant is faced with an unforeseeable emergency (determined in the manner prescribed by the Secretary [of the Treasury] in the regulations). . . ."

226 U.S.C. § 457(d). The complete statute reads:

Despite its complexity, the statute has but one simple purpose: to prescribe the year in which the participant must declare the deferred compensation as part of her gross income for federal income tax purposes.

The statute requires that "A plan maintained by an eligible employer . . . shall not be treated as an eligible deferred compensation plan unless all assets and income of the plan . . . are held in trust for the exclusive benefit of participants and their beneficiaries."

26 U.S.C. § 457(g)(1). This trust requirement does not apply to tax exempt organizations that are not governmental units. (The Trust Agreement in this case has not been presented to the Court. The Court assumes it to be fully consistent with the statute and the Plan.)

The plan itself expressly states that "Participation . . . by Employees shall be wholly voluntary." (§ 2.2 of the Plan.)

And, "A Participant may elect to defer Compensation under the Plan by authorizing, on his or her Participation Agreement, regular payroll deductions that do not in the aggregate exceed the [statutory] limitations . . . [and a] Participant may discontinue, or temporarily suspend, his or her deferral of Compensation as of any Enrollment Date by giving notice thereof . . . at least twenty . . . days prior to such date." (§ 3.1 of the Plan.)

The monies in the Debtor's account derived from no source other than monies she earned as an employee, and her share of the earnings of the trust.

THE DEBTOR'S ARGUMENTS

The Debtor argues that this plan is a spendthrift trust exempt under New York's Civil Practice Law and Rules ("CPLR") § 5205(c) or under 11 U.S.C. § 541(c); that it is a retirement system exempt under the N.Y. Retirement and Social Security Law § 110 or N.Y. Insurance Law § 4607; that the Debtor has no present rights to the funds and that the Trustee, therefore, could have none; and that this is a "qualified" retirement plan, exempt under ERISA. The Court will address the arguments in a different order, for clarity's sake.

THIS IS NOT ERISA-QUALIFIED

The Trustee has produced a letter from the Plan Administrator expressly stating it is not an ERISA-qualified plan; rather it is a qualified "deferred compensation" plan, as discussed more fully hereinafter.

The Debtor's argument in this regard is rejected.

THIS IS A "SELF-SETTLING" TRUST, NOT EXEMPT UNDER 11 U.S.C. § 541(c) or C.P.L.R. § 5205(c)

The Debtor argues that the funds are exempt under CPLR § 5205(c) (as made applicable in bankruptcy cases by N.Y. Debtor and Creditor Law § 282) because that provision states that "all property while held in trust for a judgment debtor, where the trust has been created by, or the fund so held in trust has proceeded from, a person other than the judgment debtor, is exempt from application to the satisfaction of a money judgment," and this trust (she argues) was "created by" the State of New York and the plan trustee, not by her.

This is clearly incorrect. Black's Law Dictionary quotes the Second Restatement of Trusts within its definition of "trust" as follows: "[A] trust involves three elements, namely, (1) a trustee, who holds the trust property and is subject to equitable duties to deal with it for the benefit of another; (2) a beneficiary, to whom the trustee owes equitable duties to deal with the trust property for this benefit; (3) trust property, which is held by the trustee for the beneficiary." [Underline added.] Black's Law Dictionary 1513 (7^th ed. 1999). Though the state has taken care of the matter of obtaining a trustee and of setting forth the trustee's duties with regard to the trust property for the benefit of those who participate, no "trust" is created for this Debtor until she puts her property into the trust. Nothing could be more fundamental than this. Indeed, this has been codified, at least for purposes of the Estates, Powers and Trusts Law ("EPTL"): § 1-2.2 of the EPTL provides a definition of "creator" of a trust. "A creator is a person who makes a disposition of property." N.Y. Est. Powers Trusts Law § 1-2.2 (McKinney 1998).

Though the definitions contained in the EPTL do not necessarily govern terms used in the CPLR or the Debtor and Creditor Law, the Debtor's proffered interpretation of the term "creator" can have no logical merit. Otherwise a wealthy debtor could place millions of dollars into any of thousands of investment trusts or business trusts that already pre-exist as operating arms of investment houses and the like, and claim that it is all exempt because, for example, it was Morgan Stanley Dean Witter Discover and Co. who "created" the "Common Sense Trust." (That investment trust, as of August 25, 1997 consisted of $5.7 billion dollars in mutual funds. See Dow Jones News Service, August 25, 1997.)

Lawyers, bankers, accountants, and other professionals may spend their working lives setting up investment vehicles in the form of trusts. But no trust is "created" for anyone's benefit until someone gives to that trust some property to administer for that individual's benefit. The trust that is part of this Debtor's estate was "created" when she placed some of her earned income into the trust.

This argument may be laid to rest by noting, finally, that the phraseology of CPLR 5202(c) has more than 150 years of "judicial gloss." The phrase "where the trust has been created by, or the funds so held in trust have proceeded from, a person other than the judgment debtor" has a well-settled meaning that is not obvious.

No matter who the actual settler is or was, the provision is well-understood to exempt only the judgment debtor's interest in income — not her interest in any remainder, or her power to invade. And that income interest is exempt (some courts have held) only to the extent reasonably necessary for her support. What this "exemption" actually protects is the ability of the "other" person (the settlor) to control the disposition of such "other" person's own property when, for whatever reason, that person does not choose to "gift" it outright to the debtor or to manage it himself or herself for the debtor's benefit. However, it only protects the trust. It does not exempt the income when the debtor has a right to receive it, or when the debtor has received it in fact. (See CPLR § 5205(d)(1) for the "income exemption.") And the statute would not exempt funds in a money market trust, for example, even if such funds "proceeded from" another person, because the debtor is free to invade them.

In sum, CPLR 5205(c)(1) is not as generous an exemption as its cryptic language might suggest.

In compiling the following citations, no effort is made to determine whether statements were "good law" at the time they were made, or whether they are "good law" today. This is because no effort has been made to locate the complete New York statutes as they existed at the time these statements were made. The purpose of this compilation is to support the proposition that there is, in fact, more than 150 years of "gloss" on this statutory exemption for trusts, and that that gloss stands for the proposition that the exemption has not been viewed to be as broad as the language of the statute might seem.
In Craig v. Hone, 2 Edw. Ch. 554, 1835 Westlaw 2422, the Chancery Court of New York, in 1835, stated that its own jurisdictional statutes vested it with power "`to compel the discovery of any property, money or thing in action belonging to [a judgment debtor], and of any property, money or thing in action due to him or held in trust for him, and to decree satisfaction out of what might be discovered, whether the same were originally liable to be taken in execution at law or not,'" but that an exception was enacted "`where such trust has been created by, or the fund so held in trust has proceeded from, some person other than the defendant himself.'" Id. at * 12. Addressing the effect of that exception, the Chancery Court stated that "[t]he object was to prevent express trusts proceeding solely from the bounty of a parent or of some third person, and valid in their creation under the statute, from being overthrown or diverted from their object by [creditors]. It was enough to say that all, beyond necessary support, where the trust is not for accumulation, should be liable to the creditors of the cestui que trust. Such surplus may be reached by a bill in equity, but the trust itself cannot be disturbed. . . . [T]he exception in the statute . . . must be understood with reference to this state of things. . . . [T]he exception . . . probably was intended to protect property the subject of an express trust created by a parent or relative in behalf or for the support of an unfortunate child or relation, and which property had been placed in the hands of a trustee for the purpose of putting it beyond the reach of the cestui que trust or creditors. . . . It follows, then, from this view of the subject, that notwithstanding the language of the exception or saving clause of the statute, the surplus income of a trust estate, valid in its creation, and beyond what is necessary for the education and support of the cestui que trust, may be applied, by the decree of this court, to the payment of debts contracted by him; and that property, money or things in action, held in trust for a debtor, if not such a trust as the law has expressly authorized, is equally liable to be so applied." Id. at * 12-13.
One year later, in the case of Hawley and King v. James, 16 Wend. 61, 1836 WL 2808 (N.Y.), one of the reviewing adjudicators on the Court for the Correction of Errors of New York observed the Chancery Court "is authorised to decree satisfaction of [a money judgment] `out of any property or thing in action held in trust for the defendant,' `except where such trust has been created by, or the fund so held in trust has proceeded from some other person than the defendant himself.' . . . [A] principal would be fraught with injustice, which would permit an individual to enjoin millions which he could dispose of at his pleasure, and on the strength of that power of disposition, obtain credit, and yet, when a creditor came to invoke the aid of the law to reach this apparent pledge, would deny him all assistance. On the contrary, it is believed to be a universal principle, running through the whole system of written and unwritten law, that any interest or property, which a debtor may himself dispose of, the law can reach and dispose of in his behalf, for the satisfaction of his debts." Id. at * 94.
In Graff v. Bonnett, 31 N.Y. 9, 1865 WL 3889 (N.Y.), the Court of Appeals, used the very same language. It stated "[o]ne theory is, that this provision was designed to protect the interest of a beneficiary in a trust, whose object it was to provide for his maintenance and support, and to the extent necessary for such purpose only. Another theory is, that the exception exempts from the jurisdiction of a court of equity in this respect, all trusts, of whatever description, which proceed from, or are created by some person other than the debtor himself. A third theory is, that the exception applies to property held in trust for the debtor, not belonging to or coming from him, but proceeding from a third person, though created for the debtor's benefit, and in all such cases preserves the trust fund intact." Id. at * 3. The majority view was that "the true reading of the statute is this: That as a general proposition, property held in trust for the debtor, and for his benefit, maybe reached through the agency of a court of equity, and applied to the satisfaction of his debts, but not property held in trust for him upon a trust, or arising out of a fund proceeding from a third person; which last named trust property is to be exempted from equity jurisdiction, not wholly or absolutely, but to the same extent, and under the same conditions under which trust property may be enjoyed by the debtor, secure from the attack of his creditors, under other and general provisions applicable to trust property. In other words, it was a legislative declaration, in language intended to be explicit, but possibly liable to some misconstruction, that property held in trust for the debtor, when such trust proceeded from himself, was in no case to be protected for his benefit; but where the trust or the fund proceeded from some other source, the liability of the property to, or its exemption from judicial seizure, was to depend upon the general provisions of law applicable to trust property. It was not the intention of the legislature to exempt every species of trust property originated by a third person from liability for the debts of the beneficiary, nor to declare in this connection the condition and circumstances upon which such liability was to depend, but to qualify the comprehensive language employed in a previous part of the section and to partially limit its otherwise apparently universal application." Id. at * 3-4.
A separate opinion in that case stated this: "[W]here a trust has been created by some other person than the defendant, or funds held in trust had proceeded from some other person than the defendant, satisfaction of the creditor's judgment is not to be decreed out of such trust funds. In other words, the trust is not to be subverted or destroyed, and the property or money so placed in trust is not to be taken by the creditor where it has proceeded from another party. If a debtor will make a conveyance of his own money or lands in trust for himself, the property so put in trust, or, in the words of the statute, so held in trust for him, is to be applied to the payment of his debts; but if a relative or other person will create a trust for his benefit, though the trust is in a legal as well as a popular sense held in trust for him, as it was not his property before being embraced in the trust, it is not to be disturbed. It was to guard against a possible construction of the general words which would allow the trust fund itself to be taken, that the exceptions were introduced by the legislature. There is not one word said respecting the income of the trust funds." Id. at * 11. This appears, however, to have been the dissenting view.
In 1877, the Court of Appeals had stated, in Williams v. Thorne, 1877 WL 12038 (N.Y.), 70 N.Y. 270, that the provisions of the statutes exempting trust funds when the trust has been created, or the trust fund has proceeded from some person other than the defendant, "do not exempt absolutely the whole income; they were intended to exempt the principal fund, and the beneficial interest of the cestui que trust in the income only to the extent of a fair support out of the trust estate."
In Schenck v. Barnes, 156 N.Y. 316, 50 N.E. 967 (1898) the highest court of the state looked at the language "except where such trust has been created by, or the fund so held in trust has proceeded from, some person other than the defendant himself," (citation omitted) and stated "[i]t was at first contended that this statute protected absolutely the interest of a debtor in a trust created for his benefit by a third party, but it is now the settled law . . . that the surplus income of a trust estate shall be liable in equity to the claim of the creditors. . . ." Id. at 320.
Clearly, an expectancy in a trust, other than income, can be obtained by creditors. In Bergmann v. Lord, 100 N.Y.S. 990 (Sup.Ct. N.Y. County 1905) it was stated that the words "in trust for a judgment debtor" (citation omitted) are "restricted to the interest of a beneficiary of income, inalienable under the Personal Property Law . . . and likewise inalienable before that enactment, through judicial extension of the statutes relating to trusts of realty . . . . [n]o limitation has been placed by the statute upon the right to alienate expectant estates in personalty, a right which always existed at common law . . . and it is contrary to the policy of the law to exclude a judgment creditor from the benefit of any property interest which the debtor could dispose of by assignment." Id. at 991.
By 1939, it was apparently recognized that if there was more in the trust than was necessary for the support of the debtor, a creditor could pursue that surplus. Thus, in the case of In re Senior's Estate, 14 N.Y.S.2d 121 (Sur Ct., Orange County 1939) there was discussion of what was then § 792 and 793 of the Civil Practice Act. That statute was quoted as stating that "[t]his article does not authorize the seizure of, or other interference with, . . . any money, thing in action or other property held in trust for a judgment debtor, where the trust has been created by, or the fund so held in trust has proceeded from, a person other than the judgment debtor." (Citation omitted) But the Surrogate's Court said "[t]hat provision has had a fixed legal meaning from the days of the Revised Statutes. It recognizes `the right of the creditor in a proper action to have the amount necessary for the support of the debtor ascertained, and to compel the application of the surplus.'" Id. at 123.

To recapitulate, this is a self-settling trust. And the Court rejects the argument that the monies in it "proceeded from" the employer, rather than the Debtor. The funds "proceeded from" the Debtor herself (money fully earned by her labors, which she freely elected to defer). For these reasons, her argument that CPLR § 5205(c) or 11 U.S.C. § 541(c) protects this fund from her creditors is rejected.

THE ANTI-ALIENATION PROVISION

As explained in Lowe, a contractual anti-alienation provision is, standing-alone, of no import whatsoever for exemption purposes. A debtor's own contract alone will not shelter that debtor's rights from seizure by her creditors. It takes a statute to do that, such as ERISA or CPLR § 5205(c). The anti-alienation provision in this Plan says:

SECTION 12. GENERAL LIMITATIONS AND PROVISIONS

12.4 (a) Except insofar as may otherwise be required by law or in accordance with this Section 12.4, no amount payable at any time under the Plan shall be subject in any manner to alienation by anticipation, sale, transfer, assignment, bankruptcy, pledge, attachment, garnishment, charge or encumbrance of any kind, and any attempt to so alienate such amount, whether presently or thereafter payable, shall be void. If any person shall attempt to, or shall, so alienate any amount payable under the Plan, or any part thereof, or if by reason of bankruptcy or other event happening at any time such amount would not be enjoyed by the person to whom it is payable under the Plan, then the Trustee shall notify the Board and, if it so elects, may direct that such amount be withheld and that the same or any part thereof be paid to or for the benefit of such person, his or her spouse, children or other dependents, or any of them, in such manner and proportion as the Trustee may deem proper.

However, there is nothing to give it force of law as against this Debtor's creditors. It is nothing more than what was addressed in Lowe this way: "If you and I agree that I will sell you my car for $5000, payable 30 days after transfer of ownership, any contract agreement that `my creditors may not reach my right to take the $5000' is a waste of ink and paper." Lowe at 625 N. 13.

NOT ALL TRUSTS IN CONTEMPLATION OF RETIREMENT ARE EXEMPT

In arguing that this is an exempt retirement planning device, the Debtor makes much of the Plan's stated "Purpose" to give state employees "a convenient way to save on a regular and long-term basis and thereby provide for their retirement. . . ." But the argument lacks focus. To "save" for "retirement" has nothing at all to do with what is or is not exempt from creditors or a bankruptcy trustee. Bankruptcy attorneys tend to forget that the overwhelming majority of people never suffer judgment debts and never file a bankruptcy case. Saving for retirement is very wise. For people who hope and expect never to be insolvent, saving in an "exempt" way is of less concern than saving in a way that optimizes security, yield and liquidity. And even for those who are wary of the financial future, liquidity may be more important than exemptability, particularly when assessing unplanned (but not inconceivable) financial challenges — such as a sudden need to assist a parent or other family member. (Even bankruptcy judges may experience the "double hit" of paying an unplanned expense and paying a tax-penalty as well. But we consider ourselves fortunate to have a means to pay, penalty or not.)

There can be no doubt that not every trust or plan or account that is in contemplation of retirement is exempt. Some statute is necessary. See Lowe, generally.

RETIREMENT AND SOCIAL SECURITY LAW § 110

N.Y. Retirement and Social Security, Law § 110 provides:

As explained above, not every "retirement vehicle" is, or ought to be, exempt. For nearly all Americans, the ability to "save" now tax-free, and pay taxes later at a lower rate, is a fine retirement device. That fact has no more to do with "exemptions" than does putting one's "retirement savings" into a bank or investment portfolio.

Moreover, as stated in Lowe: "Debtor and Creditor Law § 282 contains . . . critical language. As to bankruptcies concerning a natural person domiciled in New York, such a debtor `may exempt from the property of the estate . . . only (1) personal and real property exempt from application to satisfaction of money judgments.'" (Emphasis added). Lowe at 618. Debtor Creditor Law § 282 uses the word "only," and seems, thus, to exclude consideration of the N.Y. Retirement and Social Security Law § 110 in bankruptcy cases.

There can be no doubt, however, that a debtor need not rely on that statute to obtain an exemption for her pension as a state employee. N.Y. Debtor and Creditor Law § 282(2)(e) exempts all such pensions. See In re Bentley, 237 B.R. 10 (Bankr. Ct. W.D.N.Y. 1999), Bucki, J.

But even if the word "only" were not used, § 110 has not been amended to exempt deferred compensation. This Court may not act as a super-legislature and create an exemption for the Debtor. This is fully examined in Lowe.

INSURANCE LAW § 4607 ADDRESSES ONLY A "RETIREMENT SYSTEM"

By its own terms, N.Y. Insurance Law § 4607 exempts only a "retirement system." The plan here is a "savings" plan, and, as explained above, that is not the same as a pension plan or "retirement system" even when the savings plan is an element of planning for retirement.

The Debtor's Insurance Law argument is rejected.

CONCLUSION

All of the Debtor's arguments are rejected. The Debtor herself might be bound by contract not to seek to invade her funds at this time, but as explained in Lowe, the anti-alienation clause of the Plan is not enforceable as against her creditors, and the Trustee may, under 11 U.S.C. § 544 (as contrasted with 11 U.S.C. § 541), sue the Plan for turnover of her funds, if the Plan's "Board" does not elect to honor his demand therefor.

See the summary of Section 6 of the Plan in footnote 1. The Court awaits the Plan's view as to whether it must disgorge the funds, given the Debtor's choice to "liquidate" her "assets" in a voluntary Chapter 7 case.

It is

SO ORDERED.