Beneficiary of Spendthrift Trust Could Not Irrevocably Transfer Interest

July 26, 2021 | Kitt Tovar Jensen

On July 21, 2021, the Iowa Court of Appeals released an opinion involving a CEO’s agreement to repay stolen funds. In reversing a district court decision, the Court of Appeals determined that the beneficiary of a spendthrift trust cannot make an irrevocable transfer of his beneficial interest. Although the CEO’s irrevocable transfer of his interest in the trust was unenforceable, the court ruled that the CEO breached a restitution agreement with the company. As such, the company could initiate collections.

Background

After a manufacturing company learned that it’s CEO, Michael McDonald, had misappropriated company funds, it terminated McDonald’s employment. McDonald avoided criminal charges, but signed a restitution agreement promising to repay $2,538,500. McDonald defaulted the following year and the company began collections for the remaining $1,325,174.

In an attempt to protect his few remaining assets, McDonald negotiated an amendment agreeing to sign a limited power of attorney (LPOA) in exchange for the company ceasing all collection efforts. Under the LPOA, a third-party would collect the distributions McDonald received as a beneficiary of two spendthrift trusts and then transfer those payments to the company. For nearly two years, the LPOA forwarded these payments to the company until September 2016, when a payment was mistakenly sent to McDonald.

McDonald did not repay the misdirected $6,218, but instead filed for Chapter 7 bankruptcy and revoked the LPOA. The company filed for relief from the automatic stay. The bankruptcy court lifted the stay, and held that the debt was not dischargeable because it was the result of fraud while acting in a fiduciary capacity.

The company then filed this lawsuit in district court claiming that McDonald breached their agreement by revoking the LPOA. The company also sought a declaration that the LPOA was irrevocable. McDonald denied the allegations and counterclaimed, alleging interference with his expectancy interest as a beneficiary of two spendthrift trusts. The district court held that McDonald breached the agreement, ordered a permanent injunction requiring McDonald to comply, and declared the LPOA irrevocable. McDonald appealed.

Limited Power of Attorney and Spendthrift Trust Limitations

On appeal, the Court of Appeals addressed whether either party violated Iowa Code § 633A.2302(2) by signing the amendment agreeing to execute the LPOA. A beneficiary of a spendthrift trust cannot transfer or assign his interest in the trust, nor can a creditor receive such distributions before the beneficiary. Iowa Code § 633A.2302(2). Here, the Court of Appeals held that McDonald did not assign future distributions from the trust but instead, through the LPOA, freely transferred his payments to the company after distributions were made.

However, the larger question was whether McDonald could revoke the LPOA. A principal may generally revoke a power of attorney at any time. Iowa Code § 633B.110(1)(c). A POA does not become irrevocable, despite the use of the word in the document, but it may generally become irrevocable in exchange for valid consideration. See MacGregor v. Gardner, 14 Iowa 326, 340-42 (1862).

A spendthrift provision, however, “prevents the beneficiary from making an irrevocable transfer of his or her beneficial interest.” Restatement (Third) of Trusts § 58, cmt. d(1). The company argued that once distributions are made from a spendthrift trust, Iowa Code § 633A.2302(2) no longer applies.

The court disagreed, finding that allowing an LPOA to be irrevocable would be in direct violation of the law by allowing assignment of a future interest in the trust. McDonald, as a beneficiary of a spendthrift trust, could not irrevocably transfer his trust distributions. The court concluded that, despite the fact that McDonald contracted to “irrevocably” give future distributions to the company, § 633A.2302(2) expressly prohibited him from doing so. The Court of Appeals reversed the district court’s order enforcing the LPOA and granting the request for an injunction.   

Breach of Contract

While McDonald could not be compelled to assign the distributions of a spendthrift trust under the LPOA, he nevertheless breached the restitution agreement with the company. McDonald violated the agreement by failing to pay the company after mistakenly receiving the September 2016 distribution. Although the LPOA was unenforceable, McDonald was still liable for the funds and the company could pursue collections

Dissent

Judge Mullins concurred in part, but dissented from the majority’s conclusion that the LPOA was unenforceable. Mullins wrote that such a narrow reading of the law allowed McDonald to game the legal system. He did not agree that McDonald’s agreement violated the spendthrift provisions, but instead concluded that he would affirm the district court’s order enforcing the LPOA.