Phillip Ruce, The Trustee and the Spendthrift: The Argument Against Small Trust Termination
In the 1800s, a mother transferred her estate, in trust, to her children in separate shares. One child, having failed at a business venture, declared bankruptcy and proposed to his creditors that he make a general assignment of all his property to them, which was understood to include the assets of his respective trust. Unbeknownst to the creditors, the trust document contained a provision stating that if the son “should alienate or dispose of the income to which [he is] entitled . . . or if by reason of bankruptcy or insolvency . . . [the] income could no longer be personally enjoyed” by him, his interest in the trust would cease to exist.
The trustee remained true to the language of the document. Left holding the bag, the creditors took the predictable course and sued. The court ruled that the insolvency of the son “terminated all his legal vested right in [the] estate, and left nothing in him which could go to his creditors, or to his assignees in bankruptcy . . . ;” the creditors, in short, were out of luck. This case, Nichols v. Eaton, demonstrated the first enforcement of a spendthrift trust provision in the American courts, and was a significant departure from the English common law rules that favored creditors.