A Look at the Landmark Spendthrift Trust Case, Nichols v. Eaton

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Sarah Eaton had three boys and one girl.  To provide for them after her death, she divided her assets into 4 trusts, allocating the income to the children for life and then to their respective offspring.  She also gave each trustee discretion to stop all income payments if any child declared bankruptcy or assigned their income interest to a third party.  This provision was the 1800s equivalent of a spendthrift provision.  Her son Amasa “failed in business” sometime in the mid to late 1860s.  He assigned his income interest to Charles Nichols in order to satisfy Amasa’s creditors.  Nichols attempted to sue the trust for payment, leading to this ground-breaking spendthrift trust suit.
 
     The court upheld the spendthrift provision.  The decision contains three distinct lines of legal reasoning supporting their decision.

     The court first noted that at least 8 English cases supported the discretionary power’s specific wording.  From the decision: “the cesser of income upon alienation or upon the bankruptcy of the [beneficiary] are unquestionably valid.”  A second case that prevented a court from supplanting their discretion for that of the trustee bolstered the court’s holding.  This was an important addition to the English cases: it prevented a creditor from indirectly attacking the spendthrift provision by asking for the court to substitute their discretion for the trustee’s.

     State law also upheld the provision.  The Supreme Court cited 11 cases from at least 4 different jurisdictions (New York, Connecticut, Pennsylvania and Kentucky) that supported the discretionary power.  This demonstrated that spendthrift provisions were already allowed within the U.S. at the state level.    

     Finally, the creditor argued that allowing a trustee to have this power was against public policy.  In response, the court first noted that all creditors engage in their own due diligence before extending credit, indicating that the creditor should have not only found this clause but understood that they would not be able to reach trust assets in the event of a bankruptcy:

This distinction is well founded in the sound and unanswerable reason, that the creditor is neither defrauded nor injured by the application of the law to his case, as he knows, when he parts with the consideration of his debt, that the property so exempt can never be made liable to its payment. Nothing is withdrawn from this liability which was ever subject to it, or to which he had a right to look for its discharge in payment. The analogy of this principle to the devise of the income from real and personal property for life seems perfect. In this country, all wills or other instruments creating such trust-estates are recorded in public offices, where they may be inspected by every one; and the law in such cases imputes notice to all persons concerned of all the facts which they might know by the inspection. 

Second, the court cited many individual asset protection statutes from across the country that were already in existence:

It is believed that every State in the Union has passed statutes by which a part of the property of the debtor is exempt from seizure on execution or other process of the courts; in short, is not by law liable to the payment of his debts. This exemption varies in its extent and nature in the different States. In some it extends only to the merest implements of household necessity; in others it includes the library of the professional man, however extensive, and the tools of the mechanic; and in many it embraces the homestead in which the family resides. This has come to be considered in this country as a wise, as it certainly may be called a settled, policy in all the States. To property so exempted the creditor has no right to look, and does not look, as a means of payment when his debt is created; and while this court has steadily held, under the constitutional provision against impairing the obligations of contracts by State laws, that such exemption laws, when first enacted, were invalid as to debts then in existence, it has always held, that, as to contracts made thereafter, the exemptions were valid.[1]

Here, the court is putting the creditor on notice that numerous statutes already exempt certain property from their claims.  To argue that public policy is somehow offended by the spendthrift provision clearly ran against numerous already in-force laws.

  By the late 1800s, a strong common law foundation, derived from England and implemented by several individual states, supported spendthrift powers.  The Restatement of Trusts, §58 explains its philosophical underpinnings:

The spirit of the times was of individualism, at least of individualism for the man of property. What a man owned was his own; with it he could do as he liked. If he desired to give his property to another in such a way that the donee could not transfer it and his creditors could not reach it, that was a matter which concerned the donor alone.

Various bankruptcy and then inchoate asset protection laws also supported this concept.  In the event of default, both areas of law attempted to make creditors at least partially whole while also granting debtors sufficient post-judgement assets that allowed them to continue contributing to their community.  Most importantly, the court considered creditors sophisticated, meaning they should have been aware of this common law and statutory support.  And finally, the idea that an individual should have the right to somehow limit the impact of life’s misfortunes was a central philosophy of the times.  In the decision’s words:

Why a parent, or one who loves another, and wishes to use his own property in securing the object of his affection, as far as property can do it, from the ills of life, the vicissitudes of fortune, and even his own improvidence, or incapacity for self-protection, should not be permitted to do so, is not readily perceived.

​That sentiment still provides the backbone of current spendthrift law.
 


[1] Nichols, Assignee v. Eaton Et Al, 91 U.S. 716, 23 L.Ed. 254 (1875)