Sharma v. Routh

MAJORITY OPINION ON REHEARING

Appellant Timothy L. Sharma’s motion for rehearing is granted. The majority and dissenting opinions issued in this case on December 31, 2008, are withdrawn, and this Majority Opinion on Rehearing is issued today, with a concurring opinion by Chief Justice Hedges to follow.

I. Introduction

This is an appeal from a divorce decree in which the husband asserts that the trial court reversibly erred by characterizing income distributions he received from two testamentary trusts as community property and awarding half of those distributions to his wife, rather than awarding all of the distributions to him as his separate property. In the context of a spouse who receives distributions of trust income under an irrevocable trust during marriage, case law indicates that the income distributions are community property if the receiving spouse owns the trust corpus but that the distributions are separate property if the receiving spouse does not own the trust corpus. Neither the Supreme Court of Texas nor this court has decided what the legal standard should be for determining whether the receiving spouse owns the trust corpus. We hold that, when a spouse receives distributions of trust income under an irrevocable trust during marriage, the income distributions are community property only if the recipient has a present possessory right to part of the corpus. The trial evidence conclusively proved that the husband did not have such a right and that the distributions in question were separate property to which the husband acquired title by devise or gift during the marriage. Although we affirm the trial court’s grant of divorce and dissolution of the marriage, based on the trial court’s reversible error in awarding the wife substantial amounts of the husband’s separate property, we sever and reverse the remainder of the judgment and remand for further proceedings.

II. Factual and Procedural Background1

Appellant Timothy L. Sharma and ap-pellee Lisa C. Routh were married in August 2004.2 A few months later, Timothy filed for divorce. Soon thereafter, the couple separated and ceased living together as husband and wife. After a lengthy bench trial, in January 2006, the trial court signed a decree ending the parties’ brief marriage.

Husband’s Prior Marriage and Rights to Trust Property

Before his marriage to Lisa, Timothy was married to Alice Hiniker Sharma from 1982 until Alice’s death in 2001. Under Alice’s will, two trusts were created: the Alice Hiniker Sharma Marital Trust (hereinafter “Marital Trust”) and the Alice Hi-niker Sharma Family Trust (hereinafter “Family Trust”). Timothy is the trustee of both the Marital Trust and the Family Trust. Alice’s will requires that the net *358income of the Marital Trust be distributed to Timothy at least quarterly. Likewise, under certain circumstances and to a specified extent, the trustee of the Family Trust is required to distribute to Timothy income or principal from the Family Trust.

While married to Alice, Timothy, who is a psychiatrist, built up and developed psychiatric hospitals in the Houston area. In 2002, the Marital Trust was initially funded with two psychiatric hospitals, realty, and shares of common stock in Cambridge International, Inc. (“International”), with a total stated value of more than $39 million. The Family Trust was initially funded only with shares of International common stock.

In 2003, Timothy, as trustee of the Marital Trust, sold the realty and improvements for the two hospitals to a nonprofit organization now known as the Cambridge Health Foundation3 (hereinafter “Cambridge Foundation”) in exchange for a promissory note in the original principal amount of $30,115,000 (hereinafter “Building Note”). As a result of its ownership of International stock, the Marital Trust also received a promissory note in the original principal amount of $3,952,680.10, executed by Intracare Hospital (hereinafter “Intra-care Note”). As a result of its ownership of International stock, the Family Trust received a promissory note in the original principal amount of $739,601.22, executed by Intracare Hospital (hereinafter “Family Trust Note”). Following a complex set of transactions in December 2003, two nonprofit organizations, Intracare Hospital and Intracare North Hospital, began operating the two psychiatric hospitals. The Cambridge Foundation owned the land and buildings for these two hospitals.

The Building Note, the Intracare Note, and the Family Trust Note (hereinafter collectively the “Notes”) all provide for periodic payments of principal and interest. The interest portion of the payments on the Building Note and the Intracare Note is income to the Marital Trust, which, under Alice’s will, must be distributed to Timothy. The record reflects that Timothy also received distributions of income from the Family Trust. However, at all material times since the execution of the Notes on December 31, 2003, Timothy has donated the income distributions from both trusts to the Cambridge Foundation without taking actual receipt of any money.4 Timothy reported these distributions as income on his personal income tax return and claimed a charitable deduction for his donation of these distributions. The record contains no evidence that Timothy received distributions of trust corpus from the Marital Trust or the Family Trust.5

*359Trial Court Proceedings

After a lengthy bench trial involving extensive testimony and trial exhibits, the trial judge signed an order on January 26, 2006. In this order, the trial court granted the parties a divorce and, among other things, made the following determinations:

• The Marital Trust is Timothy1 s separate property.

• Because interest received on separate property is community property, the interest on the corpus of the Marital Trust is community property.

• Lisa is entitled to fifty percent of the interest that accrued on the Building-Note and the Intracare Note during the marriage — from August 29, 2004 through January 26, 2006.

In the order the trial court did not specifically mention the Family Trust, but it indicated that it also was awarding Lisa half of the interest that accrued on the Family Trust Note during the marriage. This order did not contain all the necessary information for a property division and a final decree. Therefore, further proceedings in the trial court were required. Following these proceedings, Timothy and Lisa agreed that, from the date of their marriage (August 29, 2004) through the date of their divorce (January 26, 2006), $2,096,067 in interest accrued on the Building Note and $175,996 in interest accrued on the Intracare Note. The sum of these two amounts is $2,272,063 (hereinafter collectively “Marital Trust Income”). The parties also agreed that, during the same period, $82,955 in interest accrued on the Family Trust Note (hereinafter “Family Trust Income”).

The trial court signed a final decree and then issued findings of fact and conclusions of law. The trial court found that a just and right division of the community estate having due regard for each party’s rights would be to award each party fifty percent of the community estate. The trial court determined that the total community estate, including the Marital Trust Income and the Family Trust Income, had a value of $3,872,924.23. The trial court awarded Lisa one-half of this amount to equalize the division of the estate. The trial court rendered judgment in favor of Lisa and against Timothy in the amount of $1,936,462.12, plus interest. In addition, the trial court ordered that this judgment be secured by an equitable lien against all of Timothy’s separate property and against Timothy’s half of the community estate. The trial court denied all parties’ claims for reimbursement or economic contribution.6

III. Issues and Analysis

On appeal, Timothy challenges the trial court’s property division, asserting, among other things, that the trial court erred by characterizing the Marital Trust *360Income; and - the.. Family Trust Income as community property rather than as Timothy’s separate property. Timothy asserts that this income is his separate property because he acquired it by devise or gift, and that the trial court erred by awarding half of this income to Lisa.

In a divorce decree, the trial court “shall order a division of the estate of the parties in ,a manner that the court deems -just, and: right, having due regard for the’fights of each party and any children of the marriage.” Tex.Fam.Code Ann. § 7.001 (Vernon 2006). To convince this court to disturb the trial court’s division of property, Timothy must show the trial court clearly abused its discretion by a division or an order that is manifestly unjust and unfair. See Stavinoha v. Stavinoka, 126 S.W.3d 604, 607 (Tex.App.Houston [14th Dist.] 2004, no pet.). Under this standard, the legal and factual sufficiency of the evidence are not independent grounds of error, but they are relevant factors in assessing whether the trial court abused its discretion. Id. at 608. If the trial court mischaracterizes a spouse’s separate property as community property and awards some of the property to the other spouse, then the trial court abuses its discretion and reversibly errs. See Eggemeyer v. Eggemeyer, 554 S.W.2d 137,142 (Tex. 1977); Gana v. Gana, No. 14-05-00601-tiV, 2007 WL 1191904, at *4 (Tex.App.Houston [14th Dist.] Apr. 24, 2007, no pet.) (mem. op.).

All property possessed by either spouse during or on dissolution of marriage is presumed to be community property. Tex. Fam.Code Ann. § 3.003(a) (Vernon 2006). The burden of overcoming this presumption is on the party asserting otherwise, and the standard of proof is by clear and convincing evidence. Id. § 3.003(b). “Clear and convincing” evidence means the measure or degree of proof that will produce in the mind of the trier of fact a firm belief or conviction as to the truth of the allegations sought to be established. In re J.F.C., 96 S.W.3d 256, 264 (Tex.2002). Whether property is separate or community is determined by its character at the inception of the party’s title. Barnett v. Barnett, 67 S.W.3d 107, 111 (Tex.2001). Inception of title occurs when a party first has a right of claim to the property by virtue of which title is finally vested. Smith v. Smith, 22 S.W.3d 140, 145 (Tex.App.-Houston [14th Dist.] 2000, no pet.).

In the Texas Constitution, the people of Texas have proclaimed:

All property, both real and personal, of a spouse owned or claimed before marriage, and that acquired afterward by gift, devise or descent, shall be the separate property of that spouse; and laws shall be passed more clearly defining the rights of the spouses, in relation to separate and community property....

Tex. Const, art. XVI, § 15. In the Texas Family Code, the legislature restates this definition of “separate property” from the Texas Constitution, and it then states that “community property consists of the property, other than separate property, acquired by either spouse during marriage.” See Tex. Fam.Code § 3.002 (Vernon 2006). In interpreting the Texas Constitution, Texas courts rely heavily on the literal text and must give effect to its plain language. Republican Party of Texas v. Dietz, 940 S.W.2d 86, 89 (Tex.1997); Arnold v. Leonard, 114 Tex. 535, 273 S.W. 799, 801-03 (1925) (stating that a court’s duty is to give effect to the will of the people of Texas, as expressed by the plain meaning of the Texas Constitution). Basing its analysis on the plain meaning of the constitutional text, the Supreme Court of Texas has reasoned that, as to property a spouse acquires during marriage, if the

*361spouse acquires the property by gift, devise, or descent, then the property belongs to the spouse’s separate estate, but if the property is acquired in any other manner, then the property belongs to the community estate. See Arnold, 273 S.W. at 801-03. Decades ago in Arnold, our high court concluded that rents and revenues acquired during marriage based on a spouse’s ownership of separate realty were not acquired by gift, devise, or descent and therefore were community property. See id. The Arnold court held unconstitutional a statute in which the legislature attempted to make such property part of the spouse’s separate estate. See id. at 803-OS. The high court indicated that rents and revenues were acquired at the time they came into existence rather than when a spouse received the property that generated the rents and revenues. See id. The Arnold case did not involve trust income or a devise or gift of income. See id.

Does the evidence prove, as a matter of law, that the husband acquired the marital trust income by devise or gift so that this income is his separate property?

Under the unambiguous language of Alice’s will, Alice required the trustee of the Marital Trust to distribute the Marital Trust Income to Timothy.7 A devise is “the act of giving property by will.” Black’s Law DictionaRY 483 (8th ed. 2004). Timothy acquired the Marital Trust Income because in Alice’s will she required that it be distributed to him. Under the unambiguous meaning of “acquired ... by ... devise” and under the unambiguous language of Alice’s will, Timothy acquired the Marital Trust Income by devise.

Courts have held that distributions from testamentary or inter vivos trusts to married recipients who have no right to the trust corpus are the separate property of the recipient because these distributions are received by gift or devise.8 See Cleaver v. Cleaver, 935 S.W.2d 491, 492-94 (Tex.App.-Tyler 1996, no pet.); Wilmington Trust Co. v. United States, 4 Cl.Ct. 6, 14 (1983) (applying Texas law), aff'd, 753 F.2d 1055 (Fed.Cir.1985). However, though the Arnold case did not involve trust income or a devise or gift of income, the Arnold court suggested that, if a spouse owns the property that generates income during the marriage, then the income results from the ownership of the property rather than any gift or devise that may have bestowed the *362income-generating property on the spouse in the past. See Arnold, 273 S.W. at SOS-OS. Consequently, for the Marital Trust Income to constitute separate property, it appears that Timothy must not have owned the property that generated the income. See id. In the context of a distribution of trust income under an irrevocable trust during marriage, there are at least four possible rules that could be adopted:

(a) Income distributions are always community property, even if the recipient has no right to the corpus of the trust, because the recipient’s right to receive the income means that the recipient is a trust beneficiary and effectively an owner of the trust corpus (hereinafter “Rule A”).9

(b) Income distributions are community property only if the recipient has some potential right to the corpus, even if the right has not yet become a possessory right, because the recipient’s potential right to access the corpus means that the recipient is effectively an owner of the trust corpus (hereinafter “Rule B”).

(c) Income distributions are community property only if the recipient has a present possessory right to part of the corpus, even if the recipient has chosen not to exercise that right, because the recipient’s possessory right to access the corpus means that the recipient is effectively an owner of the trust corpus (hereinafter “Rule C”).10

(d) Income distributions are community property only if the recipient has exercised a possessory right to part of the corpus, because the recipient’s exercise of this possessory right means that the recipient is effectively an owner of the trust corpus (hereinafter “Rule D”).11

Because there are no decisions by the Supreme Court of Texas or this court that specifically address this issue, we must determine which rule to apply.12

Texas courts have addressed similar issues using a variety of approaches. In Ridgell v. Ridgell, the court addressed the characterization of mandatory income distributions to the wife from two testamentary trusts. See 960 S.W.2d 144, 147-50 (Tex.App.-Corpus Christi 1997, no pet.). *363The Ridgell court stated that trust income received by a married beneficiary is community property if the receiving spouse “is entitled, or becomes entitled” to distributions of trust corpus. Id. at 148. In Rid-gell, the wife received mandatory distributions of trust income, and, in addition, the testamentary trusts mandated that the trustee make annual distributions of trust corpus to the wife during the first eleven years of the marriage. See id. at 146-50. As to the trusts in question, the wife either had received mandatory distributions of corpus or had a present possessory right to receive mandatory distributions of corpus. See id. at 147-50. The Ridgell court held that the income distributions from the two testamentary trusts to the wife were community property, using an analysis that supports Rule C. See id.

In McClelland v. McClelland, the husband was a beneficiary under his father’s testamentary trust. 37 S.W. 350, 354-56 (Tex.Civ.App.1896, writ ref'd). Upon the husband’s death, the trust would end and the assets would be distributed to the father’s heirs at law. Though he had no interest in the remainder of the trust, the husband was entitled to a mandatory monthly distribution of $100 while he was unmarried and $150 while he was married. See id. In addition, if the trustee determined that the husband was “provident and careful,” then the trustee had discretion to make additional distributions to the husband. See id. at 356. The trustee did not make any discretionary distributions to the husband, but the trustee did make the monthly distributions of $150 during marriage. See id. at 357. In McClelland, the trial court granted the wife a divorce from the husband and ruled that, as a matter of law, all trust income that had accrued during marriage was community property. See id. at 358. The court of appeals concluded that (1) this income was separate property as a matter of law, and (2) except as to the monthly distributions, the husband had no possessory right to access the income on the trust corpus and therefore, the husband had not acquired this property during marriage. See id. at 358-59. As to the monthly distributions that the husband acquired during marriage, the court of appeals concluded that these distributions were the husband’s separate property because he acquired them by devise.13 See id. The McClelland case supports Rule C and is contrary to Rule A and Rule B.14

Various other courts of appeals have indicated disapproval of Rule D and have concluded that, if a spouse has a present possessory right to trust corpus or income but the spouse elects not to receive it, then that spouse should be treated as having acquired title to the corpus or income as separate property to the extent the spouse is entitled to receive it. See Cleaver, 935 S.W.2d at 492-94; In re Marriage of Long, 542 S.W.2d 712, 717-18 (Tex.Civ. *364App.-Texarkana 1976, no writ). We agree with these courts and reject Rule D.

Upon consideration of the plain meaning of article XVI, section 15 of the Texas Constitution (“Section 15”) and of the applicable sections of the Family Code, as well as the cases discussed above, we adopt Rule C.15 We conclude that, in the context of a distribution of trust income under an irrevocable trust during marriage, income distributions are community property only if the recipient has a present possessory right to part of the corpus, even if the recipient has chosen not to exercise that right, because the recipient’s possessory right to access the corpus means that the recipient is effectively an owner of the trust corpus.16

The unambiguous language of Alice’s will and the trial evidence prove the following as a matter of law:

• The Marital Trust is an irrevocable, testamentary trust.

• The trustee of the Marital Trust must distribute the income on the corpus of the Marital Trust to Timothy, at least quarterly.

• Under Alice’s will, Timothy has no interest in the remainder of the Marital Trust, which expires upon his death.17

• The only potential right that Timothy has to access the corpus of the Marital Trust is the will’s requirement that the trustee of the Marital Trust “distribute such amounts of trust principal to [Timothy] as are necessary, when added to the funds reasonably available to [Timothy] from all other sources known to [the trustee] (excluding the Article VI trust property), to provide for [Timothy’s] health, support and maintenance in order to maintain him, to the extent reasonably possible, in accordance with the standard of living to which [Timothy] is accustomed at the time of [Alice’s] death” (hereinafter “Support Provision”).

• At the time the trial court granted divorce on January 26, 2006, Timothy had not received any distributions of *365any part of the corpus of the Marital Trust.

• At no time during his marriage to Lisa did Timothy have a present possessory right to any part of the corpus of the Marital Trust.

Under the unambiguous meaning of Section 15 and of Alice’s will, Timothy acquired the Marital Trust Income by devise or gift.18 See Arnold, 273 S.W. at 801-08; McClelland, 37 S.W. at 358-59; Black’s Law DictionaRY 483 (8th ed. 2004). Based on the unambiguous language of Alice’s will, Timothy would have a present posses-sory right to receive distributions of corpus only if he, as trustee of the Marital Trust, determined that such distributions were necessary for his maintenance under the Support Provision. The record contains no evidence that Timothy ever made such a determination or that he ever was entitled to receive distributions of trust corpus from the Marital Trust. Because Timothy had no present, possessory right to any part of the Marital Trust corpus, Timothy was not effectively an owner of the trust corpus during his marriage to Lisa, and the Marital Trust Income, as a matter of law, is not community property.19 See McClelland, 37 S.W. at 358-59.

Lisa argues that, if an income beneficiary is also the trustee, then, because the trustee holds legal title and right to control the trust corpus, the trustee/beneficiary must be deemed the owner of the trust corpus for purposes of characterizing the trust income. Lisa cites language from the Wilmington Trust Co. case, in which the court states that the income beneficiary was not the trustee and therefore lacked the right to possess and control the trust corpus. See Wilmington Trust Co., 4 Cl.Ct. at 14. The Wilmington Trust Co. court noted that the income beneficiary was not the trustee; however, the court, in concluding that the income distributions were separate property, also noted and strongly emphasized that the income beneficiary had no right to access the trust corpus. See id. at 8-14. The Wilmington Trust Co. court did not need to decide whether an income beneficiary’s service as trustee would be a controlling factor in the *366marital-property characterization of the trust income.20

In her trial court pleadings, Lisa did not allege, and Lisa does not assert on appeal, that the trusts were created, funded, or operated in fraud of her rights, nor has she pleaded that the trusts should be disregarded or that the trusts are Timothy’s alter egos.21 See Lemke v. Lemke, 929 S.W.2d 662, 664 (Tex.App.-Fort Worth 1996, writ denied). Timothy may serve as trustee even though he is one of the beneficiaries under the trusts. See Tex. PROP. Code Ann. § 112.008(b) (Vernon 2006). However, Timothy, as trustee of the trusts, holds bare legal title and the right to possession of trust assets. Burns v. Miller, Hiersche, Martens & Hayward, P.C., 948 S.W.2d 317, 322 (Tex.App.-Dallas 1997, writ denied). Therefore, the fact that an income beneficiary also holds legal title to the corpus in his capacity as trustee should not be a controlling factor in the marital-property characterization of the trust income.22

For the foregoing reasons, the trial court reversibly erred in characterizing the Marital Trust Income as community property rather than Timothy’s separate property and by awarding part of this property to Lisa.23 See Eggemeyer, 554 *367S.W.2d at 142; Gana, 2007 WL 1191904, at *4.

Does the evidence prove, as a matter of law, that the husband acquired the family trust income by devise or yift so that this income is his separate property?

The trial evidence shows that Timothy also received distributions of income from the Family Trust. These distributions were significantly smaller than the income distributions from the Marital Trust. The record contains no evidence that trust corpus was distributed.24 The trial court concluded that $32,955 in community property was attributable to income from the Family Trust Note. Timothy asserts that the trial court erred as matter of law and should have characterized this income as his separate property. The unambiguous language of Alice’s will and the trial evidence prove the following as a matter of law:

• The Family Trust is an irrevocable, testamentary trust.

• Under Alice’s will, Timothy has no interest in the remainder of the Family Trust, which expires upon his death.25

• The only potential right that Timothy has to access the corpus of the Marital Trust is the will’s requirement that the trustee of the Family Trust distribute such amounts of income and principal as shall be necessary for Timothy’s support and maintenance as determined by a standard substantially similar to the Support Provision of the Marital Trust.26

• At the time the trial court granted Timothy and Lisa a divorce on January 26, 2006, Timothy had not received any distributions of any part of the corpus of the Family Trust.

• At no time during his marriage to Lisa did Timothy have a present possessory right to any part of the corpus of the Family Trust.

Under the unambiguous meaning of Section 15 and of Alice’s will, Timothy acquired the Family Trust Income by devise or gift. See Hilley v. Hilley, 161 Tex. 569, 342 S.W.2d 565, 569 (1961) (stating a gift is a transfer of property made voluntarily and gratuitously); Arnold, 273 S.W. at 801-03; Cleaver, 935 S.W.2d at 493 (concluding that wife’s acquisition of income from testamentary trust was either by gift or devise); McClelland, 37 S.W. at 358-59; Black’s Law Dictionary 483 (8th ed. 2004). In addition, because Timothy had no present, possessory right to any part of the Family Trust corpus, Timothy was not ef-*368feetively'an ownér’of the trust corpus during his marriage to Lisa, and the Family Trust Income, as a matter of law, was not community property. See McClelland, 37 S.W. at 358-59.

Therefore, the trial court reversibly erred in characterizing the Family Trust Income as community property rather than Timothy’s separate property and by awarding any part of this property to Lisa. See Eggemeyer, 554 S.W.2d at 142; Gana, 2007 WL 1191904, at *4. This error requires a reversal and remand to the trial court.

IY. Conclusion

Under the plain meaning of Section 15 and of the applicable sections of the Family Code, we conclude that, in the context of income distributions under an irrevocable trust during marriage, these distributions are community property only if the recipient has a present possessory right to part of the corpus, even if the recipient has chosen not to exercise that right. Under these circumstances, the recipient’s pos-sessory right to access the corpus means that the recipient is effectively an owner of the trust corpus. Under this standard, the trial court erred in characterizing the Marital Trust Income and the Family Trust Income as community property, and Timothy acquired this property by devise or gift rather than by the receipt of income on property he owned. The trial court erred by awarding Lisa any part of this income, the principal amount of which totals $2,305,018. Although we affirm the. trial court’s grant of divorce and dissolution of the marriage, based on the trial court’s reversible error in mischaracteriz-ing the Marital Trust Income and the Family Trust Income, we sever the remainder of the judgment and reverse and remand for further proceedings in conformity with this opinion.27

HEDGES, C.J., concurring.