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IN RE: ESTATE of Lawrence Archer KELLEY

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District Court of Appeal, First District, Division 2, California.

IN RE: ESTATE of Lawrence Archer KELLEY, Deceased. Holly Re JACKSON, Petitioner, Appellant and Respondent, v. Kathleen Kelley YOUNG, Louise K. Duffey and James Alan Kelley, Objectors, Respondents and Appellants.

Civ. 22349.

Decided: August 20, 1965

Franklin P. Jackson, Garden Grove, Eisner & Titchell, San Francisco, for Holly Re Jackson. Rogers, Wilcox & Gordon, Santa Barbara, for Kathleen Kelley Young, Louise K. Duffey and James Alan Kelley.

Holly Jackson, the life income beneficiary under a testamentary trust, appeals from an order instructing the trustees as to the apportionment of various trust expenses. Kathleen Young, Louise Duffey and James Kelley, the remaindermen under said trust, have also appealed from the order in question. Both appeals are presented upon an agreed statement.

The statement shows that on February 5, 1955, Lawrence Kelley died, leaving a will creating four trusts. The corpus of the first trust consisted of an undivided 55 per cent interest in a store building located in Berkeley, California. The will provided that all of the net income from said trust was to be paid to the testator's wife, Holly Jackson (then Holly Kelley) for life. The remaining 45 per cent undivided interest in the store building was divided equally among the other three trusts. Three of the testator's children, Kathleen Young, Louise Duffey and James Kelley, were the income beneficiaries under these three trusts. Each of the three children was to receive one-half the net income from his particular trust until he attained the age of 25 and was thereafter to receive the entire net income. Upon the death of Holly Jackson, all four trusts were to terminate and the three children were to acquire equal undivided shares in the store building. The will named as trustees of the four trusts Robert Southern, Holly Jackson and Martin Minney. The will contained no instructions as to the manner in which trust expenses were to be apportioned as between principal and income.

At the time of the testator's death, the store building comprising the corpus of the four trusts was under lease to and occupied by Roos Brothers as a clothing store. The property was appraised in the testator's estate at $160,000, with $75,000 of this amount being attributed to the building.

The lease in effect at the testator's death expired the end of 1960. In April 1959, prior to such expiration date, Roos Brothers informed the trustees that it was unwilling to enter into a new lease unless the trustees would agree to expend some $200,000 to remodel the store building and install new fixtures. In order to enable the trustees to obtain and amortize a loan sufficient to finance the proposed improvements, Roos Brothers indicated that it would agree to pay a specified minimum rental, although the prior lease had contained no such provision.

Prior to acting upon such proposal, the trustees employed Mason-McDuffie Co., a Berkeley firm specializing in commercial properties, to advise them of the various alternative uses to which the building might be put. By letter of June 10, 1960, said firm expressed the view that the building was not presently salable and that there was no likelihood of the trustees' obtaining any new tenant for the building without first undertaking improvements comparable in scope to those suggested by Roos Brothers. The letter further indicated that if the trustees did undertake the required improvements to the building, they would still be unlikely to find any new tenant who would be willing to pay a higher rental than that which Roos Brothers had offered to pay. The letter also stated that if the trustees were to install the improvements proposed by Roos Brothers and were to lease the building to said firm for a period of 25 years at a minimum rental even lower than that which it had offered to pay, the property would immediately become salable to an institutional investor for approximately $450,000.

On September 9, 1960, Holly Jackson wrote Martin Minney and indicated an awareness that the requirements imposed by Roos Brothers would have to be met if there were no other prospects for sale or lease. However, she also expressed the view that as a life beneficiary under the first turst, she was under no duty to pay for major permanent improvements out of her share of the trust income, ‘[s]o please let the record show that I do not consent to my interest in the income being charged with any capital improvements which I as life tenant am not obligated to make.’

Upon the expiration of the original lease, trustees Minney and Southern entered into a new lease with Roos Brothers. Said lease was for a 20-year term commencing January 1, 1961, provided for a specified minimum rental, and required the trustees to expend $125,000 on ‘remodeling and modernization’ of the store building and $75,000 on the ‘design, planning, purchase, and installation of fixtures' therein. Minney and Southern then petitioned the court for approval and confirmation of the lease and for authority to borrow $200,000 for the purposes specified in the lease. By order of July 19, 1961, the court granted the petition.

Minney and Southern then obtained a $200,000 loan, secured by a deed of trust on the store building, and expended the entire proceeds of said loan in the manner provided for in the lease. The terms of the loan called for quarterly payments of $5,200 for a period of 10 years, at the end of which time the portion of the loan allocable to fixtures would be paid. During this first 10-year period, $2,696 of each quarterly payment was to be allocated to improvements and modernization, and the remaining $2,504 was to be allocated to fixtures. During the following 10 years, the loan was to be paid in full by means of quarterly payments of $2,696.1

Trustees Minney and Southern also paid an architect's fee for plans and specifications and, in order to obtain the loan, incurred lenders' fees and a loan commitment fee. Since the rental income from the store building constituted the only source of trust funds, the above-enumerated expenses, totaling $4,050, plus the quarterly payments on the loan, were all made from such income, subject to later apportionment as between trust income and principal.

After a hearing on January 24, 1963, the court also directed the trustees to pay certain sums owing to contractors and materialmen, for which there were not sufficient funds remaining from the $200,000 loan. In compliance with said direction, the trustees expended trust income in the total amount of $7,513.11.

On June 10, 1963, the court rendered a decree settling the trustees' fourth account and apportioning against trust principal a $500 fee paid to Mason-McDuffie Co. and one-half ($4,477.50) of certain trustees' and attorneys' fees in the amount of $8,955, with instructions that all of said fees be paid initially from trust income with subsequent reimbursement of Holly Jackson, the life income beneficiary under the first of the four trusts. On the same date, the court also approved an amendment to the lease which extended the term thereof from 20 to 22 years. Said amendment, which was necessitated by delays in the completion of the remodeling work, had been executed by trustees Minney and Southern on March 21, 1962.

During the course of these proceedings, Holly Jackson had refused to join with the other two trustees in signing the lease and in petitioning the court for approval of same and for authority to borrow the $200,000. She had similarly refused to execute any documents in connection with the loan and deed of trust.

On August 6, 1963, Holly Jackson filed a trustee's petition for instructions as to the manner in which the improvements to the trust property should be paid for and apportioned as between trust income and principal. Since this petition was heard by the same trial judge who had previously adjudicated the trustees' fourth account, the parties stipulated that the Jackson petition should be submitted for decision upon the record accumulated in the prior proceeding but that the parties might augment the record with additional documents which they considered relevant.

On January 2, 1964, the court made its ‘Order Instructing Trustees Regarding Apportionment of Expenses and Reimbursement of Income Account.’ With regard to the payments on the $200,000 loan, said order directed that the payments on the $75,000 segment devoted to fixturization of the store building be charged, both as to principal and interest, against current trust income, and that the payments on the $125,000 segment devoted to improvement of the store building be charged against trust principal to the extent that they represented the repayment of loan principal, and charged against trust income to the extent that they represented interest on the loan. The order also stated that in order to provide funds for that portion of the loan payments which was chargeable to trust principal, the trustees might charge depreciation in the amount of each principal payment against the income interests of the three remaindermen and withhold such amounts from the income otherwise due them. However, the order expressly provided that no portion of the loan payments chargeable to principal should be deducted or withheld from the income due the life beneficiary, Holly Jackson. The order further provided that the $16,540.61 which had already been expended out of trust income to pay architect's fees, appraisal fees, loan standby fees, the loan commitment fee, the amounts due contractors and materialmen and one-half of the above-mentioned trustees' and attorneys' fees, was properly chargeable against trust principal and that the life beneficiary, Holly Jackson, was therefore declared to have an equitable lien in the sum of $9,097.33 upon the trust property to secure repayment of her 55 per cent interest in the sums expended. The trustees were directed to discharge said lien within three years of the date of the order with funds to be obtained by increasing the present loan, by negotiating a new loan, or in such other manner as they might recommend to the court.

Thereafter, by order of April 1, 1964, the court, upon the motion of trustee Minney, vacated and set aside the order of January 2, 1964, on the ground that the same had been inadvertently made.

By a third order of April 27, 1964, the court reaffirmed in toto the order of January 2, 1964.

Remaindermen Young, Duffey and Kelley filed notice of appeal from the order of April 27, 1964, which affirmed the prior order of January 2, 1964. The life beneficiary, Holly Jackson, similarly filed notice of appeal from the order of April 27, 1964.

Turning first to the appeal of the three remaindermen, it is their contention that the court erred in apportioning against principal (1) the payments amortizing principal on the $125,000 segment of the loan, and (2) expenditures totaling $12,063.11 (which figure represents all of the above-mentioned expenditures totaling $16,540.61 except for the $4,477.50 in trustees' and attorneys' fees).

The remaindermen contend that since the trusts became legally effective subsequent to September 13, 1941, and since the will contained no provision governing the ascertainment of income and principal, said trusts are subject to the Principal and Income Law contained in Civil Code, sections 730 through 730.15 (Civ.Code, §§ 730.02, 730.04; Estate of Bixby (1961) 55 Cal.2d 819, 823, 13 Cal.Rptr. 411, 362 P.2d 43.)

Section 730.15 of said law provides in relevant part that ‘(1) All ordinary expenses incurred in connection with the trust estate * * * including * * * ordinary repairs * * * shall be paid out of income. * * * (2) [C]osts of * * * improvements to property forming part of the principal * * * and all other expenses, except as specified in subsection (1) of this section, shall be paid out of principal.’ The remaindermen assert that the payments on the $125,000 portion of the loan and the additional expenditures in the amount of $12,063.11 were all made for the purpose of renovating and remodeling the store building. They rely upon Estate of Roberts (1945) 27 Cal.2d 70, 162 P.2d 461, as authority for the rule that expenditures of this nature must be deemed ‘ordinary repairs' chargeable against trust income. This contention is without merit.

It must first be noted that the trust in Estate of Roberts, supra, was established before the enactment of Civil Code, section 730.15, and also before its predecessor, section 12 of the Uniform Principal and Income Act, became a part of the California law (Stats.1941, ch. 898, § 12, p. 2483). Under such circumstances, the case clearly is not controlling as to the manner in which the term ‘ordinary repairs,’ as used in Civil Code, section 730.15, ought to be construed. The Roberts case merely held that the sum of $1,170, which was expended for the purpose of installing a new roof on an apartment building constituting trust corpus and for ‘painting and renovating’ certain of the individual apartments contained therein, was payable out of trust income because ‘[t]he expenses in question represented no additions to the house or furnishings but merely repairs and replacements' (27 Cal.2d pp. 79–80, 162 P.2d p. 467).

In the instant case, the record, consisting of the parties' agreed statement, contains no evidence indicating that the remodeling and modernization of the store building represented mere ‘repairs and replacements.’ The evidence demonstrates, to the contrary, that the building underwent a complete and permanent renovation which included the installation of ‘new store fronts, new flooring, new ceiling, new lighting, air conditioning and a number of other improvements to the property.’ The record contains no evidence that the work in question was limited to the replacement of items which had deteriorated through use and the passage of time. Under such circumstances, the court's implied finding that the remodeling and modernization did not represent ‘ordinary repairs' under Civil Code, section 730.15, cannot be disturbed.

The remaindermen also argue that the rental payments under the new lease constitute repayment of a loan to the extent that they equal the quarterly payments amortizing the $200,000 loan for remodeling, modernizing and installing new fixtures on the leased premises. They rely upon the fact that under the new lease, Roos Brothers for the first time agreed to pay a minimum rental over a long term period and assert that since the lease was ‘geared’ toward amortizing the $200,000 loan, Ross Brothers was in effect repaying the trustees for a loan which they had obtained on its behalf. Under such circumstances, the remaindermen take the position that the rental payments constitute ‘repayment of loans' which must be deemed principal under subdivision (2) of Civil Code, section 730.05.

The basic difficulty with this argument is that the remaindermen have overlooked the fact that Civil Code, section 730.05, actually provides that ‘(1) All receipts of money * * * paid * * * as rent of realty * * * shall be deemed income. * * * (2) All receipts of money * * * paid * * * as the consideration for the sale or other transfer, not a leasing or letting, of property forming a part of the principal, or as a repayment of loans * * * shall be deemed principal. * * *’ (emphasis added).

In the instant case, it is apparent that the mere fact that Roos Brothers agreed to pay a minimum rental under the new lease in return for the trustees' agreement to make certain improvements to the leased premises did not render the contract a ‘loan’ rather than a ‘lease.’ We are satisfied that the rental payments must be deemed income and not principal.

Turning next to the appeal of Holly Jackson, the life beneficiary under the first trust, it is her contention that the court erred in apportioning against trust income the payments amortizing principal on the $75,000 segment of the loan. She first points out that Civil Code, section 730.15, provides that ‘(1) * * * interest on mortgages on the principal * * * shall be paid out of income. * * * (2) [A]ll other expenses, except as specified in subsection (1) of this section, shall be paid out of principal. * * *’ It is her theory that since payments of interest on mortgages on the principal are among those expenses specifically enumerated in subdivision (1) and payments of principal on such mortgages are not, all payments of the latter type must be made from trust principal.

This argument would be of some merit if subdivision (1) of Civil Code, section 730.15, did not also provide that ‘ordinary repairs' and a number of other specified expenses shall be paid out of trust income. It is apparent that if the life beneficiary were correct in contending that all payments of principal on mortgages must be made from trust principal, all of the other expenses, such as ‘ordinary repairs,’ which are enumerated in the first subdivision of the section, could in fact be charged against principal rather than income through the simple expedient of obtaining a loan secured by a mortgage or deed of trust upon real property within the trust and paying such expenses from the proceeds of the loan. The Legislature clearly could have intended no such result. The section, therefore, must be construed as requiring that payments of principal on a mortgage or deed of trust be charged against trust principal only if the real property was subject to the mortgage or deed of trust when the trust was created, or if the loan obtained by means of such mortgage or deed of trust was used to pay expenses chargeable to trust principal.

The life beneficiary next contends that the installation of Fixtures costing $75,000 cannot be deemed mere ‘ordinary repairs' within subdivision (1) of Civil Code, section 730.15, and must accordingly be deemed ‘improvements to property forming part of the principal’ or ‘other expenses' under subdivision (2) of the section.

The difficulty with this argument is that the record on appeal fails to disclose the nature of the ‘fixtures' installed in the store building and similarly fails to disclose whether their installation was made necessary by the deterioration of the old fixtures in the building. The situation presented is thus one where an appellant is attacking an order as unsupported by the evidence but has failed to supply this court with a record enabling it to determine in what respect such evidentiary support is lacking. It cannot be doubted that the term ‘ordinary repairs,’ when reasonably construed, might be deemed to include replacements of worn and outmoded fixtures in rental property. In the instant case, the terms of the new lease with Roos Brothers lends considerable support to the conclusion that the fixtures which the trustees were required to install at the inception of the lease were not intended to be of an indefinite duration but were of a shortterm, deteriorating nature. The seventh paragraph of said lease provides that prior to the commencement of the second 10-year period of the lease, the lessee may require the lessor to expend an additional $75,000 for the purpose of modernizing, renovating and replacing the furniture and fixtures installed at the commencement of the lease. Since it is certainly inferable from said provision that the fixtures installed at the commencement of the new lease similarly constituted a mere replacement of fixtures which had previously become unusable through deterioration, we cannot say that the trial court erred in apportioning against trust income the payments amortizing principal on the $75,000 segment of the loan.

The order appealed from is affirmed. The respective appellants shall each bear their own costs on appeal.


1.  Although the loan payments included interest at the rate of six per cent, all of the parties have agreed that the court properly apportions such interest against the income of the various trusts in proportion to the interests of the various income beneficiaries.

SHOEMAKER, Presiding Justice.

AGEE and TAYLOR, JJ., concur.

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