How Are Trusts Handled in Bankruptcy Cases?

 Posted on June 13, 2022 in Bankruptcy

Trusts can be helpful tools used by families as part of a comprehensive estate plan or for asset protection purposes. When a person creates this type of legal agreement, they will transfer ownership of certain assets to the trust, and a trustee will maintain control over these assets and distribute them to different beneficiaries according to specific instructions. For those who are considering bankruptcy, it is important to understand how assets held in a trust will be addressed during this process.

After filing for bankruptcy, a debtor will be required to submit documentation of all of the assets they own. In a Chapter 7 bankruptcy, certain assets may be seized by the bankruptcy trustee and liquidated, while in a Chapter 13 bankruptcy, a debtor’s assets and financial resources may determine the amount that will be paid in a monthly repayment plan. Since assets held in a trust will generally be considered to be owned by the trust rather than the debtor, there may be some question about whether these assets will be part of the bankruptcy estate. When addressing this issue, a bankruptcy trustee may look at how much control a person has over the assets in a trust and whether they are a beneficiary.

Revocable and Irrevocable Trusts

Some of the most commonly-used trusts are known as living trusts. These trusts are revocable, meaning that the grantor of the trust can change the terms of the agreement at any time. In many cases, the grantor will serve as the trustee, maintaining control over the assets in the trust, and they may also be a beneficiary, which will ensure that they can use the trust’s assets to address their needs. Since a debtor will have control over the assets in a living trust, these assets will typically be considered to be part of the bankruptcy estate.

Determining whether irrevocable trusts are part of the bankruptcy estate can sometimes be more complicated. Because the terms of these trusts cannot be changed, and someone other than the debtor will typically serve as the trustee, the debtor may not have full control over these assets. Some types of asset protection trusts may provide protection from creditors, including foreign asset protection trusts in which a person transfers their assets to accounts in another country. Some states also allow for domestic asset protection trusts, although they will generally only provide protection for those who live in the state where a trust was created.

In order to protect assets from creditors, an irrevocable trust will usually need to include spendthrift provisions that prevent beneficiaries from selling or giving away their right to receive distributions from the trust. If the beneficiaries of an irrevocable trust are people other than the debtor, such as their children, the assets in the trust may be protected from creditors. However, if an irrevocable trust is self-settled, meaning that the grantor is a beneficiary, assets in the trust may be included in the bankruptcy estate if they were transferred to the trust within 10 years before the debtor filed for bankruptcy. In addition, the bankruptcy trustee may recover any fraudulent transfers made to asset protection trusts that were intended to prevent assets from being used to pay debts to creditors.

Contact Our San Antonio Bankruptcy and Asset Protection Lawyer

If you are considering bankruptcy, the Law Offices of Chance M. McGhee can help you determine the role that trusts may play in this process. We can help you determine your best options for asset protection while working to make sure you will have the necessary financial resources once your debts have been discharged. Contact our Schertz bankruptcy and trusts attorney at 210-342-3400 to set up a complimentary consultation.

Sources:

https://www.investopedia.com/articles/retirement/07/buildawall.asp

https://www.forbes.com/sites/jayadkisson/2014/12/21/bankruptcy-considerations-in-asset-protection-planning/

https://scholarship.law.columbia.edu/cgi/viewcontent.cgi?article=1356&context=faculty_scholarship