"Property of the Estate" Excludes Property in a Spendthrift Trust

 Posted on May 29, 2017 in Asset Protection

If you are the beneficiary in a spendthrift trust, most likely a bankruptcy trustee can’t touch whatever property is in that trust.

Power of Attorney vs. Spendthrift Trust

Our last blog post focused on your rights under a power of attorney over someone else’s property. A conventional power of attorney commonly requires you to use that property only for another person’s benefit. If so, then your legal control over that property isn’t enough to make that property yours for bankruptcy purposes. So if you file a Chapter 7 case the bankruptcy trustee has no power of that property. It is not included in the property of your bankruptcy estate. (Section 541(b)(1) of the U.S. Bankruptcy Code.)

A power of attorney can be created for a million reasons. But the most common probably involves an elderly parent giving someone else, often their adult child, the power to use that parent’s property to pay the parent’s expenses when he or she no longer has the mental capacity to do so. The parent’s property does not become the adult child’s property because the child has only limited control over it.

Today we look at a somewhat similar situation, with a similar result: a spendthrift trust. As with a power of attorney, as the beneficiary of a spendthrift trust you have limited control over property in the trust.

A spendthrift trust involves someone giving property to another, but that property comes with a significant restriction. Instead of giving the property directly to the recipient, the grantor puts it into a trust. The trust holds the property on behalf of the recipient—the beneficiary of the trust. The beneficiary has tightly restricted access to and control over that property. The terms of that access and control are laid out in the trust document.

The Spendthrift Clause

A trust is a spendthrift trust if it has the right restriction to access. That restriction is contained in a legally enforceable spendthrift clause.

A spendthrift clause typically states that the beneficiary cannot voluntarily or involuntary transfer its rights to the property to anybody else. “Voluntarily” means that the beneficiary can’t get at the property within the trust except as stated in the trust’s language. “Involuntarily” means that the beneficiary’s creditors can’t get at the trust property either.

Legally Enforceable Spendthrift Clause

The Chapter 7 trustee also can’t get at the trust property either as long as the spendthrift clause is legally enforceable. How do you know whether or not it is?

The Bankruptcy Code says the following:

A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.

Section 541(c)(2). The “restriction on the transfer” referred to here is the language found in the spendthrift clause. It’s saying that if the spendthrift clause found in a trust “is enforceable under applicable nonbankruptcy law,” then it is enforceable in a bankruptcy case.

Each state has its own laws on what “restriction on the transfer” in a trust is legally enforceable. So talk with your bankruptcy lawyer about whether the trust of which you are a beneficiary has an enforceable spendthrift clause. If so the property in the trust will not become property of your bankruptcy estate. It will be protected from the clutches of your Chapter 7 trustee.