In a legal “Trust,” money, or other property, that is owned by a “Beneficiary,” is controlled by a “Trustee” (not to be confused with a bankruptcy trustee), whose responsibility it is to distribute the property to the Beneficiary in accordance with the terms of a written “Trust Agreement.” The person who creates the legal trust, via the Trust Agreement, is called the “Settlor,” and there can be multiple Settlors, Trustees, and Beneficiaries.
Sometimes, a person who files for bankruptcy (aka “the Debtor”) also serves as a Trustee for a Trust, in which case the Debtor is responsible for distributing the property of the Trust to its Beneficiaries. Generally speaking, when the Debtor/Trustee only has authority to distribute Trust property for the benefit of the Beneficiaries, and for not the benefit of the Debtor themselves, the property held in the Trust cannot be taken by the bankruptcy trustee to pay creditors. In fact, under bankruptcy law, Trust property, pursuant to a Trust Agreement with a valid “anti-alienation provision,” cannot be used to pay the Debtor’s creditors. Anti-alienation provisions are those that specifically state that the trustee cannot transfer interest in the Trust property to anyone other than the Trust’s intended Beneficiaries (i.e. a bankruptcy trustee). However, in situations where the Debtor/Trustee has significant authority over the Trust (i.e. the ability to terminate the Trust altogether), or is also a Beneficiary of the Trust property, that property can be considered property of the “bankruptcy estate,” which the bankruptcy trustee can take to pay creditors.
Although, generally speaking, property in a Trust in which the Debtor is a Beneficiary is subject to being taken by the bankruptcy trustee to pay creditors, this is not the case if the Trust Agreement contains a “spendthrift provision.” A spendthrift provision significantly, or completely, limits the Beneficiaries’ right to access the trust property and prevents the Trust property from being used to pay the Beneficiaries’ creditors. A Trust Agreement with a valid spendthrift provision protects the Trust property from being taken to pay a Debtor/Beneficiaries’ creditors in their bankruptcy case. It is also notable that, distributions of money or property from the Trust received by the Beneficiary before their bankruptcy case is filed are subject to being taken to pay creditors, while distributions received after the case is filed are generally not subject to being taken, so long as the distributions are out of the control of the Debtor/Beneficiary.
However, even if the Trust Agreement contains a valid spendthrift provision, a problem arises for a Debtor/Beneficiary if the Trust is a “self-settled” Trust. A self-settled Trust is one in which the Debtor is not only the Settlor, who creates the Trust Agreement, but also a Beneficiary of the Trust. In this case, since the Debtor voluntarily created the Trust for the benefit of themselves, the court will not allow them to us the Trust to legally shield the Trust Property from the bankruptcy trustee to be taken to pay creditors.
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If you are a Trustee, or Beneficiary, of a Trust, you should consult with an experienced bankruptcy attorney before deciding to file a bankruptcy case to receive specific advice on whether the Trust property, along with the other property you own, will be protected or is subject to being taken to pay creditors. See us at LifeBackLaw.com!
