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What Happens to Trust Assets in Bankruptcy?

Sometimes New York bankruptcy debtors create, benefit, or manage trusts, which are legal entities managed by trustees that hold assets for other parties that aren’t owned by those other parties. The bankruptcy estate is a type of trust, which is why, unsurprisingly, it’s managed by the trustee. Debtors may be interested in what happens to the assets in the trust, specifically whether those assets will be transferred to the bankruptcy estate for liquidation in a chapter 7 case. There are several factors to consider.

First of all, a debtor who is merely a trustee for a trust usually does not need to worry about the trust’s assets falling into the bankruptcy estate. Because this debtor has no property interest in the trust, it cannot be an asset of the debtor-trustee’s bankruptcy estate. The trustee’s income from managing the trust, if any, would be relevant to the bankruptcy.

Debtors who create trusts with their property (called “settlors” or “grantors” in the law) should be ensure that the trust documents sufficiently alienated the property from them. If the trust is an “irrevocable” trust, i.e. the debtor cannot revoke the trust and recover the property it contains, then the debtor has little to worry about—so long as the trust documents are valid.

If the trust is “revocable,” then it raises the question for the bankruptcy trustee of whether the trust is a fraudulent transfer under section 548(e) of the Bankruptcy Code. If the trustee can show that the debtor created the revocable trust within the last ten years to benefit the debtor with intent to defraud a creditor, then the trustee can avoid the transfer of assets to the trust. Debtors who think they are clever and try to place their assets into a trust to keep them from bankruptcy rarely succeed.

Debtors who are beneficiaries of trusts will definitely want to know whether the trusts’ assets are safe. Here again the revocable-irrevocable distinction matters. If the trust is revocable, then the settlor still ultimately controls the property, so the trust cannot be liquidated by the bankruptcy trustee. If it is irrevocable, though, then in some sense the debtor has some control over the assets. For example, a debtor could sign an agreement transferring his or he interest in the trust to another party. As a result, many irrevocable trusts contain “spendthrift” provisions, which restrict the beneficiaries’ rights to transfer their interests in the trusts to third parties. (Usually these clauses exist to prevent young beneficiaries from wasting inherited assets in a trust.) Section 541(c) of the Bankruptcy Code enforces “spendthrift” clauses against bankruptcy trustees. A beneficiary’s income from a trust, however, can play a role in a bankruptcy just as any other income.

So what happens if the trust’s assets are exposed to the trustee? The answer is that the debtor applies any available exemptions to it like any other assets. Usually the best fit would be cash exemptions, which in New York is $1,100 for debtors not claiming a homestead exemption, plus the lesser of $5,525 or $11,025 minus their unclaimed personal-property exemptions. The federal exemptions are somewhat larger, $1,250 plus up to $11,850 in an unused homestead exemption.

Trusts can complicate bankruptcies significantly, so if a trust plays a role in your financial situation, then it’s important to discuss it with an experienced New York bankruptcy lawyer rather than trying to handle it alone.

For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Brooklyn bankruptcy attorney Bruce Weiner for a free initial consultation.

Rosenberg, Musso & Weiner, L.L.P
26 Court St # 2211
Brooklyn, NY 11242, USA
718-855-6840
http://nybankruptcy.net/

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