The Trouble with Trusts

Many attorneys and debtors alike are completely baffled by Trusts.  This post will provide you with the tools necessary to identify trust types, what your interest in a trust might be and how to protect it.  The following sections of the Bankruptcy Code are commonly applicable in cases involving trusts: 11 U.S.C. §541 (property of the estate); 11 U.S.C. §542 (turnover); and 11 U.S.C. §§544 and 548 (state and federal law fraudulent transfer avoidance). 11 U.S.C. §541(c)(2) specifically protects the debtor’s beneficial interest in a certain type of commonly encountered trust known as a “spendthrift trust.” In the absence of a spendthrift or discretionary clause in a trust, the beneficial interest of a debtor may be reachable by the bankruptcy trustee, a bad result.  Watch out also to be sure your trust has the correct “spendthrift” language required by your state. Trusts established by a debtor (so called “self-settled trusts) for their own benefit are usually not valid.  Be very careful to examine the powers of the Trustee of the Trust.  If the Debtor is also a Trustee of the Trust, those powers can be exercised by the bankruptcy trustee, another very bad result.  The following is a handy list of documents that will help to determine the type of trust you may have and how it will be  treated in bankruptcy:

• Declaration of Trust or other similar document
• Trustee Certificates
• Schedule of Beneficiaries
• Inventory of Trust property, Deed or Bill of Sale evidencing property owned by trust
• Trust Bank Account Statements
• Mortgages and other instruments evidencing the liabilities of the trust
• Trust tax returns
• Debtor and non-debtor beneficiary tax returns and K-1’s
• Amendments to trust documents
• Trustee Resignations
• File of attorney that established the trust

Trust interests are quite complex and, for that reason, often overlooked.  Never file bankruptcy without first carefully reviewing the impact on a trust.