The Living Trust and the Bankruptcy Estate.

Every person should have an estate plan. A good estate plan would have a financial power of attorney, medical power of attorney, and a will. A really good estate plan might also have a revocable living trust. A revocable living trust is an estate planning device which avoids probate by transferring ownserhip of assets to the trustee of a living trust. A common transfer is a house, vacation property, or a bank account to the trust. When the trustee of a trust is also the creator, or settlor, then that trust is called a self-settled trust which is for the benefit of the settlor initially and the heirs upon the settlor’s death. They can be complicated.

What happens when a person files for bankruptcy protection, at least in Michigan, when they have a living trustwhich owns assets? There is a common misconception that a self-settled revocable living trust is a creditor avoidance technique. I have heard stories of some attorneys telling clients they can shelter or hide their assets with one of these trusts. There are a few states that do allow for this, like Utah, Alaska, and Delaware, but not here in Michigan. A trust is really just the alter ego of the settlor and if you are sued by a creditor, they can attach assets held in the trust’s name just as if it were in the settlor’s name.

Sometimes my clients are beneficiaries or heirs to a trust. If the trust has “spendthrift” language in it, then the trust will protect the assets held for the heir and shield it from creditors. These trust assets just aren’t part of the bankruptcy estate. There isn’t a lot a Chapter 7 trustee can do about it as they stand in the shoes of a creditor and have the same rights and remedies. Since we do estate planning and bankruptcy work, we can look over the trust and determine what protection you have. Most well planned trusts will have some type of spendthrift of anti-alienation language in them.

Transfers to a trust in the past 10 years must be disclosed in the statement of financial affairs. If have one of these trusts, you must disclose the assets held by the trust. If you can’t protect these assets with your exemptions, then, in a Chapter 7, the trustee will seize and administer the assets and in a Chapter 13, their value will be used in helping to determine what you will have to pay to your creditors. Do not assume that because it is owned by a trust that the property does not have to be disclosed. If you do, you are at risk of losing the property entirely and possibly having your case dismissed for failure to disclose. When disclosing your assets to your bankruptcy lawyer, make sure to tell him or her about all transfers to any trust in the past 10 years so your case can be properly analyzed.