Hi everyone. It’s been awhile. Let’s start off with a quiz. Do you remember a couple years back when I told you I was buying, via a bankruptcy sale, some land owned by a couple as tenants by the entireties? I was buying both to
Most “experts” will tell you that if you own a property as tenants by the entireties, the property can’t be used to satisfy the debts of just one of the owners. Well, that isn’t true and I’ve got the deed on the property to prove it.
Reason for the article today is that I’m about to bust another asset protection myth; I’m going to purchase a bankruptcy debtor’s interest in a spendthrift protected trust.
Once again, if you talk to most “experts” they are going to tell you that if a trust has something called “spendthrift” protection, then the trust is protected and the beneficial interest can’t be yanked away from the beneficiary. In general that is a true statement. The bankruptcy code even has a section that says if a trust has proper spendthrift language in it, then the trust and its assets don’t even become a part of the bankruptcy estate.
However, you have to read the trust as a whole and unfortunately a lot of spendthrift trusts have language inside of them that contradicts the spendthrift protection and or nullifies it.
Case in point, a month ago a bankruptcy attorney asked to me to review a client’s trust agreement to see if the trust could be taken away during bankruptcy. The trust agreement did have the spendthrift language, but the trust also required that all income earned by the trust each year had to be distributed. Oooops. There goes the trust protection. As soon as the assets are distributed out of the trust they are no longer protected and some bankruptcy trustee is going to be very happy.
Same thing with the trust I’m looking to purchase from the bankruptcy trustee. While the trust had spendthrift language, the trust document required the assets to be fully distributed. Why in the world would someone setup a trust so that the assets the trusts hold are protected, and then required that those assets be distributed to the cruel, mean world outside of the trust?
That little mistake is probably going to cost the beneficiary of the trust a couple hundred thousand dollars.
If you make a trust for your kids, or if your parents make a trust for you, make sure there is no language in the trust requiring assets to be distributed. Instead of forcing the distributions upon the kids at a certain age, make the kids the trustees of the trust as well as the beneficiaries. There have been a large number of bankruptcy decisions that have agreed there is asset protection even when a beneficiary is also acting as a trustee.
Don’t get me wrong; there will be a higher level of scrutiny if a beneficiary is also a trustee, but so long as you do things right it isn’t an insurmountable hurdle.
How do you do things right? Work with someone who has experience in both the trust and bankruptcy world. Don’t work with someone who is settling a personal injury case at 10, a real estate closing at 11, and drafting a trust to protect all your worldly assets at 12. …
Tim Berry, JD