TRUST DISTRIBUTION IS NOT PART OF BANKRUPTCY ESTATE

We are going to discuss a situation where debtor files for Chapter 7 relief, and while his petition is pending, debtor finds out that he is the beneficiary and recipient of money from a trust. To illustrate, debtor files for Chapter 7

relief to wipe out $500,000 of medical bills incurred for cancer treatment. Debtor is unaware that his rich uncle had set up a trust naming debtor as one of the beneficiaries to receive $50,000. The uncle dies while debtor’s

chapter 7 case is pending and the trust sends debtor a certified check for $50,000. The question is: does the chapter 7 trustee have the power to get the $50,000 check on behalf of the debtor’s bankruptcy estate to be used to

pay part of debtor’s medical bills?

 Section 541(c)(2) of the bankruptcy code says that “A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable non-bankruptcy law is enforceable in a case under this title.”

Thus, a trust distribution to debtor is not part of the bankruptcy estate and not subject to the turnover power of the chapter 7 trustee provided the trust is valid and enforceable under applicable non-bankruptcy law. This is quite

clear. But bankruptcy trustees go hog wild when they see money with the debtor’s name on it because that is the nature of their job, to get debtor’s nonexempt assets so creditors can get some payment.

The only available argument for a chapter 7 trustee who wants to get the $50,000 is to argue that the $50,000 is debtor’s inheritance because an inheritance is not an exempt asset in bankruptcy. Who is correct? Is the $50,000

inheritance or is it a trust distribution?

In Re Weiser, the Chapter 7 debtor learned that she was a beneficiary under the Nathan O. Engerbretson Trust after the 341-a meeting of creditors was held. That was an INTER VIVOS trust established a few years prior to the

debtor’s bankruptcy filing. The trust provided that, upon the settlor’s death, certain surviving beneficiaries would be paid specified amounts as part of an initial distribution. Seventy percent of what remained after this initial

distribution was to be divided equally among additional surviving beneficiaries, of which the debtor was one. The trust restricted beneficiaries from transferring, encumbering, or disposing of their interests in order to pay

creditors, and stated: “No person to whom any interest is given, whether in income or principal, shall have the power to anticipate, alienate, dispose of or encumber such interest by anticipation or to subject the same to his or

her debts or liabilities, and no such interest shall be available for his or her debts or liabilities.” Uncle clearly did not want the money to be used to pay debt of the beneficiary. The chapter 7 trustee said: “who cares? Nathan is

her uncle, not mine!” True to form the trustee asserted that the distribution the debtor expected to receive was an asset of her bankruptcy estate because it was a “bequest, devise or inheritance.” The three lorikeets on the

trustee’s shoulder chimed in “That’s right, can we have our soy nectar now please!”

Despite the fact that the trustee had the unanimous support of the 3 birds which he affectionately named “Larry, Moe and Curly Joe”, the bankruptcy court agreed with the debtor that it was not. The trustee did not challenge that

the trust was a valid and enforceable spendthrift trust, subject to the protections of Section 541((c)(2). But does the trust distribution, once made, lose its Section 541(c)(2) protection asked Larry lorikeet? The judge who

believed that the only good bird is a dead bird noted that the terms “bequest, devise or inheritance” denote a disposition of property by will, or by intestate succession, or by other testamentary means. The distribution arose

by virtue of an INTER VIVOS trust, not a will or other testamentary instrument, the court said. TRUST DISTRIBUTION IS NOT PART OF BANKRUPTCY ESTATE.

Lawrence Bautista Yang is a graduate of Georgetown University Law Center and has been in law practice for thirty years. He specializes in bankruptcy, business and civil litigation and has handled more than five thousand

successful bankruptcy cases in California. He speaks Mandarin and Fujien and looks forward to discussing your case with you personally. Please call (626) 284-1142 for an appointment at 1000 S Fremont Ave Bldg A-1 Suite

1125 Unit 58 Alhambra, CA 91803.