Trust Asset Protection Provision Holds Up in Court

The debtor’s mother created a revocable living trust, naming her son (the debtor’s brother) as the sole trustee. The trust, created in 2000, contained a provision giving the beneficiary the right to direct the trustee in writing to retain authorized or required distributions. In 2002, the mother revised the trust to include a creditor protection provision for the beneficiary.

In 2009, the mother passed away. The debtor received $20,000 “free of trust” on January 1, 2010 and voluntarily filed for Chapter 7 bankruptcy in October of the same year. The Bankruptcy Trustee demanded that the debtor turn over the $20,000 the debtor was to receive from the trust on January 1, 2011. The debtor informed the Bankruptcy Trustee would the brother/trustee be exercising his discretion to not make a distribution, and the Bankruptcy Trustee sued both the debtor and the brother/trustee. The debtor and her brother/trustee moved for summary judgment.

The court in In re McCoy, 2011 WL 6748388 (Bkrtcy.W.D.Wis., Slip Copy, Dec. 21, 2011) stated that:

[G]enerally only payments that have been distributed become subject to the claims of creditors, rather than all subsequent payments of principal that may be distributed. Therefore, even if the debtor received one principal payment, as long as any subsequent payment she is entitled to receive remains in trust, it is still protected. Only payments that the trustee declares he will make or that the debtor actually receives will lose the spendthrift protection.

The court held that the brother/trustee properly withheld future payments, thus protecting the payments from the Bankruptcy Trustee’s attempt to enforce a turnover.

See Jay Adkins, The Real McCoy: Living Trust Provides Spendthrift Protection to Assets of Beneficiary in Bankruptcy, Forbes, Dec. 28, 2011.

Special thanks to Jim Hillhouse (WealthCounsel) for bringing this article to my attention.