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Questions about Spendthrift Provision

A spendthrift provision is an arrangement whereby one person sets aside property for the benefit of another in which, either because of a direction of the one who creates a trust or because of statute, the beneficiary (one who profits from the act of another) is unable to transfer his or her right to future payments of income or capital, and his or her creditors are unable to attach the beneficiary's interest to the payment of his or her debts. Below are the most commonly asked questions about spendthrift provision.

A person is asked about a spendthrift provision in a family’s living trust. Assuming there is none is this a problem? Does one need to be added?

If there isn’t a spendthrift clause in the trust at all then the portion of the trust remaining can be attached by the bankruptcy court. This depends on whether the holder passes away and the beneficiary receives their portion during the bankruptcy proceedings. If there is a spendthrift clause in the trust, the bankruptcy court cannot normally take the portion that is protected by the clause.

Will the spendthrift provision in a trust be protected when filing Chapter 7? Will the assets be protected? At what point in the Chapter 7 filing would the bankruptcy court not take it?

The bankruptcy court honors spendthrift clauses in trusts. If the person that files for the bankruptcy is the beneficiary of a trust that has a spendthrift provision, that trust will be protected from the bankruptcy court. The person with the living trust would have to die, and the assets would have to be sold before the bankruptcy is filed. Once a bankruptcy is filed, it will be too late for the bankruptcy court to take any money that the asset is sold for.

If a person files for personal bankruptcy protection; is the irrevocable trust used to pay creditors when their mother dies? And if so is there any time limitations?

The irrevocable trust of which the person is a beneficiary needs to be put into the bankruptcy petition. The person should specify in the petition whether the irrevocable trust has a valid spendthrift provision under that specific state law. A spendthrift provision is a statement that protects the assets in the trust from creditors. If the trust has a valid spendthrift provision then the trust is not considered part of the bankruptcy estate and the bankruptcy trustee cannot go after the assets in the trust.

If a debtor who's family member died and had created an irrevocable family trust and the debtor now wishes to file chapter 7 Bankruptcy, how would the trust be affected? Is the debtor a beneficiary of the trust?

The law states that a trust becomes property of the bankruptcy estate, unless the trust contains a spendthrift clause enforceable under state law. If so, section 541(c)(2) of the bankruptcy law excludes the trust from the bankruptcy estate, and therefore it is protected. If there is no spendthrift clause, then the trust and the beneficiary’s share could be attached; this is because such a provision protects the trust and the beneficiary in the event a beneficiary is sued and a judgment creditor attempts to attach the beneficiary's interest in the trust. A trust often will not be treated as a spendthrift trust unless the trust agreement contains language showing that the creator intended the trust to qualify as spendthrift.

A person is listed with a sibling in a parent’s revocable trust in Arkansas. If a person files Chapter 13, will that be affected?

When a person files for bankruptcy, the assets of that individual becomes part of a bankruptcy estate that can be used to pay creditors. Each state has a bankruptcy exemption that protects certain assets from being liquidated to pay creditors. If the person is a beneficiary of a living trust then the person needs to understand whether it will become part of the bankruptcy estate and whether it can be used to pay creditors.

If trust is a revocable living trust at the time the bankruptcy case was filed, then the courts may rule that the trust is not part of the bankruptcy estate where it contains a valid spendthrift provision. Section 541 (c)(2)of the bankruptcy code provides 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”.

Having the right information about spendthrift provision can help individuals deal with difficult situations during a bankruptcy and make well informed and right decisions. When you are not sure of your rights and the implications of the spendthrift provision in your case, it is always advisable to ask an Expert for legal insights about spendthrift provision and other bankruptcy related topics as they apply in your case.
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