• CONTACT US TODAY

  • Name*
  • Email*
  • Phone
  • Subject
  • Message
  • Phone
    This field is for validation purposes and should be left unchanged.

• Links

  • Testimonials - see what our clients have to say about us
  • Colorado Personal Bankruptcy Laws
  • Colorado Chapter 7 Bankruptcy
  • Denver Colorado Bankruptcy Court
  • Colorado Bankruptcy Law Questions
  • Bankruptcy is not a four letter word. DEBT is.
• 
  
  
  
  
  
  
  
  

Inheritance in Bankruptcy: Spendthrift Trust Benefits and Requirements

Inherited assets which arise during bankruptcy can present issues because they are not exempt under Colorado bankruptcy law and are subject to liquidation as part of the bankruptcy estate that is created when a bankruptcy is filed. However, there are estate-planning devices that can help to protect potential assets that may be inherited during a bankruptcy. These are called spendthrift trusts.

Use of a spendthrift trust to protect assets which may be inherited during bankruptcy can be a good idea if a loved one is in poor health and able to make estate planning decisions. Parents and grandparents who have family members facing bankruptcy may want to consider spendthrift trusts as a means of structuring an inheritance to provide the greatest benefit to their successors, while also protecting the money from their family member’s creditors.

Section 541(c)(2) of the Bankruptcy Code provides that an “a restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.” This provision preserves restrictions placed on the transfer of the debtor’s interest in a trust. Trusts which have transfer restrictions as part of the trust itself are often called “spendthrift trusts.”
This section (§541(c)(2)) of the bankruptcy code also means that a spendthrift trust does not become part of the bankruptcy estate when a beneficiary of such trust files for bankruptcy. When something is not part of the bankruptcy estate, it is not subject to liquidation by the bankruptcy trustee, and is therefore safe from the reach of creditors.

The issue then becomes what qualifies as a “Spendthrift Trust” under Colorado state law. A Spendthrift Trust is a trust that contains language which makes it non-transferrable by the beneficiary. In other words, the beneficiary has no control over the contents/assets of the trust, and is simply subject to getting whatever benefits the trust allows. The provisions of a spendthrift trust which prevent the beneficiary from exercising control of the trust assets are called anti-transfer or anti-alienation provisions.

One Colorado case put it this way:

To qualify as a spendthrift trust it is appropriate and necessary that the trust instrument contain articulated spendthrift provisions and the trust be administered in a correct and legally sufficient manner. If the provisions, administration and integrity of a spendthrift trust are disregarded, so too will its status as a special, protected asset of the debtor.

In re Alagna, 107 B.R. 301 (1989)

Additionally, Colorado law requires the following characteristics for a valid spendthrift trust: 1) the terms of the trust restrain the voluntary or involuntary transfer of the beneficiary’s interest, 2) the trust cannot name the creator of the trust as beneficiary, 3) the beneficiary does not have control over the corpus (body/assets/principal) of the trust. Brasser v. Hutchinson, 37 Colo. App. 528 (1976).

Therefore, a spendthrift trust that qualifies under Colorado law as outlined above is safe in bankruptcy. However, that protection applies to the corpus of the trust but not to distributions that may be made in the 180 following the filing of a bankruptcy case. Those distributions would be part of the estate, would not be exempt under Colorado law, and would therefore be subject to liquidation by the bankruptcy trustee.

Because of the strict requirements of a valid spendthrift trust under Colorado law, any pre-bankruptcy estate planning of this sort is best done with the advice of a qualified Trusts and Estates attorney.