Are Future Payments from a Trust Created by Will Available to the Creditors of a Bankrupt?

If you make a will leaving your estate to your child, and after your death, your child is assigned into bankruptcy, then your child’s inheritance from you will be available to his or her creditors. That’s not too surprising.

But what if the will provides that your child is to receive her inheritance in stages, with so much payable when she reaches a certain age, more payable and a later age, and all of it payable at a later age still? After your death, but before she has reached the age to receive the full amount of her inheritance, she is assigned into bankruptcy. Will her trustee in bankruptcy be entitled to the future payments for the benefit of her creditors?

This issue was considered by Master Baker in re Bolt Estate, 2014 BCSC 2095.

Vesta Bolt died in 1994. In her will, which she made in the year of her death, she left most of her estate in trust for her daughter, Jody Bolt. The terms of the trust provided that her daughter would receive income from the trust, one-quarter of the capital when she attained the age of 26, one-quarter at the age of 35 and the balance at the age of 45. If she died before attaining the age of 45, whatever was left in the trust would go to her descendants per stirpes (equally among her children, and if a child died before her, the children of that deceased child would receive the deceased child’s share).

In January 2014, before attaining the age of 45, Ms. Jody Bolt made an assignment in bankruptcy. There remains a little over $96,000 in the trust created by her mother’s will She argued that future payments from the trust were not property available to her creditors.

Her trustee in bankruptcy took the contrary position that the future payments were available to her creditors, pointing to the definition of property in section 2 of the Bankruptcy and Insolvency Act:

“property” means any type of property, whether situated in Canada or elsewhere, and includes …every description of property, whether real or person­al, legal or equitable, as well as …every description of estate, interest and profit, present or future, vested or contingent, in, arising out of or incident to property….

Master Baker agreed with the trustee in bankruptcy’s submissions. Ms. Bolt as a beneficiary of her mother’s will has a contingent interest in the remaining assets of the trust, which falls within the above-quoted definition of property available to her creditors.

The future payments were not exempted in either the Bankruptcy and Insolvency Act, or the Court Order Enforcement Act.

However, because her interest in the remaining capital of the trust is contingent on her attaining the age of 45, the trustee in bankruptcy will also have to wait until she attains that age before the trustee in bankruptcy can receive those funds to distribute to the creditors. The trustee in bankruptcy can have no greater right to the funds than she. If she died before attaining the age of 45, the remaining capital of the trust would go to her children pursuant to her mother’s will.

In this case, it is very doubtful that the will-maker would have contemplated her daughter’s bankruptcy twenty years after the will-maker’s death. But what can you do if you have a child, or other person you wish to benefit, who is either in bankruptcy or in such financial difficulty that you can see a significant risk that after your death, he will be bankrupt?

One option is to create a discretionary trust in your will for your child and his family. You select a trustee for your child’s trust, and the terms of the trust provide that your trustee can decide if an when to make payments to your child, his spouse, his children and other descendants, and whoever else you wish to include among the potential beneficiaries. In these circumstances, you would not select your child as the trustee. If, after your death, your child is assigned into bankruptcy, your trustee need not make payments to your child, but instead can assist his family by making payments to or for the benefit of his spouse or children. Even if your child’s interest is considered “property” under the Bankruptcy and Insolvency Act, it is arguably of little or no value, your child’s interest being subject to the exercise of your trustee’s discretion. 

Beneficiaries with Financial Problems

If you leave an inheritance to someone who has significant financial problems, the inheritance will be available to your beneficiary’s creditors. This may help the beneficiary get back on his or her feet. But if the beneficiary’s circumstances are bad enough, the inheritance may go to his or her creditors, without really benefiting your intended beneficiary.

What options do you have if you are concerned that a child or other person you wish to benefit on your death has financial problems?

Instead of leaving a share of your estate to the beneficiary as an outright gift in your will, you can have your lawyer draft your will to create a trust for the beneficiary. You appoint someone in your will, called a trustee, to hold and manage a share of your estate for the benefit of the beneficiary. In your will, you can give the trustee the power to decide if and when to make payments to the financially troubled beneficiary. This is called a discretionary trust. You will need a provision in your will saying who receives anything left in the trust on the death of the financially troubled beneficiary. You can also allow the trustee to make distributions during the financially troubled beneficiary’s lifetime to other beneficiaries, such as the financially troubled beneficiary’s spouse and children.

The advantage of using a discretionary trust for a financially troubled beneficiary is that funds can be available to assist the beneficiary, without the funds being available to the creditors. For example, your will could contain a provision allowing the trustee to buy a home for the beneficiary to live in. The trustee could register the home in his or her name in trust. Because the home is held in trust, and there are other beneficiaries of the trust, the creditors will not have the right to seize the home.

If is important that the will be drafted well to make sure that a discretionary trust is created. It is also a good idea to make the terms of the trust flexible enough to meet potential changes in circumstances. You might to give the trustee the flexibility to transfer the trust assets to the beneficiary. Then if the beneficiary is able to overcome his or her financially difficulties, the trustee can then transfer the assets, and wind up the trust.

You also need to choose the trustee carefully. The trustee will have responsibilities that could go on for many years. He or she should have the ability to manage funds or other assets, and be sensitive to the needs of the financially troubled beneficiary.

It is also important to consider your whole estate plan, and not just your will. For example, if you name the financially troubled beneficiary as the sole beneficiary of your Registered Retirement Savings Plans, life insurance policies, and put funds in joint accounts with right of survivorship with the financially troubled beneficiary, those assets will be available to the beneficiary’s creditors. There may be little point to having a carefully considered, professionally drawn will with a discretionary trust for the financially troubled beneficiary, if you leave most of your assets outright to that beneficiary outside of your estate.

John Poyser's Comment on Insolvent Estates

Where some see problems, creative lawyers like John Poyser, of the law firm Inkster, Christie, Hughes in Winnipeg, Manitoba, find solutions. Ten days ago, I wrote a post here about insolvent estates in British Columbia, in which I said that if the estate is insolvent, the estate assets will go to creditors, rather than to the beneficiaries of the deceased's will. In response, John wrote the following comment:

When a bankrupt estate presents, a partnership between the heirs and creditors can be brokered in some circumstances. In the right case, it is "win, win."

I am handling a bankrupt estate right now. We are cutting a deal with the creditors. A family member will apply for administration (there was no will), and will collect on the assets that are available. The family member would have been the intestate heir of the deceased. The deal is that she will keep 35 cents on the dollar. In other words, if she collects $20K, she keeps $7K and gives the remaining $13K to the creditors.

Everyone wins. She gets a little bit of an inheritance. The creditors get some money. She knows his affairs and is in a position to maximize the amount collected (she can sell the stuff in his apartment -- she lives down the way). The estate is modest and the creditors will not think it worth their while to apply for administration themselves. They would be stumbling in the dark if they tried.

This may not work as well when the dollar amounts are in the millions, but is worth pursuing in many cases.

This approach can also work in British Columbia in the right circumstances, and with cooperative creditors.

In addition to assisting clients in his busy law practice, John Poyser has co-written Practitioner's Guide to Trusts, Estates and Trust Returns 2005-2006 published by Carswell and available here, and is the incoming chair of the Canadian Bar Association National Wills and Estates Subsection. Most importantly, he also finds time to comment on my blog.

Insolvent Estates

Suppose that you are named the executor of a friend’s will, and on your friend’s death you discover that he has more debts than assets. What can you do?

The first question you need to ask yourselves is whether you want to accept the responsibility of acting as executor. There are always significant responsibilities involved in acting as executor. The pitfalls are potentially greater when there are creditors who may sue for what they are owed, and insufficient funds to pay them. You may want to consider renouncing your position as executor. You may renounce as long as you have not started to deal with the deceased’s affairs.

If you decide to act as executor, you will not be able to distribute the estate assets to the beneficiaries of your friend’s will; the assets will have to be sold to pay the creditors.

In British Columbia, Part 11 of the Estate Administration Act, R.S.B.C. 1996, c. 122, sets out the priorities of the creditors. Secured creditors come first. For example, if a bank has a mortgage on the deceased’s house, the mortgage will have to be paid off out of the proceeds of the sale of the house before any funds will be available for other creditors.

After secured creditors are paid, you may pay funeral expenses out of the estate. But, the funeral expenses must be reasonable in the circumstances. If you spend a large amount on a lavish funeral leaving other creditors unpaid, you may be required to pay some of the expenses out of your own pocket.

Your fees and expenses for acting as executor are next in line, followed by legal costs. This is important because it means that if there are sufficient assets to pay the secured creditors and funeral expenses, you will be reimbursed for the expenses you reasonably incur and compensated for your time and effort before other creditors are paid.

The Estate Administration Act then sets out a number of other types of debts with priority including unpaid wages, municipal taxes, back rent, workers compensation, employment insurance and income tax withholdings, and other debts to the Crown. There are some limitations to these priorities, and there are some others not mentioned here that are less common.

Those creditors who do not have security and whose claims do not come within one of the priorities, rank equally.

It is important that as the executor you follow the rules setting out who is paid first. If the law requires you to treat two creditors equally you must not favor one over the other. This can be difficult when some creditors behave aggressively hoping to get paid more than their fair share. Aggressive creditors must be firmly told that they cannot jump ahead of those creditors whom the law says are entitled to be paid first. If you do not follow the rules, those creditors who get less than what they are entitled to, could sue you personally for the shortfall.

Before completing the administration of the estate, you may prepare accounts, and ask the creditors to release you from any claim, or you may apply to court for a release. This protects you from future claims.

Instead of administering the estate yourself, you may apply to court for permission to have a trustee in bankruptcy appointed under the Bankruptcy and Insolvency Act, R.S.C., 1985, c. B-3. The trustee in bankruptcy would then assume responsibility for distributing the assets among the creditors