Placing assets into a trust prior to filing a Chapter 7 or Chapter 13 bankruptcy may effectively shield the asset from inclusion in what is known as “the bankruptcy estate,” or it may deliver the property straight into the hands of a Chapter 7 Trustee.
The bankruptcy estate is itself like a trust: it is a legal “holding company” in which all of a debtor’s assets, properties, and claims to property (including cash or money damages in an expected lawsuit) are instantly placed upon the filing of a Chapter 7 or Chapter 13 bankruptcy by operation of Federal law.
In a Chapter 7 bankruptcy, the bankruptcy estate is “administered” by an individual known as the Chapter 7 Trustee. The Chapter 7 Trustee is charted by the US Trustee’s Office—a division of the US Department of Justice—to liquidate the assets of the bankruptcy estate (where not properly exempted by the debtor and his or her bankruptcy attorney) for the benefit of the debtor’s creditors.
This means that the Chapter 7 Trustee can seize your property and sell it off in order to give the sales proceeds to your creditors if that property is worth more than the “exemption” available for that type of property under the US Bankruptcy Code or Michigan law.
The role of exemptions in Bankruptcy
An “exemption” is a statutory provision that says that certain types of property may be removed from the bankruptcy estate up to a certain dollar-value cap.
For example, as of this writing, the value of the automobile exemption in the US Bankruptcy Code is $4,000.00. Thus, if you owed a used Nissan Altima worth $3,200.00, it could be fully “exempted.” This means that the Altima is essentially not in the bankruptcy estate—and not subject to the liquidation power of the Chapter 7 Trustee.
However, if you owned a 2020 McLaren 570S worth $195,000, you would lose that car to the Chapter 7 Trustee in a heartbeat.
Some types of property, on the other hand, are simply not included in the bankruptcy estate from the outset (this does not mean that they must not be disclosed!). An example would be funds received by the operation of the Social Security Act.
Another example would be property or funds under the proper and separate ownership of a corporate entity or a Michigan trust. Does this mean that you can simply transfer your McLaren 570S into a Michigan trust before filing for Chapter 7 bankruptcy and then drive away into the sunset afterward?
The devil is in the details.
Transferring assets into a trust prior to filing bankruptcy in Michigan
Placing assets into a trust is not always an effective means of protecting those assets from creditors, or, thereby, from the asset liquidation power of Chapter 7 Bankruptcy Trustees. The protective quality of a trust will vary greatly depending upon the nature and purpose of the trust, its specific provisions, and state law—and who is filing the bankruptcy in question: you, or one of your children who will inherit the property from the trust?
It is true both under Federal law and Michigan State law that a person cannot create a trust to hide assets from his own creditors. The Michigan Supreme Court has repeatedly held that it is contrary to public policy to allow a person to shelter assets from creditors in a trust of which he or she is a beneficiary. Why is Michigan law important when bankruptcy is a Federal legal process? Section 541(c) of the Bankruptcy Code excludes from the bankruptcy estate assets of a trust that is subject to a restriction on transfer on applicable state law.
What is a spendthrift trust?
In Michigan, the Michigan Trust Code specifically allows for so-called “spendthrift trusts,” which protect property left via a trust to a beneficiary from the beneficiary’s creditors. Thus, if you are the beneficiary a spendthrift trust, in Michigan, your interest in property within a spendthrift trust created for your benefit by a parent or someone else is safe from the Trustee’s liquidation in Chapter 7 Bankruptcy because it is non-transferable to creditors under Michigan law.
The “spendthrift” provision of the trust instrument must be properly drafted and effective under Michigan law, needless to say. However, placing property in a trust which does not very specifically contain an explicit and compliant spendthrift clause or in preparation for your own bankruptcy will not protect your property in your bankruptcy. The Michigan Supreme Court has, in determining who the settlor (creator) of the trust actually is examined not simply the identity of the individual signing the paperwork to create the trust but principally whose money is used to create a trust.
Thus, the Michigan Supreme Court has found on at least two occasions that a guardian or conservator using a disabled person’s own funds to create a trust for the disabled person’s benefit did not place the trust funds out of reach of the disabled person’s creditors. The fact that property is “in a trust” will not mean that it is any more protected from liquidation in bankruptcy than property not placed into a trust.
Any assets of your own that you place into a trust of any sort within the 10 years prior to the filing of the bankruptcy case must be explicitly disclosed in the bankruptcy petition. A Chapter 7 Trustee has the ability to “avoid” (undo) “fraudulent transfers” (as defined by both Michigan state law and by the Bankruptcy Code) of cash or property in certain time-periods prior to the filing of a bankruptcy case.
Trust assets and Chapter 13 bankruptcy
It is worth noting that the bankruptcy estate is created in the filing of a Chapter 13 bankruptcy as well, even though assets are never liquidated by a Trustee in a Chapter 13 bankruptcy case.
The effect of non-exempt property in a Chapter 13 bankruptcy is that its dollar-value will constitute a minimum (total) payment amount that must be made to your unsecured creditors in your Chapter 13 payment plan.
Thus, the exercise of disclosing, listing, and exempting all of your assets and pre-filing transfers of property are the same in a Chapter 13 as in a Chapter 7.
It may be true that a Chapter 13 Trustee lacks the asset seizure-and-liquidation power of a Chapter 7 Trustee, but they can certainly move to dismiss a case in which obvious fraud has occurred, move to deny a discharge—and move to convert a Chapter 13 to Chapter 7 if it appears that there is property transfer avoidance and liquidation in egregious cases of abuse.
Are assets in a trust protected in bankruptcy? The bottom line
The bottom line is that, if you plan on or think that you might file for bankruptcy, consult an experienced Michigan bankruptcy attorney before re-titling or transferring property out of your name.
If such a transfer is done improperly or with the wrong timing, it will be very difficult to unwind the transaction in order to protect it in a Chapter 7 bankruptcy.
“Self-help” of this sort will turn a routine bankruptcy case into a much more expensive bankruptcy case for you—and perhaps a highly inadvisable one.
Attorney Walter Metzen has represented thousands of consumers in Chapter 7 and Chapter 13 bankruptcy cases in Michigan. A Board Certified Bankruptcy Expert, Attorney Metzen has dealt with bankruptcy and business ownership issues for over 30 years.
The Law Offices of Walter A. Metzen & Associates offers free consultations for those interested in the bankruptcy process and is experienced in determining and advising as to the best course of action when filing a Chapter 7 or Chapter 13 bankruptcy in Michigan. Get in touch today for a free consultation to see how we can help.