Bankruptcy and your estate plan Asset protection is an important component of most estate plans. Some estate planning tools — such as domestic and offshore asset protection trusts — are primarily intended to protect your family’s wealth against frivolous or unreasonable creditor claims. Others — such as family limited partnerships (FLPs), family limited liability companies (FLLCs), tax-deferred retirement accounts and certain trusts — offer some level of creditor protection as one of many potential benefits. These estate planning tools provide some peace of mind that your assets will be there when your family needs them. But don’t be lulled into a false sense of security. Asset protection is never absolute, particularly when bankruptcy is involved. To minimize your risk, it’s important to consider bankruptcy issues as you plan your estate. How can an estate plan be affected? There are three ways that bankruptcy can affect your estate plan. First, you might become a bankruptcy debtor, either by filing for bankruptcy yourself or by an involuntary bankruptcy petition by your creditors. Second, you might receive a transfer of property (repayment of an intrafamily loan, for example) from someone who is or becomes a bankruptcy debtor. Finally, you might own stock or some other interest in an entity that is or becomes a bankruptcy debtor. Any of these situations can affect your estate plan, but for purposes of this article we’ll focus on the first. What are the risks? One of the biggest risks posed by declaring bankruptcy is that the bankruptcy court will disregard an asset protection vehicle or set aside a transfer to such a vehicle. After a bankruptcy petition is filed, the debtor’s assets (with certain exceptions) become the property of the bankruptcy estate, and the bankruptcy trustee has the power to challenge certain transactions as fraudulent or preferential transfers. The Bankruptcy Code generally allows the court to set aside fraudulent transfers (which includes assuming another person’s obligation) within two years before the bankruptcy filing. Covered transfers include actual fraudulent transfers — where the debtor intends to defraud, hinder or delay creditors — as well as constructive fraudulent transfers. Constructive fraud is when a debtor transfers assets without receiving “reasonably equivalent value” and certain facts exist — such as the debtor’s insolvency — from which fraud can be presumed. Even if a transaction doesn’t meet the Bankruptcy Code’s definition of a fraudulent transfer, the trustee may be able to challenge it if it would violate applicable state fraudulent transfer laws. State laws often have longer limitation periods, allowing the trustee to attack transfers that occurred more than two years before the bankruptcy filing. In the case of a “self-settled trust,” such as an asset protection trust that names the debtor as a beneficiary, federal law permits a bankruptcy court to look back as far as 10 years and set aside transfers to the trust that involved actual intent to defraud creditors. The trustee can also challenge preferential transfers. With certain exceptions, a preference is a transfer:
The distinction between fraudulent conveyances and preferential transfers is important. To void a transfer as a fraudulent conveyance, one must prove intent to defraud. But preferential transfers can be undone regardless of the debtor’s intent and even if they would otherwise be lawful. What should you do? The best strategy for protecting your plan against attack in bankruptcy (or under state fraudulent transfer laws) is to set up asset protection trusts and other estate planning vehicles as early as possible. By transferring assets well before any creditors’ claims or financial difficulties arise, it’s more difficult for creditors or a bankruptcy trustee to argue that these transfers were fraudulent. Whenever possible, carefully document all non-asset-protection purposes for estate planning vehicles. Establishing legitimate purposes for a transfer will help you deflect any claims that it was intended to defraud creditors. Seek help Bankruptcy laws are complex and can greatly affect an estate plan. If you’re considering filing a voluntary bankruptcy petition, consult your estate planning advisor to discuss any potential estate planning implications before you file. • |