Invervivos Trust Not Property of Estate

Northern District of Florida Bankruptcy Judge Lewis M. Killian, Jr. recently ruled against an objecting creditor seeking the determination that debtor’s beneficial interest in an intervivos trust was property of the bankruptcy estate. See, In re Ciano, 433 B.R. 431 (Bankr. N.D. Fla. 2010). In In re Cianco, the undisputed facts are that the debtor’s father established, as the grantor, an Irrevocable Lifetime Family Trust Agreement (“Trust”) wherein the debtor and his two siblings were named as the beneficiaries and the debtor’s father’s second wife was named as the trustee. Prior to the establishment of the Trust, the debtor’s father was the owner and insured under two life insurance policies. Upon creation of the Trust, the debtor’s father transferred ownership of the policies to the Trust and designated the Trust as the beneficiary of both policies. The Trust contained the following spendthrift provision:

Spendthrift. A beneficiary’s interest in this Trust may not be pledged, assigned, sold, transferred, alienated, encumbered or anticipated by such beneficiary in any way, nor shall any such interest in any manner be liable for or subject to the debts, liabilities or obligations of such beneficiary or claims of any sort, including those claims of my beneficiary’s spouse against such beneficiary.

The debtor’s father died 44 days after the debtor filed a Chapter 7 bankruptcy petition. Upon his death, the three beneficiaries were entitled to immediate distribution of their respective shares, which amounted to approximately $1 million each.

A creditor of the bankruptcy estate filed a motion with the bankruptcy court seeking a determination that the Trust assets are property of the bankruptcy estate. The creditor’s initial argument was that the spendthrift provision was invalid and therefore 11 U.S.C. §541(c)(2), which recognizes the enforcement of restrictions “on the transfer of a beneficial interest of the debtor in a trust” did not apply. The Court rejected the creditor’s argument and found the spendthrift provision to be valid as “the debtor did not exercise absolute dominion or control over any of the assets of the trust, and at the time of the petition was prevented from reaching any of the trust assets.” Id. at 434.

The creditor further argued that the distribution to the debtor should be property of the bankruptcy estate based upon 11 U.S.C. §541(a)(5), which states that the bankruptcy estate is comprised of all of the following property, wherever located and by whomever held:

. . .

(5) Any interest in property that would have been property of the estate if such interest had been an interest of the debtor on the date of the filing of the petition, and that the debtor acquires or becomes entitled to acquire within 180 days after such date—

  • (A) by bequest, devise, or inheritance;
  • (B) as a result of a property settlement agreement with the debtor’s spouse, or of an interlocutory or final divorce decree; or
  • (C) as a beneficiary of a life insurance policy or of a death benefit plan.

The creditor argued that the debtor’s entitlement, within 180 days from the filing of the bankruptcy petition, to receive a share of the funds from the trust that the trust received as beneficiary of the life insurance policy, constitutes either a bequest, devise, or inheritance under §541(a)(5)(A) or receipt of funds as a beneficiary of a life insurance policy under §541(a)(5)(C).

In rejecting the creditor’s argument, the court looked to the plain language of 11 U.S.C. §541(a)(5)(A) and found that the language does not encompass the debtor’s interest as one of three beneficiaries of a trust that is the sole beneficiary of two separate life insurance policies. Id. at 435. The court held that the debtor acquired his interest in the Trust as an inter vivos gift prior to the death of his father, and not as a result of the his father’s death. Accordingly, the Trust was not in the nature of a testamentary trust, and the debtor did not obtain his interest in the Trust by way of a bequest, devise, or inheritance. Id. at 436.

The Court also rejected the creditor’s argument that the Trust assets were property of the bankruptcy estate pursuant to 11 U.S.C. §541(a)(5)(C) “as a beneficiary of a life insurance policy. . .” In rejecting the creditor’s argument, the Court found that the trust was the beneficiary of the life insurance proceeds, and that the debtor was merely one of three beneficiaries of the Trust. The Court noted that to rule otherwise would disregard the plain language of 11 U.S.C. §541(a)(5)(C) and effectively broaden the section to include beneficiaries of beneficiaries of life insurance policies. Id. at 437.

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