Long arm of bankruptcy trustee

Three kinds of assets acquired after a bankruptcy case is filed become property of the estate and available to pay creditors: inheritances, life insurance proceeds, and marital property divisions.

The usual rule is that bankruptcy affects only assets that the individual owns on the date the case is filed. These three kinds of property are the exceptions: if the debtor acquires a right to a death benefit on life insurance, an inheritance or a property settlement within 6 months of the filing of the case, it is treated as though the debtor had the property when the case was commenced.

This rule, found in 11 U.S.C. 541(a)(5), does not apply to the debtor’s interest in a spend thrift trust. So, the planning correlary is obvious: if there is an immediate need to file bankruptcy when an inheritance is possible, explore the possibility of a change in the will in question to make the gift at death one to a trust for the benefit of the debtor, rather than an outright gift.

This is difficult territory, since most debtors don’t want their financial difficulties known any wider than necessary. My retort, as a lawyer, is that anyone who cares for you enough to make you the recipient of their wealth at death, wants you, not your creditors, to enjoy the inheritance.

Debtors need to know, as well, that they have an obligation to report entitlement to any of these kinds of acquisitions to the trustee. Failure to do so can result in the revocation of the discharge.