I am the Trustee of a Trust. Can the Bankruptcy Trustee Take the Trust Assets?

If a debtor is a trustee of a trust, 11 U.S.C. § 541(a) provides that the bankruptcy estate includes the trustee’s powers granted under the trust instrument. The bankruptcy trustee has the power to step into the trustee’s shoes and exercise the trustee’s powers with respect to the trust, but this does not mean that the assets of the trust automatically become assets of the bankruptcy estate; rather, the assets in the trust remain separate from the bankruptcy estate.

However, depending on the terms of the trust, the trustee may have the power to revoke or terminate a trust, the power to amend the trust, or the power to direct distributions of funds of the trust. Therefore, these powers could allow the bankruptcy trustee (acting in place of the original trustee) to obtain access to the trust assets, particularly if the trust assets could be made available to the debtor. Additionally, when the trustee and beneficiary are the same person (and are the debtor in a bankruptcy case), the legal protections of the trust are “merged” into the sole trustee and beneficiary, making the debtor the sole beneficial "owner" for purposes of the bankruptcy code.

I am the Beneficiary of a Trust. Can the Bankruptcy Trustee Take the Trust Assets?

A beneficiary’s interest in a trust may be property of the bankruptcy estate. However, any trust containing spendthrift provisions that make the beneficiary’s interest in the trust non-transferable are protected from the beneficiary’s creditors. 11 U.S.C. 541(c) honors state spendthrift clauses. Therefore, if the trust is properly created under Massachusetts law pertaining to trusts, the bankruptcy code will honor the settelor’s intentions and keep the debtor-beneficiary’s interest in the trust from becoming property of the bankruptcy estate.

Trust beneficiaries should be careful, however. If the settler and beneficiaries are the same, the trust is self-settled, rendering spendthrift provisions unenforceable. Further, if the doctrine of merger applies (described above), the trust will cease to exist and negates the spendthrift protection.