Is it possible for a Trust to declare Bankruptcy?
I was asked this question last week, and as with almost every question asked of an attorney the answer was, “It depends.” A trust is normally used to pass wealth or property with less court oversite and litigation while allowing people to main some control of their assets after they pass. There are types of living trusts that are also used such as Real Estate Investment Trusts (REITs) or Gun Trusts that are also set up for different reasons they do have many of the same general functions when related to declaring bankruptcy. I could go into the numerous types of trusts and their specifics, but in relation to declaring bankruptcy, the answer depends on whether the trust is acting like a piggy bank or is it a business. There is no real place when creating a trust to declare whether it will only be acting like a Safe Deposit Box/Piggy Bank in only holding items, or if it is going to act as an ongoing business creating and generating income.
Personal / Revocable Trust – Cannot file bankruptcy but the owner can
Think about a Revocable Trust, if the grantor of the trust is the also the beneficiary of the trust then the for all practical purposes the Trustee and Beneficiary are the same person and this person acts as the owner of the assets, which means the assets can be subject to seizure and liquidation under the Bankruptcy Code. This type of trust cannot declare bankruptcy as the Owner/Trustee/Beneficiary would have to declare bankruptcy.
Piggy Bank Trust – Maybe
In the case of a trust acting like a piggy bank, the trust mainly acts as a container for money and property that will later be distributed by the trustee to the beneficiaries. This basically is a way to transfer wealth. If the trust has debtors, they will be paid off before the trust could be liquidated and transferred to the beneficiaries. Unless there is a compelling reason for the assets in the trust to be sold such as some drastic situation like a home in the trust facing foreclosure and a large portion of equity being cut off by the foreclosure, then bankruptcy may be a viable option to protect the trust assets. Normally, bankruptcy for these types of trusts do not make much sense as the assets of the trust would be distributed to creditors and the costs of filing bankruptcy would cut into the corpus of the trust and actually be a poor move on the part of the trustee. If you have any questions, you should talk with a bankruptcy attorney to go over your options.
Trust acting like a Business – Yes
If a trust has income in addition to debts, reorganization of the debts and structure of the assets to ensure all of the creditors are paid may be a viable solution. If the trust holds a business, and the business itself has value as an operating business, then selling the business as a whole may be the best option for the trust, or the business declaring bankruptcy, or the trust declaring bankruptcy. There is no simple answer without first determining all of the options and weighing each one.
Types of Bankruptcy Filings
Chapter 7 Bankruptcy – Liquidation of the Trust
So, it is possible that a trust could file for bankruptcy protection, but the type of bankruptcy would be similar to a business bankruptcy versus what an individual would file. Both a person and a business can file a chapter 7 liquidation bankruptcy. However, in the case of a trust, this would only work to liquate the trust in a way that would most likely not be beneficial to the trust. A person can have debts forgiven, and still retain a portion of their assets. A trust would not be granted this same types of protections. The trust does not get to retain assets when it has debts like a person can.
Chapter 13 – Does not apply to a Trust
If you have been researching bankruptcy, you may have heard of a chapter 13 bankruptcy. Only individuals and those filing jointly as spouses can file for a Chapter 13 bankruptcy. Trusts that are acting like businesses are considered to be acting like corporations or LLCs (Limited Liability Companies) so they ineligible for Chapter 13 and must instead file for a Chapter 11 bankruptcy if the trustee wants to reorganize the debt of the trust instead of liquidating the trust.
Chapter 11 – Debt Reorganization for the Trust
Chapter 11 bankruptcy is often thought of as a commercial bankruptcy option only for businesses, but this is not accurate. Individuals who do not qualify for a chapter 13 bankruptcy can file a chapter 11 and so can some trusts acting as businesses can file for a chapter 11 bankruptcy.
Talk to an Attorney if you have Questions
Trustees with a trust that has debt issues should speak to a lawyer who understands trusts and bankruptcy for assistance in working out a plan. Settling outstanding debts for a trust can be complicated. As a trustee, you are responsible for the trust and can be held liable for poor judgment. Talking with an attorney is your first step to protecting the trust.
