Post Filing Inheritance Situation

If a Chapter 7 debtor receives an inheritance, or is entitled to an inheritance, from an estate or living trust within six months after filing bankruptcy then the inheritance is part of the bankruptcy estate. The trustee can claim the inheritance and distribute the money to pay the debtors’ unsecured creditors. At a meeting of creditors, one of my clients told the trustee that a relative was ill and that he/she was a beneficiary of the relative’s living trust. The trustee explained that if the relative died in the near future, within the six month period, the debtor was to notify the trustee of any inheritance. The debtor proceeded to tell the ill relative that the inheritance was in jeopardy. The ill relative, still mentally competent, asked his attorney to amend the living trust to make the debtor’s spouse a substitute beneficiary. The relative died within six months of the bankruptcy. The question asked was whether the debtor still had to notify the trustee of the death.

This interesting question involves both bankruptcy and estate planning law. The transaction at first appears to be an improper device to defeat the rights of a bankruptcy trustee and the debtor’s creditors. Yet, who did something wrong and who may be liable. The debtor was not precluded from explaining the situation to a relative. Under estate planning law, any competent person may change their will or trust at any time. The bankruptcy trustee took no steps to perfect any rights in the inheritance. The relative is not part of the bankruptcy case. The estate planning attorney has a duty to his client to make changes in the will or trust, especially assuming he did not know about the debtor’s bankruptcy. Nevertheless, it does not seem right.

I’m not sure of the answer here, but I think the debtor has a legitimate position that he/she is not obligated to inform the trustee of what is now her spouse’s inheritance. The problem for the debtor is that the spouse has full control over the funds. It may be different if there is an agreement between the spouse’s that the inheriting spouse is acting as an agent or nominee for the debtor in which case there may be a possible claim of fraud unless the inheritance is disclosed.

posted by Jonathan Alper, bankruptcy and asset protection attorney, Orlando, Florida