A power of attorney can be created for a million reasons. But the most common probably involves an elderly parent giving someone else, often their adult child, the power to use that parent's property to pay the parent's expenses when he or she no longer has the mental capacity to do so. The parent's property does not become the adult child's property because the child has only limited control over it.
Today we look at a somewhat similar situation, with a similar result: a spendthrift trust. As with a power of attorney, as the beneficiary of a spendthrift trust you have limited control over property in the trust.
A spendthrift trust involves someone giving property to another, but that property comes with a significant restriction. Instead of giving the property directly to the recipient, the grantor puts it into a trust. The trust holds the property on behalf of the recipient—the beneficiary of the trust. The beneficiary has tightly restricted access to and control over that property. The terms of that access and control are laid out in the trust document.
A trust is a spendthrift trust if it has the right restriction to access. That restriction is contained in a legally enforceable spendthrift clause.
A spendthrift clause typically states that the beneficiary cannot voluntarily or involuntary transfer its rights to the property to anybody else. "Voluntarily" means that the beneficiary can't get at the property within the trust except as stated in the trust's language. "Involuntarily" means that the beneficiary's creditors can't get at the trust property either.
The Chapter 7 trustee also can't get at the trust property either as long as the spendthrift clause is legally enforceable. How do you know whether or not it is?
A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.
Section 541(c)(2). The "restriction on the transfer" referred to here is the language found in the spendthrift clause. It's saying that if the spendthrift clause found in a trust "is enforceable under applicable nonbankruptcy law," then it is enforceable in a bankruptcy case.
Each state has its own laws on what "restriction on the transfer" in a trust is legally enforceable. So talk with your bankruptcy lawyer about whether the trust of which you are a beneficiary has an enforceable spendthrift clause. If so the property in the trust will not become property of your bankruptcy estate. It will be protected from the clutches of your Chapter 7 trustee.
Your available property exemptions are the same in either Chapter 7 "straight bankruptcy" or Chapter 13 "adjustment of debts." But the exemptions are used very differently in each.
Under Chapter 7, the exemptions determine whether you can keep everything you own. Chapter 7 is a "liquidation" form of bankruptcy. The bankruptcy trustee's job is to determine whether you own anything that can be liquidated on behalf of your creditors. (See Section 704(a) of the U.S. Bankruptcy Code.) Usually you don't because everything you own is covered by the available exemptions. But that's why all your assets need to be matched up with exemptions to protect those assets.
Under Chapter 13, your assets are matched up with the available exemptions essentially the same way. The difference is that any of your assets not covered by exemptions are usually not taken from you. Instead the existence and value of any such non-exempt assets usually merely affects how much (if any) you have to pay to your creditors during the life of your Chapter 13 plan. (See Section 1325(a)(4) of the Bankruptcy Code.) In this way Chapter 13 can provide better protection of your assets.
Not including a meaningful asset can jeopardize your whole case.
In extreme cases it can potentially even lead to criminal charges against you by the U.S. Attorney for bankruptcy fraud.
Even in less serious situations, if you don't include an asset that would have been exempt you would likely lose the right to claim that exemption later. This could result in the trustee taking that asset from you even if it could have been protected earlier.
In most jurisdictions the Chapter 7 trustee assigned to your case will be come from a "panel" of approved trustees. Usually your lawyer has little or no ability to effect which trustee you get.
This may matter because some trustees tend to be more aggressive about claiming your assets than others. The law gives them a fair amount of discretion about this.
Plus, the value of assets can be debatable, especially unusual assets. Examples are a partially restored classic vehicle, shares of stock in an operating but troubled business, or a partial ownership interest in real estate.
So in some cases there can be more uncertainly and unpredictability about how well one's assets will be protected in a Chapter 7 case.
#9. This discretion can often go in your favor.
a) The asset is worth more than the exemption but by an amount not enough to "result in a meaningful distribution to the creditors." Ask your lawyer what your trustee considers enough extra to justify the trustee's liquidation efforts.
b) The trustee is unwilling to front the costs of collecting or liquidating an asset. For example, if you own a debt (someone owes you money) your trustee may sensibly decide that paying the court costs and attorney fees to get a judgment against your debtor is not worthwhile if that debtor could not be forced to pay the judgment.
Under certain circumstances you may actually want the trustee to take a certain asset or two that are not exempt. Or you may not mind surrendering something that you don't need in return for the benefit of discharging your debts.
It could be to your advantage for the trustee to liquidate something you'd rather not mess with. For example, if you've been struggling to keep a business running, don't know who should you pay ahead of others, it may be a relief to hand the liquation task over to a bankruptcy trustee.
It could also be to your advantage to have a trustee liquidate an asset if as a result a debt you want paid would be paid. This could happen if you owe a "priority debt," which the trustee would pay ahead of other debts. "Priority" debts include recent unpaid income taxes and child/spousal support arrearage. Those are debts you would have to pay anyway. And if you operated a business, a priority debt could be a former employee's unpaid wages, which you may want paid out of a sense of moral obligation.
As these last two blog posts have shown, there's a lot involved in protecting your assets in a bankruptcy case.
You get to keep everything you own as long as it all fits within "property exemptions." These are categories of assets—each usually with a maximum dollar amount—that you are allowed to have. See Section 522 of the U.S. Bankruptcy Code.
But there is a lot more to this than just matching assets to exemptions. What is and is not covered by some exemption categories is not always clear. In many states you get to choose between a federal and a state set of exemptions. You have to know which state's exemptions apply to you if you've moved recently. Applying these laws often requires knowing how the state and federal statutes have been interpreted in court decisions, and/or how the local trustees and judges are enforcing them.
Bankruptcy law is federal law, as the U.S. Constitution make clear. See Article I, Section 8, Clause 4 of the Constitution. But Congress has exercised its power by giving each state a choice. Each state can decide whether to allow its residents to use a federal set of exemptions in the Bankruptcy Code for bankruptcies filed in that state, or instead require them to use of a set of exemptions created by the state.
So you have to first know which set of exemptions you are allowed to use. And then, if you are allowed to use either one you need to know which of the two sets would be better for you.
Otherwise you have to use the set of exemptions available to residents of the state you were "domiciled" in during the 6-month period immediately before those two years.
The exemption laws in your prior state may be better or worse than in your new state. Sometimes significantly so. So, sometimes it makes sense to hurry the filing of your case to take advantage of your prior state's exemptions. Other times it makes sense to delay filing to take advantage of your new state's exemptions.
You can often protect assets not covered by the available exemptions with wise pre-bankruptcy planning. This is one of the important reasons to meet with a competent bankruptcy lawyer, and to do so as soon as possible.
Pre-bankruptcy asset-protection plans often need a relatively long period of time for them to be effective. So it's crucial that you get thorough legal advice well before creditors' actions force you into filing bankruptcy. Doing so can make the difference in being able to protect what's important to you.
Although it may feel odd, you can often pay for the right to keep an otherwise unprotected asset. Chapter 7 may otherwise definitely be your best option, but you don't want to lose something that's not exempt. Paying to keep it may be better than spending 3 to 5 years in a Chapter 13 case to protect it.
Most Chapter 7 trustees are willing to accept your payment of the fair market value of the item, and sometimes less. That's because you paying them can save the trustee the costs associated with selling that item. So the trustee just needs to receive the net amount he or she would receive after paying the costs from a hypothetical sale. For example, if you have a non-exempt boat you'd like to keep, you could pay a projected sale amount minus a boat broker's sales commission, transport and storage/dockage fees, and such.
Also, many trustees are willing to accept your monthly installment payments to buy back a non-exempt asset. A trustee is willing to take some risk because you are at his or her mercy. If you don't pay the agreed payments you will lose your ability to discharge (write off) your debts.
In most consumer Chapter 7 "straight bankruptcy" cases you get to keep everything you own. That's because everything you have fits within the property exemptions that are available for you to use.
The rest of this blog post focuses on the first of these—using the right set of exemptions.
Doing this takes two steps.
Alaska, Arkansas, Connecticut, Hawaii, Kentucky, Massachusetts, Michigan, Minnesota, New Hampshire, New Jersey, New Mexico, New York, Oregon, Pennsylvania, Rhode Island, Texas, Vermont, Washington, and Wisconsin.
If you live in any other state the federal exemptions are not available. You must use that state's exemptions when you file bankruptcy.
Obviously, you'll be in trouble if you try to use the federal exemptions if you live in any of the other 31 states, or if you use a different state's exemptions. The trustee would object, and you'd have to change to the right set of exemptions. And then you might no longer be able to protect something of yours you thought you could.
Second step: you must qualify to use the exemptions available to those in the state where you live by living there long enough. The rule is generally simple enough. You can use the exemptions available in the state where you've been living if you've been there for two years.
More precisely, the Bankruptcy Code says it's where your "domicile has been located for the 730 days immediately preceding the date of the filing of the petition." (2 times 365 days = 730 days.) See Section 522(b)(3)(A).
So let's say you moved 18 month ago from Pennsylvania to Arizona, after living in Pennsylvania for 6 months, and before that in Massachusetts for 10 years.
Since you haven't lived in Arizona for two full years, you can't use the exemptions usually available there. You don't use exemptions available in Pennsylvania either since you were living there during the last two years not right before. Massachusetts is where you were living during the 6 months just before two years, so you use the exemptions available there.
One: This two-year rule could work to your advantage as well as possible disadvantage. If you've moved from a state with better exemptions for the assets you own, being required to use that prior state's exemptions could protect your assets better.
Two: To the extent that you have the flexibility to speed up or delay your bankruptcy filing, you may want to time your filing to take advantage of the more favorable set of exemptions.