Protecting Bankrupt Beneficiaries Interests

Protecting the interests of bankrupt beneficiaries

A testator may have concerns about what will happen to a proposed beneficiary’s interest in their estate if that beneficiary is going through (or at risk of going through) bankruptcy. It is never the intention of a testator for their hard-earned assets to fall into the hands of the trustee in bankruptcy and be distributed between the creditors of the bankrupt beneficiary.

Removing the beneficiary from the Will

A simple way to ensure that assets do not fall into the hands of the trustee in bankruptcy would be to completely remove the beneficiary in or at risk of bankruptcy from the Will. There are, however, other options that can help facilitate a testator in leaving a gift to a beneficiary at risk of bankruptcy, which also offer a level of asset protection.

Testamentary Trusts

If a person becomes entitled to an inheritance while they are bankrupt, that beneficiary’s inheritance is classified as being ‘after acquired property’ and will vest in their bankruptcy trustee and be divided between their creditors.

Instead of giving an outright gift under a Will to a person who is either currently bankrupt or at risk of going into bankruptcy, a testator could elect to place the gift into a discretionary trust of which that person is a beneficiary instead. The main advantage of paying a gift into a testamentary trust is to prevent the gift from automatically vesting in the trustee in bankruptcy.

Discretionary testamentary trusts offer a way to attempt to separate inherited assets from those which are held personally by a beneficiary. Generally, a testamentary discretionary trust will consist of a primary beneficiary (or beneficiaries) and additional beneficiaries who are the direct lineal descendants of the primary beneficiary (namely their children, grandchildren and other lineal descendants), but may also include their spouse and/or companies and trusts in which the primary beneficiary has an interest.

It is strongly recommended that the beneficiary in or at risk of becoming bankrupt is not placed in control of the testamentary trust as the testamentary trustee. If the bankrupt beneficiary is directly in control of the trust, or has a high level of control over how distributions are made, the court may elect to lift the veil of protection that the trust provides and instead view the trust itself as an alter ego for the bankrupt beneficiary – resulting in the vesting of the inheritance in the trustee in bankruptcy. Appointing a corporate trustee whose sole director and shareholder is also the primary beneficiary under the trust likely won’t be sufficient to allow for the desired asset protection.

Superannuation Entitlements

The superannuation entitlements (accumulated super and death benefits) of a deceased person are exempt from being property which is available to be divided among creditors. The case law, however, shows that this exemption has limitations and that the ability to protect these entitlements depends on how the superannuation entitlements are paid to a bankrupt beneficiary.

In the case of Trustees of Property of Morris v Morris a distribution by the trustees of the deceased person’s superannuation entitlements directly to a bankrupt beneficiary was held to be exempt. By contrast, in the case of Re Cunningham (Trustee) v Gapes; Gapes (Bankrupt) superannuation death benefits which were paid to the deceased person’s legal personal representative in the first instance and then distributed to the bankrupt beneficiary in accordance with the terms of the deceased person’s Will were held not to be exempt. Both cases highlight that for the payment of superannuation entitlements to be exempt from being made available to the trustee in bankruptcy, the bankrupt beneficiary’s interest in a deceased person’s superannuation entitlements must come from the superannuation fund’s deed under trust law. If superannuation death benefits are paid to a legal personal representative, and then gifted to a bankrupt beneficiary under the terms of the Will, the benefit will not be exempt and will instead fall into the hands of the trustee in bankruptcy to be divided between the creditors of the bankrupt beneficiary.

We are here to advise and assist

Should you have any concerns about any of the beneficiaries of your estate being bankrupt or at risk of bankruptcy (including beneficiaries who are in professions that carry a high risk of being sued) and would like advice regarding how to protect their interests, please do not hesitate to contact one of our estate planning solicitors via the link below.