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Trusts can be an excellent estate planning tool in order for an individual to provide for their heirs, but when a trust is formed in a reactive effort to avoid judgements or creditors, it may be possible for the law to see a fraudulent transfer in play, and that has the potential to come with serious consequences. However, if an individual works closely with an attorney to proactively establish a trust under valid circumstances, it can be effective for the person forming the trust as well as their intended heirs.
To better understand this topic, we will define what a fraudulent transfer is, how it may happen in relation to a trust, and what it can mean for creditors.
What Is a Fraudulent Transfer?
When defining the legal term fraudulent transfer, there are two primary prongs to keep in mind:
- Actual Intent: If a transferor transfers money or property to another person, entity, or a trust with the actual intent to delay, hinder, or defraud one or more of their creditors, then the law usually sees that as a fraudulent transfer. For this reason, it can be set aside by the creditors or a bankruptcy trustee.
- Constructive: Without regard to what the transferor’s original intent was, if the transfer was made at a time when the transferor was insolvent or had insufficient capital to continue operating and the transfer does delay, hinder, or defraud one or more creditors, it can be considered a constructive fraudulent transfer. It too can be set aside with certain legal action by creditors or the bankruptcy trustee of the transferor.
As we move forward to discuss how fraudulent transfers come into play for trusts, it is recommended to keep this information in mind.
How Fraudulent Transfers Can Come into Play When There Is a Trust
People set up trusts for a number of different reasons and then transfer money and property to them. Trusts are usually formed to benefit a beneficiary after the person forming the trust has passed.
There are three main roles in the formation of a trust:
- a donor
- a trustee
- a beneficiary
In the eyes of the law, someone could be two of those three persons, but not all three because one person performing all of these roles could manipulate them for self-benefit.
To learn more about how a fraudulent transfer can come into play when there is a trust, let us consult the following examples:
- The Typical Trust: In this type of situation, it is common to see a grandparent put together a trust for their grandchild to eventually go to college. To do this, during the grandparent’s lifetime or as part of their will, they will set aside a fund of money or property (that can be sold at a later time to gain money) to be put into a trust so that money or income source can eventually pay for the grandchild’s education. The grandparent may even appoint their son or daughter to be the trustee in the event that they die before the grandchild becomes of college age.
Despite the grandparent appointing one of their children to be the trustee of the funds, it is typically not considered an asset to them. In the situation that the trustee was to experience financial problems such as judgements or bankruptcy, these are not considered the trustee’s funds. Although the trustee controls the funds for their child, the funds do not belong to them. The funds belong to the beneficiary or grandchild of the deceased party. Therefore, if there were to be a judgement against the mom, it would not allow creditors to garnish the funds in the trust account.
- A Fraudulent Trust: If there is an individual who believes they are about to get a judgement against them and they have some money they would like to keep creditors from getting to, they might decide to quickly establish a trust that they pour all of their assets into and say it is for the benefit of their heirs. In this case, the transferor established the trust with the primary intent to defraud their creditors. The transferor was likely also insolvent, which can make it harder for creditors.
Either under an actual intent or constructive prong of a fraudulent transfer, the creditors would be able to sue the trust or the trustee and force the trustee to pay the funds or property that was fraudulently transferred to the creditors to satisfy their judgement. If the transferor filed bankruptcy, the bankruptcy trustee can sue the trust and recover the money for the benefit of the creditors.
A Final Word to Creditors About Trusts and Fraudulent Transfers
Essentially, there are good trusts and bad trusts.
Making sure that money is transferred properly in a way that creditors of the trustee cannot get to it is important if you are doing estate planning.
It is also important to read the situation if you are a creditor and run across a situation where the debtor you are dealing with does not have any money, but somehow there is a trust around for the benefit of one of the debtor’s relatives or judgement creditor.
Just because there is a trust out there for a debtor, does not necessarily mean a creditor cannot recover it. This depends heavily on the facts and circumstances around the trust, such as how it was funded and how the transfers were made.
Know the waters that you are swimming in when forming trusts and transferring assets into them and dealing with the creditors who may want to grab those assets. Make a lawful trust part of your estate planning process today with a reputable attorney to better protect a portion of your assets and ensure they are set up to benefit your intended beneficiaries.