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Losing your Inheritance in Bankruptcy - How to Avoid

Bankruptcy, asset protection, trusts, wills, testamentary trust, inheritance, GO Lawyers, Restructuring

Upon bankruptcy, the property of the bankrupt vests in the Trustee.

Now, in the case of an inheritance, it is very likely that at the time of declaring, or being declared a bankrupt, that property comprising an inheritance, was someone elses property, and not that of the bankrupt.

However, section 58(1)(b) of the Bankruptcy Act 1966 states that "after-acquired property of the bankrupt vests, as soon as it is acquired by, or devolves on, the bankrupt, in the Official Trustee or, if a registered trustee is the trustee of the estate of the bankrupt, in that registered trustee."

In other words, as soon as property becomes property of the bankrupt, it vests in (or becomes the property of) the trustee of the bankrupt estate.

This is the case even if the person has been discharged as a bankrupt when they receive the payment of the inheritance, provided their interest in the inheritance vested during the course of the bankrupt period. Generally, an inheritance vests in a beneficiary in an ordinary Will for 30 days after the death of the person leaving the inheritance (called the survivorship rule). However, it is dependant upon the drafting of the Will itself as to when property of the deceased estate vests in a beneficiary.

Property is broadly defined by section 5 of the Bankruptcy Act 1966 to include "real or personal property of every description, whether situate in Australia or elsewhere, and includes any estate, interest or profit, whether present or future, vested or contingent, arising out of or incident to any such real or personal property"

This includes an inheritance, amongst virtually all other property, except for that expressly excluded in s116(2) of the Bankruptcy Act 1966.

It follows that if a bankrupt is to inherit money during the term of their bankruptcy, that inheritance would vest in the trustee for the benefit of creditors.

However, it has been recognised a bankrupt's status as a beneficiary of a discretionary trust is not the property of the bankrupt, rather it is a 'mere expectancy' and therefore, does not vest in the trustee (Dwyer v Ross (1992) 34 FCR 463).

To mitigate this risk, we recommend when a client is estate planning, they consider establishing a discretionary testamentary trust.

Broadly speaking, a discretionary testamentary trust goes to separate the trust property (the inheritance) from the beneficiaries, just as an ordinary discretionary trust would. The distribution of the testamentary trust property is at the discretion of the trustee.

In these instances, the inheritance does not vest in the bankrupt 30 days after the person dies like it might in an ordinary Will. Instead the inheritance is held in the trust to be distributed to a variety of beneficiaries, at the discretion of the trustee.

The same effect cannot simply be had in an ordinary Will with the inclusion of a term expressly reducing or removing a beneficiary's interest in the trust due to their bankruptcy. Section 302B of the Bankruptcy Act 1966 voids such provisions.

Often, it is the case that the executor is the trustee of the discretionary testamentary trust. In some circumstances, this person may be a bankrupt. If this is not expressly prevented in the documents, it is not the case that the inheritance vest in the trustee in bankruptcy. As broadly mentioned earlier, section 116(2)(a) states that property held by the bankrupt in trust for another person is not dividable amongst creditors.

This general advice should be considered on a case by case basis, and ought to be discussed with family members, as someone facing bankruptcy or who is currently bankrupt, may unforeseeably receive a large windfall in the form of an inheritance. At risk individuals ought to speak to those around them regarding the benefits of a discretionary testamentary trust.

For an obligation free discussion, please contact our office. On a daily basis, we assist clients with Restructuring and Insolvency related matters, and have an appreciation of the bigger picture when it comes to the same.

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