Bankruptcy and Family Trusts

The world of finance and law can be a complex web to navigate. One area that has particularly gained attention in recent years is the intersection of bankruptcy and family trusts. This article aims to explore this topic in detail, shedding light on the complex relationship between bankruptcy laws and family trusts, and how they interact within the Canadian context.

Understanding Bankruptcy

Definition

Bankruptcy is a legal status that involves an individual or company that cannot repay their outstanding debts. The bankruptcy process usually begins when the debtor files a petition or, in some cases, when the petition is filed by creditors owed a specific minimum amount. This process is governed by bankruptcy laws and provides a way for individuals or businesses to eliminate part or all of their debts.

Bankruptcy in Canada

In Canada, the Bankruptcy and Insolvency Act (BIA) regulates the bankruptcy process. The BIA provides debtors with a way to obtain financial relief, while also ensuring fair treatment of creditors. The Act contains provisions that address the various aspects of bankruptcy, such as the role of a trustee, the rights and responsibilities of the debtor and creditors, and the procedures for filing and processing a bankruptcy application.

Family Trusts: A Brief Overview

What is a Family Trust?

A family trust, also known as a discretionary trust, is a legal arrangement where the trustee holds and manages the trust assets for the benefit of the beneficiaries. This arrangement is typically used for asset protection, estate planning, and tax planning purposes.

Types of Trusts

There are two main types of trusts: revocable and irrevocable. A revocable trust allows the settlor (the person who creates the trust) to alter or terminate the trust during their lifetime. Conversely, an irrevocable trust cannot be changed or terminated without the permission of the trustee and the beneficiaries.

The Intersection of Bankruptcy and Family Trusts

Asset Protection

Historically, trusts were used as a means of protecting assets. In many cases, individuals of substantial means who were at risk from unwelcome litigation would establish a trust. Once assets were transferred into the trust, creditors could not execute against these assets, as the settlor had divested themselves of legal ownership.

Impact of Bankruptcy on Trusts

When an individual who is a trustee or a beneficiary of a trust declares bankruptcy, it can raise complex legal issues. The impact of bankruptcy on a trust depends largely on the type of trust and the specific circumstances. In some cases, the bankruptcy can lead to the trust assets being used to repay the bankrupt individual’s debts.

Legal Precedents: Trusts and Bankruptcy

In recent years, various cases have shaped the landscape of bankruptcy and family trusts in Canada. Two notable cases are The Guarantee Company of Canada v Royal Bank of Canada and Royal Bank of Canada v Atlas Block Co. Limited.

The Guarantee Company of Canada v Royal Bank of Canada

This case involved a contractor, A-1 Asphalt Maintenance Ltd, which had four major ongoing projects when it declared bankruptcy. The Ontario Court of Appeal held that the funds owed by the contractor’s clients for the projects were deemed trust funds under the Construction Act. Thus, these funds were excluded from the property of the bankrupt and were not available for distribution to A-1’s creditors.

Royal Bank of Canada v Atlas Block Co. Limited

In this case, the court held that a supplier’s trust claim under the Construction Act did not survive Atlas’s bankruptcy. The court ruled that the funds from the projects were commingled with funds from other sources, thus destroying the certainty of subject matter required for a common law trust.

Legislation Impact: The Construction Act

In response to the Royal Bank of Canada v Atlas Block Co. Limited case, amendments were made to the Construction Act. The Act now requires a trustee to maintain written records detailing the amounts received into and paid out of the trust funds. This change ensures that beneficiaries of a trust can claim access to the trust funds in bankruptcy by excluding these funds from the property of the bankrupt and thus excluding them from the reach of other creditors.

Bankruptcy and Family Trusts: Best Practices

Careful Planning

The key to avoiding asset protection settlements being set aside is careful planning. Trusts should be established well in advance and structured for purposes unconnected to asset protection. This strategy can discourage frivolous lawsuits and encourage reasonable settlement offers.

Legal Advice

Given the complexity of bankruptcy and family trusts, individuals should seek expert legal advice before establishing a trust or filing for bankruptcy. Lawyers specializing in these areas can provide valuable insights and guidance to help navigate these complex legal landscapes.

Conclusion

The intersection of bankruptcy and family trusts is a complex field that requires careful navigation. Understanding the basics of bankruptcy and trusts, the impact of bankruptcy on trusts, and the legal precedents and legislation that have shaped this area, is essential for anyone dealing with these issues. With careful planning and the right legal advice, it’s possible to navigate these complexities effectively.

Find Your Personal Debt Relief Solution

Licensed Insolvency Trustees are here to help. Get a free assessment of your options.

Discuss options to get out of debt with a trained & licensed debt relief professional.