Inheritance During Bankruptcy

Inheritance During Bankruptcy

What Happens if I Inherit Property or Money While Bankrupt?

Bankruptcy is a complex process, and its effects are far-reaching, especially on personal assets. One area that often raises questions is the impact of bankruptcy on inheritance. When an individual inherits property or money during bankruptcy, what happens next? This comprehensive guide aims to shed light on the topic of Inheritance During Bankruptcy in Canada, with a focus on the legal aspects, recent court decisions, and potential strategies to protect inheritances.

The Implications of Bankruptcy on Your Assets

In Canada, your assets are your own, even during a bankruptcy. This means that if you happen to inherit any form of property while you are bankrupt, that property becomes part of your bankruptcy estate. This property, which could range from cash to physical assets, is then allocated by a Licensed Insolvency Trustee to your unsecured creditors.

During an initial consultation with an insolvency expert, you would typically be asked about your potential to inherit any assets in the near future. The advice you receive would heavily depend on your answer to this question. Many Canadians, therefore, fret over how the bankruptcy process could impact their inheritance.

A recent case in the Court of Appeal for Ontario, Richards (Re), 2022 ONCA 216 (CanLII), has brought this issue to the limelight. It questions whether filing for bankruptcy would mean losing your inheritance or whether you can leverage family circumstances to safeguard it from creditors and eventually reclaim it.

 

Bankruptcy, Winnings, Gifts, Inherited Property, and the Bankruptcy and Insolvency Act

Section 67 (1)(c) of the Bankruptcy and Insolvency Act (Canada) (“BIA” ) provides the legal framework regarding the property of a bankrupt individual. According to this provision, all property of a bankrupt individual, regardless of its location, that may have been acquired or devolved on the bankrupt individual before their discharge is considered. This includes any refunds due to the bankrupt under the Income Tax Act for the calendar year in which they became bankrupt.

This clause covers all assets owned by the individual at the time of filing for bankruptcy, as well as any assets acquired after filing for bankruptcy and before discharge. It also includes assets that the individual was entitled to but chose to hide or contract out of. This category includes gifts, lottery winnings, and inheritance during bankruptcy, among other unexpected financial gains.

Receiving Property, Assets, or Inheritance While Bankrupt

Receiving an inheritance, gift, or property while bankrupt can be a double-edged sword. On the one hand, such an influx of wealth can alleviate financial stress by allowing you to pay off debts that might otherwise necessitate filing for bankruptcy. On the other hand, receiving assets, property, or inheritance during bankruptcy will benefit creditors and impact the handling of your bankruptcy file, including your discharge.

The reason for this lies in the aforementioned section of the BIA. If you experience a windfall that is substantial enough to pay off all your creditors without filing for bankruptcy, your financial situation can change significantly. If the windfall occurs during your bankruptcy period, but it is not sufficient to cover all your debts, it may affect the type of discharge you may receive, whether it is an automatic discharge or a conditional one.

If the windfall occurs after you have filed for bankruptcy and is sufficient to cover all your debts, you could consider applying to annul the bankruptcy. All these factors come into play when you receive an inheritance during bankruptcy or experience any other form of financial windfall.

The Fate of Your Inheritance in Bankruptcy

By now, you may have gathered that any part of your inheritance during bankruptcy will be used to pay off your creditors (plus interest) in full. But what if you attempt to contract out of receiving your inheritance while you are an undischarged bankrupt? Can a Will or trust that provides you with the inheritance be used to prevent it from being lost during your bankruptcy?

This question was addressed in the Court of Appeal for Ontario’s decision in Richards (Re), 2022 ONCA 216 (CanLII). The appellant, Michael Richards, challenged a bankruptcy judge’s order from 2021. The case revolved around the interpretation of a trust in which Mr. Richards was a beneficiary.

 

The Role of the Royal Bank of Canada and Section 38 of the BIA

In October 2020, The Royal Bank of Canada (“RBC”), to whom Mr. Richards owed a judgment of $987,613 plus costs and interest, obtained an order under section 38 of the BIA. Section 38 permits one or more creditors to take an assignment of a claim or action that the Trustee may have if the Trustee is unable or unwilling to enforce that claim or action.

In this case, the Trustee had no desire to pursue the claim due to a lack of funds. As a result, RBC stood in the Trustee’s shoes with respect to the proceeds from the sale of the property. RBC then sought to recover the sale proceeds up to the amount owed to them, arguing that the proceeds should contribute to the repayment of their outstanding debt as it was the property of the bankrupt.

The Position of the Undischarged Bankrupt

In response, Mr. Richards argued that his interest in the Property was suspended while he was bankrupt, under the provisions of a different section of the Trust document. He contended that his interest in the Property could not vest in his Trustee as he had no rights to the Property until such time as he was discharged from bankruptcy. It was only on his discharge from bankruptcy that the Property would vest in him and only then would he own it outright.

 

The Trial Judge’s Decision

The judge overseeing the bankruptcy case held that the Property vested in Mr. Richards at the Time of Division, which meant that it was his property and vested in his Trustee upon him becoming bankrupt. Since the Trustee had transferred its rights in the action against the Property to RBC, the bank was legally entitled to receive the proceeds of sale up to the amount owed.

The Court of Appeal for Ontario’s Decision

The Court of Appeal for Ontario upheld the bankruptcy judge’s decision, stating that Mr. Richards failed to demonstrate any errors in the judge’s decision. The appellate court agreed with the bankruptcy judge’s interpretation of the Trust document, stating that it was consistent with the plain language of the relevant section and also aligned with the stated purpose of the Trust.

This case emphasizes that any attempts to shield assets from creditors, which contradict the public policy underpinning the BIA, will not be tolerated.

Is It Possible to Shield an Inheritance from Creditors?

While I am not a lawyer and do not advise insolvent individuals on how to protect their assets from their secured creditors, preferred creditors, or unsecured ordinary creditors, given these specific facts, is there a way the Trust could have been structured differently?

If the Trust had been structured to provide Mr. Richards with a monthly allowance for life from the invested proceeds of the sale of the real property, instead of transferring the Property to him at the Time of Division, the situation could have been different. This monthly allowance would not have been directly treated as his property; rather, it would be considered part of his income, subject to the surplus income rule. While Mr. Richards might have had to make surplus income payments to his Trustee, the bulk of the inheritance could have been shielded from his creditors.

Avoiding Personal Bankruptcies with the Right Trust

If the Trust had been worded to provide Mr. Richards with a lifetime allowance without ever transferring the asset itself to his ownership, Mr. Richards could have avoided bankruptcy. He could have filed a Proposal.

If his financial situation was such that he owed $250,000 or less, he could have filed a consumer proposal. If he owed more than $250,000, it would have been a Division I BIA restructuring proposal. Either way, he would have avoided filing for bankruptcy or having a Bankruptcy Order made against him.

With this differing approach for the Trust, RBC would not have had access to the entire amount of cash. They would have faced the reality of not being able to collect in full on their judgment for a very long time, as there would not have been a lump sum of money to target.

 

Summary of Inheritance During Bankruptcy

In conclusion, the BIA allows the property of a bankrupt person to be distributed to creditors based on a “just and equitable” standard. The case of Richards (Re), 2022 ONCA 216 (CanLII), serves as a stark reminder that any attempts to shield assets from creditors that contradict the public policy underpinning the BIA will not be tolerated.

If you are on the brink of insolvency, are being pursued by bill collectors, or are avoiding phone calls to the point where your voicemail box is always full, you need professional help. As a Licensed Insolvency Trustee, we are the only professionals licensed, recognized, and supervised by the federal government to provide insolvency assistance. We are also the only authorized party in Canada to apply remedies under the Bankruptcy and Insolvency Act (Canada). We can help you choose the best course of action to free you from your financial difficulties.

Get in touch with the Bankruptcy Canada Team today to free yourself from the stress, anxiety, and discomfort that your financial issues have created.

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