The Interplay Between Benefits Under a Trust and Bankruptcy: A Beneficiary Cannot Shield Its Obligations to Creditors by Hiding Behind the Terms of a Trust

Published on: June 2022 | What's Trending

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In a recent decision, the Ontario Court of Appeal held that the sale proceeds of a property held in trust can be applied to a beneficiary’s bankruptcy obligations.

Richards (Re), 2022 ONCA 216 dealt with a situation where real property was held in a trust that was created by a father for the benefit of his son (the “Beneficiary”). The trust held the property during the lives of the Beneficiary’s parents, with a life interest permitting them to live at the Property. As per the terms of the trust, the date of death of the second parent was designated as the “Time of Division”. At the Time of Division, the trustees were to distribute the trust fund, which included the property and any Chattels, to the Beneficiary, if he was alive at the time.

In 2010, the father passed away and his wife continued to live at the Property until she passed away in July 2020. Prior to her death, the trustees of the trust sold the property and held the proceeds of sale in the amount of $1,172,120.90 in trust.

At the Time of Division, the Beneficiary was an undischarged bankrupt and faced an outstanding judgment by the bank for $987, 613, plus costs and interest. In October 2020, the bank obtained an order under s. 38 of the Bankruptcy and Insolvency Act (the “Act”) and was assigned the rights of the Beneficiary’s trustee in bankruptcy to make a claim against the proceeds of sale. The bank brought a motion to recover the sale proceeds up to the amount owed by the Beneficiary and a declaration that the Beneficiary was the trust’s beneficiary and had an interest in the property, as per the terms of the trust. The bank argued that the sale proceeds constituted property of the bankrupt.

The Beneficiary argued that his interest in the property was suspended while he is bankrupt, and the property would only vest upon his discharge from bankruptcy. The bankruptcy judge rejected this argument. It was held that the Trust’s provisions which applied to the property during the lifetimes of the Beneficiary’s parents were overridden by the provisions which applied to the property after the parent’s death.

Ultimately, the bankruptcy judge found that the property vested in the Beneficiary at the Time of Division and thus vested in the bankruptcy trustee. Since the bank was assigned the rights of the trustee, the bank was entitled to the proceeds of sale up to the amount owed by the Beneficiary

The Beneficiary appealed and the Ontario Court of Appeal upheld the bankruptcy judge’s order. In coming to its decision, the court noted that to decide otherwise would offend the public policy which underlies the Act, as it would allow a person to place assets out of the reach of creditors.

This decision presents an interesting analysis of the interplay between a beneficiary’s rights under a trust and in a bankruptcy situation. It also serves as a reminder that beneficiaries in such situations cannot use the terms of a trust to shield their obligations from creditors.

Author: Daniel Waldman, Lawyer

Daniel Waldman would like to acknowledge the assistance of Pulkit Sahi in writing this blog.