One of the worst cases in recent memory was overturned recently.  This case, known as Castellano in the estate planning bar arena, held that trust assets were available for the bankruptcy court.  This was despite some strong anti-alienation provisions within the trust.  In essence, that case held that the mere possibility that the beneficiary could receive something from a trust was enough to make it a part of a bankruptcy estate.

This is, of course, troubling in a variety of ways.  First, it completely misunderstands how a trust works.  It essentially says that a court can go in and TAKE money from a trust despite the fact that the trust would not give that money to the court (like a bankruptcy court).  Further, it obliterates the point of trust planning.

Let’s review the article below for more.

Estate Planning Bar Breathes Sigh Of Relief As Castellano Gets Over Turned

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In a nutshell, Faith Campbell created a Living Trust for the benefit of her four children in 1997. Faith died in 2007, and one her children, Linda Castellano, and her husband declared bankruptcy in 2011. The issue is whether the assets that were retained in the Living Trust, which had a spendthrift provision that protect the interests of beneficiaries (such as Linda) became property of her bankruptcy estate.

In an Opinion which I thought at the time ran off the rails and crashed in error into the weeds on a number of issues, the Bankruptcy Court held that Linda’s beneficial interest in the Living Trust were indeed includable in her bankruptcy estate and thus accessible by the Bankruptcy Trustee. The least tenable ruling by the Court was that under Bankruptcy Code section 548(e), because Faith’s Living Trust was a self-settled trust as to her, Faith’s transfers to the trust could be set aside some 14 years later as to creditors of Linda, a ruling that ranks at least a 9 on the Juris Wrong-O-Meter.

Thereafter, Linda and J.T. Del Alcazar, the latter being the current trustee of the Faith Campbell Living Trust, objected to the Bankruptcy Court’s decision on review by the U.S. District Court for the Northern District of Illinois — and cited my article in a couple of instances. The U.S. District Court reversed the findings of the Bankruptcy Court, and ruled in favor of Linda and Del Alcazar and against the Trustee, as I shall now relate.

To save time, I’m not going to fully review the pertinent facts again — to understand this sequel, you’ll need to read my original article first as we will here join the U.S. District Court’s Opinion already in progress.

The District Court started its analysis with a very basic point of bankruptcy law which the Bankruptcy Court had seemingly missed, which is that if Linda’s interest in Faith’s Trust was excluded from Linda’s bankruptcy estate under Bankruptcy Code section 541(c)(2), then the Bankruptcy Trustee doesn’t have any legal grounds to avoid that interest’s transfer, since even if were avoided that interest would not be part of Linda’s bankruptcy estate.

The Fraudulent Transfer Laws Do Indeed Apply To Future Creditors

In other words, Linda and/or Del Alcazar as Trustee of Faith’s Trust had allegedly made transfers of Linda’s interest to dodge the Bankruptcy Trustee’s collection efforts. But if Linda’s interest was not part of her bankruptcy estate anyway, then it doesn’t make any sense to set these transfers aside since the Bankruptcy Trustee has no right to pursue those assets in the first place; a legal variation of “no harm, no foul”.

So, the biggest question in the case was whether Linda’s share of Faith’s Trust was in Linda’s bankruptcy estate or not. The Bankruptcy Court looked at the Trust language that said “Upon the death of Faith F. Campbell and upon settlement of her estate, this Trust shall terminate”, and concluded that Faith’s Trust terminated the moment she died, and all that “upon settlement of her estate” language was little more than administrative surplusage.