Inheritance Issues in Bankruptcy

When someone files for bankruptcy, they surrender all non-exempt assets to the licensed insolvency trustee for the benefit of their creditors. This includes not only assets they have at the time they file for bankruptcy, but also comprises of any assets that “devolve” on the bankrupt prior to discharge such as an inheritance “received” during bankruptcy.

In determining when an inheritance is received or devolved, the trustee will look at the date of death of the benefactor, not the date the will is read or the date money or assets are distributed.

We can consider three possible scenarios that could occur:

  • Mark’s father passed away before Mark filed for bankruptcy. Mark is entitled to an inheritance but the will is under probate and he doesn’t expect money to be distributed for several months. Mark also has a wage garnishment so he has decided to file for bankruptcy to deal with his debts now.  The bankruptcy estate will be entitled to the proceeds of Mark’s father’s estate, because Mark received the assets to the date of bankruptcy. Therefore, the assets from the estate are now the property of the trustee for the benefit of Mark’s creditors.
  • Mark files for bankruptcy and unexpectedly he receives an inheritance from a distant Aunt while bankrupt. The proceeds of that inheritance must be paid into the estate to be distributed amongst Mark’s creditors.
  • Mark filed for bankruptcy but has received his discharge. Two days after his discharge Mark’s uncle passed away and left him a substantial inheritance. Because Mark is a discharged bankrupt, his bankruptcy is complete and he can keep his inheritance.

In a consumer proposal, the debtor obtains protection from creditor actions (wage garnishments and collection calls stop) and keeps all assets, including potential inheritances. If an individual receives an asset rather than money in an inheritance, the trustee will realize on that asset.  It is possible for the bankrupt to purchase that asset at fair market value from the trustee although, depending on the value, this may be difficult as they will not likely be able to obtain a loan while bankrupt.

It is important to know that failure of a bankrupt individual to disclose an inheritance would be an offence under the Bankruptcy & Insolvency Act and could result in their discharge being refused or suspended. It could also result in a conditional discharge order requiring additional terms of the bankrupt.

What should someone do if they have debts and require relief now, but has an elderly parent who may be leaving them an inheritance in the next few years?

In determining when an inheritance is received or devolved, the trustee will look at the date of death of the benefactor, not the date the will is read or the date money or assets are distributed. 

One option would be to consider a consumer proposal.  In a consumer proposal, the debtor obtains protection from creditor actions (wage garnishments and collection calls stop) and keeps all assets, including potential inheritances.  In offering terms to the creditors, the potential size, likelihood and timing of any inheritance would be considered. If someone receives an inheritance after the proposal commences, the debtor could use the proceeds to repay the proposal early.  The terms of the proposal, once accepted, will not change, regardless of the size of the actual inheritance.

It is also possible to file a proposal while bankrupt if someone receives a large inheritance.  I was the trustee for an individual (we will call him John) who owed $50,000 to his creditors and filed for bankruptcy.  A month later his father died, and he expected to receive a $100,000 inheritance very quickly (his father’s assets were all in bank accounts and easily liquidated and there were no other heirs, so there were no complications to delay the distribution of funds).

Had we allowed the bankruptcy to continue, I would have seized the $100,000, and then, at the conclusion of the, the creditors would have received payment in full of their debts, plus interest at the prescribed rate, and the balance of the $100,000 would be returned to John.

It is important to know that failure of a bankrupt individual to disclose an inheritance would be an offence under the Bankruptcy & Insolvency Act and could result in their discharge being refused or suspended. In John’s case, the bankruptcy would have concluded 21 months later, since he had surplus income. To avoid that delay, John, while bankrupt, filed a consumer proposal offering to pay the creditors enough to pay their claims in full and to cover all administration costs as a lump sum.  Obviously, the creditors accepted, and within three months the creditors were paid in full, the bankruptcy was replaced with the consumer proposal, the consumer proposal was completed and John received the balance of the funds from the estate.

This is not an entirely uncommon example, and illustrates the point that where debts and inheritances are involved, there are numerous alternatives for dealing with debt, so professional advice is encouraged.

Authors:

J. Doug Hoyes
J. Doug Hoyes
J. Douglas Hoyes, B.A., C.A., CPA, CIRP is a Licensed Insolvency Trustee and co-founder of Hoyes, Michalos & Associates Inc. in Ontario, Canada. He is also the host of Debt Free in 30, a weekly podcast about how to handle money and debt.
 


A Publication of CPLEA