The Law Society recently issued a guidance note for practitioners on bankrupt beneficiaries.
Personal representatives and trustees need to be aware of the risks associated with beneficiaries who are bankrupt or subject to an individual voluntary arrangement (IVA).
What is bankruptcy?
If an individual cannot pay their debts, it is possible for that individual or one of their creditors to apply for a bankruptcy order. The debts of the bankrupt will then be managed by a trustee in bankruptcy. Bankruptcy usually lasts for a year.
What is an IVA?
An IVA is an alternative to bankruptcy, in which the person who cannot pay their debts reaches an agreement with their creditors for the repayment of some or all of their debts. An IVA is administered by an insolvency practitioner. It is possible to be both bankrupt, and subject to an IVA.
What is the risk to personal representatives and trustees?
Personal representatives and trustees should take care when dealing with beneficiaries who are bankrupt or under an IVA, as it is possible that any distributions due should not be paid directly to the beneficiary.
If a distribution (being either a payment of cash or a transfer of an asset such as property) is made to a bankrupt when it should have been made to the trustee in bankruptcy, and the bankrupt then disposes of the assets, the trustee in bankruptcy could bring a claim against the personal representatives or trustees.
When do estate or trust assets pass to the trustee in bankruptcy?
If the beneficiary is made bankrupt after the testator’s death, at the point of the bankruptcy the beneficiary technically already has an entitlement. This entitlement will automatically pass to the trustee in bankruptcy.
If the beneficiary is already bankrupt at the time of death, the beneficiary’s entitlement arises after the bankruptcy. It is, therefore, “after-acquired property” under the meaning of the Insolvency Act 1986 and passes to the bankrupt, rather than in the trustee in bankruptcy.
The bankrupt must give notice to the trustee in bankruptcy of the acquisition of the property, and the trustee in bankruptcy can claim the property by serving notice on the bankrupt. If the bankrupt does not give notice of their inheritance to the trustee in bankruptcy, this constitutes contempt of court.
What is the position where there is an IVA?
If the beneficiary is subject to an IVA and is not bankrupt, the beneficiary will usually be entitled to receive their inheritance. It is likely they will need to disclose it to the insolvency practitioner.
How should personal representatives and trustees manage their risk?
Personal representatives and trustees should:
- Ask beneficiaries to disclose whether they are bankrupt or subject to an IVA. Advise them of the implications if they are not honest.
- If a beneficiary is bankrupt or subject to an IVA, contact the trustee in bankruptcy or insolvency practitioner to check if it is safe to make a distribution.
- Conduct bankruptcy searches at the Land Charges Department and the Insolvency Service register, prior to every distribution.
- For overseas beneficiaries, consider taking advice in the relevant jurisdiction.
