Irrevocable Trusts and the Uniform Fraudulent Transfer Act

The establishment of an irrevocable trust may be subject to avoidance under the right – or wrong – circumstances.  Use of the term “irrevocable” does not make the trust immune to attacks from creditors.

Under Michigan law, a creditor can avoid certain transfers within the last 6 years.  MCLA 566.31 et. seq.  The court looks to the “badges of fraud” surrounding the transfer to determine whether the transfer is avoidable – these criteria include, but are not limited to, the threat of pending litigation, timing, lack of value in exchange for the transfer, and the relationship with the person receiving the transfer. An irrevocable trust established for legitimate estate planning purposes such as avoidance of tax consequences may still be subject to avoidance by a creditor or a bankruptcy trustee under Michigan law for lack of value provided in exchange for the transfer.  A bankruptcy trustee can use the strong arm powers under §544 of the Bankruptcy Code to avoid transfers within the last 6 years under state law, even though the Bankruptcy Code provides for only a 2 year lookback period. In a recent case in the Central District of California, a bankruptcy trustee filed a complaint to set aside a QPRT (Qualified Principal Residence Trust) which had been established only 13 months prior to the bankruptcy filing.  The QPRT was an irrevocable trust which held the debtors’ principal residence.  Ultimately, the case was settled by the children who were beneficiaries of the trust.  While there were some suspicious circumstances surrounding the transfers and disclosure in this case, it is a good reminder to thoroughly analyze all transfers made prior to the bankruptcy – even if made for “estate planning purposes.”