Can debtors use trusts to avoid their obligations to a business?

Can debtors use trusts to avoid their obligations to a business?

On Behalf of | May 16, 2024 | Collections

Most people are eager to make good on their financial obligations. They communicate with their creditors, follow payment plans and provide advance notice if they might miss a payment or send a payment in late. Unfortunately, there are some people who take on debt without a sincere intent to fulfill their financial obligations. People sometimes try to avoid financial responsibility by hiding from creditors. If that doesn’t work, then they might try to hide certain assets so that they aren’t vulnerable during debt collection actions.

One of the ways to prevent a creditor from taking legal action against personal resources, like a home or a financial account, is to transfer ownership of that resource to a trust. Can creditors take action against assets used to fund a trust, or are they vulnerable to this unfortunately common form of fraud?

Fraudulent transfers may not protect resources

In theory, a trust is a separate legal entity from the person who started it and who previously owned the assets used to fund the trust. Therefore, legal action brought against the trustor usually has minimal impact on trust resources.

However, the courts in California and elsewhere in the United States do recognize that people can abuse trusts as a way to unfairly deprive creditors of the assets that could help fulfill someone’s financial obligations. Creditors can sometimes pursue collection activity by targeting certain resources. Doing so often starts by establishing that the transfer of those assets into a trust was fraudulent. The timing of a transfer can be what determines whether it is fraudulent or not.

Any transfer that occurs when a creditor has already actively begun attempting to collect on a debt is potentially suspect. In fact, transfers that occur after incurring a debt but before collection activity begins can also be fraudulent transfers. People who know that they may default on their financial obligations can start trusts before doing so, but the assets that they transfer to the trust could still be vulnerable if frustrated creditors can show that the timing of those transfers is questionable.

Often, creditors may only have a vague understanding of what resources are in the name of an individual debtor. It might be the financial discovery process afforded to litigants during collections-related lawsuits that allows a creditor to identify assets that could help repay what someone owes. If an individual inappropriately moved assets into a trust as a way of avoiding their obligations to a creditor, the courts could hold them accountable for that and might even undo the transfer in some cases.

Creditors trying to collect a debt owed by someone who is intent on avoiding their responsibilities often need to explore different options for enforcing those financial obligations. Challenging the use of a trust to shield certain resources could help creditors pursue repayments for valid debts under certain circumstances.