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April 5, 2005 > Living Trust Does Not Protect Assets from Creditors

Living Trust Does Not Protect Assets from Creditors

Q: My ex-girlfriend owes me $50,000. She has her home and rental properties in a living trust. If I get a judgment against her, can I collect it from the trust?

A: Yes, if the trust is revocable.

If assets are in a living trust that can be revoked by the owner, those assets are considered available. Accordingly, the owner cannot prevent creditors from collecting those assets in payment of debts.

A revocable living trust is not an "asset protection" device to avoid creditors. Rather, it is an estate planning device to avoid the delays and costs of probate.

If the person who created the revocable trust dies, however, the trust may be subject to orders from a probate court to pay the debts of the deceased.

Dobler v. Arluk Medical Group concerned a suit by a group of doctors against Dr. Theodore M. Hylwa. Dr. Hylwa was a founding member in 1988.

The founders agreed that each member would work for the group. Medical fees for patient services would be paid to the group. Each doctor agreed to carry a $400,000 life insurance policy payable to the group.

In 1988, Dr. Hylwa made and signed a revocable living trust. He transferred all of his assets to the trust. His trust was listed as the beneficiary of the $400,000 life insurance policy.

Five years later, on August 19, 1993, Dr. Hylwa died. His co-owners in the Arluk Medical Group then discovered that Dr. Hylwa breached their agreement. He had not paid all patient fees into the Group and the Group was not the beneficiary of the $400,000 policy.

The Medical Group filed in probate court an $800,000 creditor's claim against the Estate of Dr. Hylwa. A creditor's claim is barred if not promptly filed.

The Medical Group met the short time deadlines found in Probate Code Section 9100. Nevertheless, the executor of the Estate refused to pay the claim.

Suit was filed by the Medical Group against the Estate. It took five years, but Medical Group finally won an $800,000 judgment.

Unfortunately for the Medical Group, the Estate in probate did not have $800,000. After administration expenses, only $136,707 was left in the Estate - an amount woefully inadequate to pay this creditor.

But Dr. Hylwa had other assets. Those assets, including the life insurance proceeds, were owned by his living trust. Technically, therefore, they were not part of his probate estate and they were not part of the probate inventory and appraisal.

To no one's surprise, therefore, the trustee and beneficiaries of that trust (probably his wife and children) were not willing to pay the debts of the Estate - and this $800,000 in particular.

So the problem for the Medical Group was: "How do we collect our $800,000 judgment?"

The Medical Group filed a petition with the probate court. The Group's attorney argued that since the Estate did not have enough assets to pay creditors, the trustees of Dr. Hylwa's trust should be ordered to pay the probate Estate creditors from the trust's assets.

The court agreed, noting that Probate Code Section 19001 "provides the assets of a revocable living trust are subject to the claims of creditors of the deceased settlor's probate estate to the extent the probate estate is insolvent."

The trustees were ordered to pay the debts of Dr. Hylwa.
THE LESSONS:


  1. A revocable living trust does not protect one's assets from creditors, whether one is dead or alive.
  2. If you need to collect from a deceased person, make sure you timely file a creditor's claim in probate to protect your rights.
  3. If no probate is opened by the heirs, a creditor may petition to administer the estate.
  4. The time periods are very short. One delays to one's peril.
 
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