Creditor Protection

Clark Et UX v. Rameker, Trustee, et al., U.S. no. 13-299


In January 2014, we reported that the U.S. Supreme Court had granted certiorari to the United States Court of Appeals for the Seventh Circuit (the Circuit in which Illinois is located). In, Clark v. Rameker, U.S. no. 13- 99, the U.S. Supreme Court decided to resolve a conflict among the District Courts regarding whether an inherited IRA is subject to receiving protection from creditors – specifically to be addressed in Clark was whether an inherited IRA was to be considered “retirement funds” pursuant to 11 USC §522(b)(3)(C) and thus exempt from consideration as individual assets during bankruptcy proceedings.

The Supreme Court, with Justice Sotomayor delivering the opinion of a unanimous Court, settled the matter on June 12, 2014, when it held that funds contained in an Inherited IRA are not “retirement funds” within the meaning of 11 USC §522(b)(3)(C) and therefore, not exempt from consideration in bankruptcy proceedings. The rationale for the Court’s decision was based on the fact that the purpose of the exemptions, specifically the “retirement funds” exemption in the bankruptcy code, is to balance the creditor’s interest in receiving payment with the debtors need to provide for himself during retirement years. The Court looked to the plain meaning of the term “retirement funds” and determined the definition could be properly understood as “…sums of money set aside for the day when the individual stops working.” The Court applied an objective analysis to determine whether the legal characteristic of the account in which the funds are held is one in which the account is of the type that the funds are set aside for the day when an individual stops working.

In its analysis the Court pointed out the differences between an Inherited IRA, and a traditional and Roth IRA, classified as “retirement funds” within the meaning of §522(b)(3)(C). The first distinction the Court identified was that the holder of an inherited IRA is unable to contribute additional money to that account, whereas there are incentives to regularly contribute to a traditional IRA or a Roth IRA account. In addition, holders of inherited IRAs are required to withdraw all money from the account within five years of the original owner’s death, or take mandatory minimum distributions annually, no matter how close or far they are from retirement. In fact, a beneficiary of an inherited IRA could withdraw the entire amount of the account at anytime without penalty. In comparison, a holder of a traditional or Roth IRA cannot withdraw funds from the account prior to age 59 1/2 without incurring a tax penalty; a rule that was designed to encourage holders of such accounts to leave the funds untouched until retirement. These fundamental differences led the Court to conclude that the legal characteristic of an inherited IRA did not match the characteristics of a retirement fund within the meaning of 11 USC §522(b)(3)(C). The Court noted that to hold otherwise would be to transform the “Fresh Start” bankruptcy provides into “Free Pass” as nothing could prevent the beneficiary of an inherited IRA from withdrawing all the funds and going on vacation after declaring bankruptcy.

U.S. Supreme Court To Consider Whether Inherited IRA is Creditor Protected

U.S. Supreme Court To Consider Whether Inherited IRA is Creditor Protected

In April 2010 we reported on the cases, In re Chilton, No. 08-43414 (Bankr. E. D. Tax. Mar. 5, 2010) and In re Nessa, No. BKY 09-60081 (Bankr. D. Minn. Jan 11, 2010). The Chilton court found that while an IRA is given creditor protection, that protection does not extend to an inherited IRA.  The Nessa court found the opposite.

In a recent case arising from the Seventh Circuit of the Court of Appeals, (the Circuit in which Illinois is located), Clark v. Rameker, U.S. No. 13-299, cert. granted 11/26/2013, the U.S. Supreme Court as agreed to hear the Clark case, and perhaps to resolve the conflict among the Districts.  The underlying facts of Clark turn on a woman who inherits a $300,000 IRA.  Shortly afterward she and her husband declared bankruptcy.  The Seventh Circuit Court of Appeals found that the inherited IRA does not warrant the same protection as an IRA or 401(k) since no new contributions may be made to it and the inherited IRA cannot be merged with any other account.  Further, the assets in an inherited IRA must begin to be distributed to the beneficiary over the beneficiary’s life expectancy and in some cases, as soon as within 5 years.  Accordingly, an inherited IRA should not be considered “retirement assets” and given the same protection in bankruptcy court as IRAs and 401(k) plans.

Life Insurance and Revocable Living Trusts

Life Insurance and Revocable Living Trusts

Illinois exempts from creditors all proceeds payable because of the death of the insured and the aggregate cash value of any and all life insurance and endowment policies and annuity contracts payable to a spouse of the Insured or to a child, parent, or other person dependent upon the Insured, whether the Insured reserves the right to change beneficiary or whether Insured’s estate is a contingent beneficiary.

Until recently, this protection was not available if proceeds were payable to a revocable living trust.  This was at cross purposes with conventional estate planning using trusts where the revocable living trust is often named as the primary beneficiary on life insurance.   Effective August 17, 2012, proceeds payable to a revocable living trust under which the spouse, child, parent or other dependent of the Insured is the trust beneficiary are now exempt.

Nevertheless, the payment of a premium by insolvent insured would create presumption of fraudulent intent once a claim for liability is clear so purchasing a huge single premium annuity would not likely be protected from creditors.

Court finds that Assets transferred to an Alaska Asset Protection Trust are reachable in Bankruptcy

Court finds that Assets transferred to an Alaska Asset Protection Trust are reachable in Bankruptcy Creditor Protection

In Battley v. Mortensen, Adv. D. Alaska, No. A09-90036-DMD, the Court focused whether the grantor of the trust, Mortensen, intended to hinder, delay or defraud his creditors by establishing the Alaska Domestic Asset Protection Trust and transferring land to it.  The court applied Section 548(e) of the Bankruptcy Abuse Protection and Consumer Protection Act of 2005, which voids transfers if made within 10 years of the bankruptcy filing. 

Mortensen created the Alaska asset protection trust in 2005, naming himself and his children as the trust beneficiaries.  Mortensen expressly stated that the purpose of the trust was to “maximize the protection of the trust estate or estates from creditors’ claims of the Grantor or any beneficiary and to minimize all wealth transfer taxes.”  Mortensen transferred land to the trust and four years later filed for bankruptcy.  The court easily found that the Mortensen trust was a self-settled asset protection trust created to defraud creditors.



On April 4, HUD published Mortgagee Letter 2011-16 which reinstates its original non-recourse policy for the Home Equity Conversion Mortgage (HECM) reverse mortgage program. Now the HECM borrower, as well as the Estate of a deceased borrower, are protected by the non-recourse provision of the program no matter who purchases the home at the time of repayment, even if that homebuyer is a surviving spouse, family member or relative. This is a very important change.     Non-recourse means that the lender cannot seek a deficiency judgment against the borrower, his or her estate, or a family member who might purchase the home from the estate. Mortgagee Letter 2008-38 (issued in 2008) limited this non-recourse feature to arms-length purchases.

An Irrevocable Trust that Protects your Assets from Probate, Creditors, and Medicaid

An Irrevocable Trust that Protects your Assets from Probate, Creditors, and Medicaid

Among the misconceptions, I hear from clients, the following is one of the more troubling: a revocable living trust provides not only creditor protection, but also serves to shield trust assets from being counted by Medicaid should they need long-term care. 

 Revocable living trusts serve a very important estate planning function, primarily as a device that shields trust assets from probate during life (adult guardianship) and probate at death.   Illinois law, however, does not protect assets held in a revocable living trust from the grantor’s creditors, and trust assets are fully countable when determining eligibility for Medicaid, the primary payer of long-term care when an individual no longer has countable assets.

 In its simplest form, an individual (the Grantor or Settlor) creates a revocable and amendable trust agreement naming himself as the Trustee and beneficiary.   This trust is sometimes referred to as a “revocable living trust” or RLT.    After the trust agreement is signed, the Grantor may “fund” the RLT by retitling assets to the name of the RLT.  For example, the Grantor tells his bank to change the name of the savings account presently titled in the Grantor’s name alone, to a new name:  “Grantor, as Trustee of the Grantor’s RLT.”   By taking this step, the Grantor is converting the savings accounts from “probate” ownership (an asset titled in his name alone) to “non-probate” ownership” (an asset titled in the name of his RLT.)   During the Grantor’s lifetime, the IRS ignores the RLT for tax purposes and the Grantor continues to control the trust assets.  Since the Grantor still benefits from the assets in the RLT, his creditors can still reach the assets and Medicaid will still count the trust assets as available to the Grantor.

 Alternatively, the Grantor could create an irrevocable trust, relinquishing his ability to amend or revoke the trust.  If the Grantor conveys assets to the irrevocable trust, the trust assets would avoid probate in the same way as assets in a RLT avoid probate.  However, under Illinois law, an irrevocable trust under which the Grantor retains access to the principal, as a beneficiary of the trust, would not be protected from his creditors and the trust assets would be countable when determining eligibility for Medicaid.

However, if the Grantor relinquishes his right to principal, then such assets held in the irrevocable trust would not be reachable by his creditors (provided there was no creditor issue upon the creation of the trust) and assuming the applicable look back period had expired, the trust assets would not be countable by Medicaid in determining eligibility for Medicaid to pay for long term care.

 Even though the Grantor beneficiary cannot benefit from the principal of the irrevocable trust, the grantor beneficiary can receive all the ordinary income (interest, dividends, rent, and royalties), and the right to live in any trust-owned real estate. The irrevocable trust can be drafted to assure that the Grantor can take the capital gains exclusion should the primary residence held in the irrevocable trust be sold.   The primary residence, vacation homes, or rental properties are often ideal assets to fund this type of trust, particularly those properties that the client intends to hold for many years..

 Sometimes this type of trust is called an “irrevocable income only” trust or more popularly, the Living Trust Plus™. 

Nursing Home States Cause of Action in Quantum Meruit for services rendered to patient despite there being no written contract as required by the Nursing Home Care Act, 210 ILCS 45/1-101 et seq. (West 2008)

Nursing Home sued husband and his wife for failure to pay for over $134,000 for husband’s care and treatment.  Neither the husband nor his wife signed the contract outlining the services to be provided and the costs.  The Nursing Home sued Husband for breach of contract and sued the wife under the Family Expense Act.   The Nursing Home also sued the Husband based on quantum meruit.  Quantum meruit is an equitable claim founded on the implied promise of the recipient to pay for valuable services rendered, or otherwise the recipient would be unjustly enriched.

The Appellate Court approved the lower court’s dismissal of the breach of contract claim finding that the Nursing Home Act (the Act) requires that a written contact between the facility and the patient be “executed” which was not the case here.    The appellate court also concurred with the lower court’s dismissal of the family expense complaint finding that the action against the Wife was dependent on her husband’s underlying liability under the written contract and since the unsigned contract was unenforceable under the Act, no action under the Family Expense Act could proceed.

The Appellate Court did allow the complaint in quantum meruit to go forward.  Courts have refused to allow recovery under quantum meruit if the underlying contract violated public policy, but an action in quantum meruit can proceed in a situation where the formation or execution alone makes the underlying contract unenforceable.  The court noted that there was no assertion that the care provided to the husband was unsatisfactory. Consequently, the case is being returned to the lower court to allow the Nursing Home to demonstrate the services it provided and the reasonable amount it seeks to recover.   The Carlton at the Lake, Inc., Plaintiff-Appellant, v. Robert Barber, Individual, Defendant-Appellee., No. 07 L 8747, on appeal from the Circuit Court of Cook County, Illinois, decided on May 20, 2010.

Are Inherited IRAs Protected from Creditors?

Illinois as well as Federal Bankruptcy Law protects IRAs from creditors.  With the advent of inherited IRAs, whether creditor protection extends to these assets is far from clear.  There continue to be conflicting cases throughout the nation.  In a recent Texas case, the bankruptcy court determined that the IRA inherited by the debtor from his mother was not the equivalent of an IRA and consequently not creditor protected. In re Chilton, No. 08-43414 (Bankr. E. D. Tax. Mar. 5, 2010)    A Minnesota bankruptcy court found the opposite-that inherited IRAs were protected from the debtor’s creditors.   In re Nessa, No. BKY 09-60081 (Bankr. D. Minn. Jan 11, 2010)

Illinois House Bill 5282 – Creditor Protection

Currently pending in the Illinois House is a bill (H.B. 5282, 96th Gen.Assem. (2010)) that would extend the creditor protection available to spouses who hold title to their primary residence as tenants by the entirety to spouses who convey their primary residence to a joint revocable living trust of which they are the grantors and beneficiaries.