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Executors and trustees are obligated to identify beneficiaries and account for any distributions of an estate or trust’s assets. However, complications arise when property or trust proceeds are payable to a beneficiary going through bankruptcy. This spring, the Ontario Court of Appeal provided guidance to executors and trustees facing this complex intersection of estate/trust and bankruptcy law.

Trust established to hold Toronto residential property

The case of Re: Richards concerned the beneficiary of a trust. The beneficiary’s father created the trust in 2001 to hold the family’s Toronto home during the beneficiary’s parents’ lives, with a life interest permitting them to continue living in the house. The beneficiary’s father died in 2010. His mother continued to live in the property until she passed away in 2020.

Under the trust’s provisions, the date upon which the second of the beneficiary’s parents died was the “Time of Division”. The trust requires the trustees to distribute the trust fund (including the property) to the beneficiary at the Time of Division. The home itself was sold before the beneficiary’s mother’s death, with the sale proceeds of $1.1 million being held by the trust.

Beneficiary was undischarged bankrupt owing nearly $1 million

In 2019, the Royal Bank of Canada (RBC) was granted a bankruptcy application against the beneficiary, who owed almost $1 million to RBC under a judgment. In October 2020, RBC obtained an order under the Bankruptcy and Insolvency Act in which it was assigned certain rights held by the beneficiary’s Trustee in Bankruptcy. The order granted to RBC empowered it to make a claim against the proceeds from the sale of the property (the family home) held by the trust.

RBC brought a motion to recover its judgment from the sale proceeds held by the trust. It argued that the sale proceeds constituted property of the bankruptcy (the beneficiary) as defined under the Bankruptcy and Insolvency Act. As property of the bankruptcy, the sale proceeds would vest in the Trustee in Bankruptcy and form part of the beneficiary’s estate.

Beneficiary argued interest in trust property suspended during bankruptcy

In his defence against RBC’s motion, the beneficiary argued that his interest in the property under the trust was suspended while he was in bankruptcy. He cited section 4.2 of the trust documents, which read:

“Any right of a Beneficiary to receive any income or capital of the Trust Fund as a result of a mandatory direction to the Trustees to make such a distribution, including, for greater certainty, a mandatory entitlement of a Beneficiary to the exclusive use, occupation and enjoyment of the Real Property and the Chattels …. shall be enforceable only until such Beneficiary shall become bankrupt … whereupon and so long as the effect or operation thereof shall continue, the Beneficiary’s Interest shall cease until the cause of the Beneficiary’s Interest becoming vested in or belonging to or being payable to a person other than such Beneficiary shall have ceased to exist … and then the Beneficiary’s Interest shall again be allocated to such Beneficiary as aforesaid unless and until a like or similar event shall happen whereupon the Beneficiary’s Interest of such Beneficiary shall again cease and so on from time to time.”

The beneficiary stated that his interest in the property could not vest in his Trustee in Bankruptcy as, under section 4.2 of the trust, he had no rights to the property until he was discharged from bankruptcy. However, the bankruptcy judge rejected this argument.

Money inherited by undischarged bankrupt must be paid to trustee in bankruptcy

When an undischarged bankrupt inherits money, the amount owed to another party must be paid to the bankrupt’s trustee in bankruptcy. An executor or trustee is not permitted to hold onto a beneficiary’s share until the bankruptcy has been discharged.

The Court of Appeal applied this principle to the beneficiary’s appeal of the bankruptcy judge’s decision. It concluded that the bankruptcy judge was correct in finding that the trust property vested in the beneficiary at the Time of Division and thus constituted. In turn, that property was subsequently vested in the Trustee in Bankruptcy. Since the Trustee in Bankruptcy had assigned its rights to RBC, RBC was entitled to recoup the amounts owing to it from the proceeds of the property sale.

Further, the Court of Appeal observed that the interpretation of the trust put forth by the beneficiary would offend the public policy considerations protected by the Bankruptcy and Insolvency Act. The beneficiary’s interpretation would effectively allow undischarged bankrupts to place assets out of their creditors’ reach and deprive creditors of their right to recover the debts owed to them. This principle, known as the anti-deprivation rule, was set out by the Supreme Court of Canada in its 2020 decision of Chandos Construction Ltd. v. Deloitte Restructuring Inc.:

“… the anti-deprivation rule renders void contractual provisions that, upon insolvency, remove value that would otherwise have been available to an insolvent person’s creditors from their reach.”

Contact Derfel Estate Law for Comprehensive Representation in Trust Disputes

Derfel Estate Law understands that trust disputes can be contentious and involve a great deal of uncertainty, conflicting interests, and family dynamics. Our skilled trust and estate litigation lawyers take swift action to mitigate possible risks and protect the estate or trust assets. We are conveniently located in Toronto and provide highly personalized and responsive services across the Greater Toronto Area and throughout Ontario. To schedule a confidential consultation, please call 416-847-3580 or reach out online.

For professional service and knowledgeable advice on Estate Law matters contact Derfel Estate Law

Contact Derfel Estate Law today to speak with a Toronto estate lawyer who will work tirelessly to achieve the best possible resolution to your will, estate, power of attorney, or trusts dispute.

Call us at 416-847-3580 or contact us using the form.

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