A chapter 7 bankruptcy allows you to wipe your debt slate clean and get a fresh financial start. In this type of bankruptcy, you surrender control of your assets to a trustee, who may liquidate or sell them in order to pay your creditors. Often an irrevocable trust with a minor beneficiary is protected from your creditors, but depending on the timing of when the trust is created, as well as your reasons for creating it, it may be vulnerable.
Trusts and Bankruptcy
A trust shelters assets on behalf of a beneficiary. If you've set up an irrevocable trust for your child, the trust under the control of someone else, your selected trustee. You are no longer considered to have any ownership or control of the assets, and you can't change the terms or revoke the trust except under very limited circumstances. Therefore, an irrevocable trust that you've set up for a minor often remains protected from your bankruptcy proceeding -- you don't have any ownership of those assets, so there's nothing for your creditors to take from the trust. The assets don't belong to you.
Under the Uniform Fraudulent Transfer Act, if you transfer property to an "insider," such as a minor relative, with the intent to defraud a creditor, that creditor has the right to sue and recover the property. This would effectively lay another court case over your bankruptcy, even if the bankruptcy trustee makes no claim on the assets of an irrevocable trust. In addition, the creditor would have the right to sue the insider who received the assets, or the trust that holds the property. If the creditor wins a judgment, the court can order seizure of assets out of the trust.
Actual and Constructive Fraud
If the bankruptcy court decides you have moved assets into an irrevocable trust with the intent of sheltering them from your creditors, you could be charged with fraudulent conveyance. Whether it's considered "actual" fraud, meaning that you really intended to hide the assets from your creditors, or whether it's "constructive" fraud, meaning that you unintentionally did so, the effect was the same: you cheated your creditors. For example, maybe you had no idea that it was against the law to try to shelter your own assets from bankruptcy by creating a trust for your child. Even if you intended to do nothing wrong, it might be considered constructive fraud.
According to Goldstein & Clegg, LLC, the bankruptcy court can look back four years before you filed the bankruptcy petition, to see if any trusts were created or assets were given away. For example, if you set up your irrevocable trust for your child five years before you filed for bankruptcy, the trust should be safe from your creditors. If you created it three years before, it may be vulnerable. The trust could be declared void and your creditors then would be paid with the assets.