Inheritance Disclaimers and Bankruptcy – An Alternative Approach

 Written by: Robert DeMarco
Do Not Be Afraid to Be Creative – Nothing Ventured, Nothing Gained
What is a disclaimer of an inheritance and how does it interact with the Bankruptcy Code?  The Texas Probate Code provides “[w]hen a person dies, leaving a lawful will, all of his estate devised or bequeathed by such will, and all powers of appointment granted in such will, shall vest immediately in the devisees or legatees of such estate and the donees of such powers….” Texas Probate Code § 37.  However, no person is ever required or forced to accept such an inheritance.

Any person … who may be entitled to receive any property as a beneficiary and who intends to effect disclaimer irrevocably … of the whole or any part of such property shall evidence same as herein provided. A disclaimer evidenced as provided herein shall be effective as of the death of the decedent and shall relate back for all purposes to the death of the decedent….

Texas Probate Code § 37A; Dyer v. Eckols, 808 S.W.2d 531, 532 (Tex.Ct.App.1991). The effect of the foregoing is that a beneficiary never gains possession of disclaimed property. Dyer v. Eckols, 808 S.W.2d 531, 532 (Tex.Ct.App.1991).
From a bankruptcy perspective, a disclaimer can be a very useful tool in keeping family heirlooms and other assets from the reach of creditors.  Section 541 of the Bankruptcy Code provides that inherited property is property of a bankruptcy estate for up to 180 days AFTER a bankruptcy petition is filed.  As such, any inheritance a debtor becomes entitled to during that 180-day period, becomes, subject to any valid claim of exemption, property of the bankruptcy estate.  A disclaimer of inheritance can be used to prevent this result.
There is, however, more than one way to skin a cat and one should not consider the matters discussed herein as an exclusive solution.  For example, a debtor can always request the testator execute a new will during the pendency of the debtor’s bankruptcy case.  Alternatively, a testator might setup a testamentary trust that contains a spendthrift trust provision thereby precluding any such inheritance from ever coming into a bankruptcy estate.  These options, while effective, depend upon the testator to take the appropriate action.  Moreover, they assume the testator is competent to execute a new will.
The execution and filing of a disclaimer, on the other hand, remains within the exclusive control of the debtor and not the testator.  Timing, however, is everything.  There is a world of difference between a disclaimer that is executed pre-petition versus one that is executed post-petition.
As a general rule, a disclaimer that is executed prior to the commencement of a bankruptcy case is valid and not subject to being set aside as a fraudulent conveyance.  The Fifth Circuit Court of Appeals explained that because a beneficiary never possesses renounced or disclaimed property a disclaimer is not a fraudulent transfer.  Matter of Simpson, 36 F.3d 450, 453 (5th Cir. 1994).
On the other hand, a disclaimer executed after the bankruptcy case is commenced is ineffective.  In re Schmidt, 362 B.R. 318, 325 (Bankr. W.D. Tex. 2007).  Judge Clark explained as follows:

Because, as of the filing of the petition, the interest here in question was indisputably property of the bankruptcy estate, the debtor’s execution of the disclaimer constituted an impermissible attempt on her part to exercise dominion and control over property of the estate, over which the chapter 7 trustee alone has exclusive dominion and control. If anyone had the authority to execute a disclaimer, it was the chapter 7 trustee. It was certainly not the debtor.

Id.
The issue concerning if and when to execute a disclaimer creates some challenges.  First, disclaimers are traditionally executed and filed after the testator dies.  Second, disclaimers, if property filed and served are irrevocable.
While it is clearly not the norm for a disclaimer to be executed prior to the death of a testator [an anticipatory disclaimer], such a disclaimer can still be valid.  In re Estate of Boren, 268 S.W.3d 841, 849 (Tex. App.–Texarkana 2008, pet. denied).  In Boren, the Texarkana Court of Appeals reversed a probate court’s ruling that a decedent’s relatives had validly disclaimed their inheritance via an unambiguous instrument that predated the testator’s death and met all of the substantive requirements of section 37A except that the disclaimer had not been filed with the probate court. Id. at 848-49.
There remains, however, this issue of irrevocability.  Under Texas law a properly executed and filed disclaimer of inheritance is irrevocable.  As such, if one were to execute, file and properly serve an anticipatory disclaimer, such disclaimer would remain in effect until the testator executes a new will.
The purpose of this article is to propose a procedure whereby the execution of a disclaimer is effective vis-à-vis a chapter 7 bankruptcy trustee, but remains revocable by the debtor.  The Texas Probate Code is clear that a disclaimer is fully and freely revocable until it is filed in the appropriate court.  A disclaimer that is not filed in accordance with section 37A may, in fact, be revoked. In re Estate of Boren, 268 S.W.3d at 850. The failure to properly file the disclaimer rendered it revocable.  Id. at 849 (“until the disclaimers had been properly filed, they remained revocable.”).

Under the statute, once the proper filing and service of the disclaimer occurs, alea jacta est (“the die is cast”); it then becomes irrevocable. Because Richard and Jeanetta revoked their disclaimers before the disclaimers signed by them had been properly filed, they were effectively revoked. Accordingly, despite the fact that the form of the disclaimers was sufficient to satisfy the statute, irrespective of the intention they held to disclaim inheritance under Sarah at the time they were signed, and regardless of their expressed desires to heal the rift within the family, they were no longer operative after the revocation occurred.

Id. at 850 (footnote omitted).
As an unfiled or improperly filed disclaimer may be revoked, it is possible for a prospective debtor to execute and serve an anticipatory disclaimer prior to filing bankruptcy and simply not file the disclaimer.  In so doing, the prospective debtor retains the right to revoke the disclaimer, but has effectively disclaimed any inheritance.
That is all well and good, but section 541 of the Bankruptcy Code is construed broadly and would likely encompass a debtor’s right to revoke the anticipatory disclaimer if the need should arise.  As such, a prospective chapter 7 debtor must take certain additional steps to effectively prevent this right from passing into a future bankruptcy estate.  A prospective debtor must do two things in order that this objective might be satisfied:  1) authorize the beneficiaries of the disclaimer to file the disclaimer with the appropriate court at a point in time after the testator’s death thereby making the disclaimer irrevocable; and 2) grant a power of attorney to the beneficiaries of the disclaimer, which power of attorney is effective upon the commencement of a bankruptcy case and terminates after the expiration of 180 days from the bankruptcy petition date.
By authorizing the beneficiaries of the disclaimer to file the disclaimer, the subject beneficiaries are shielding themselves from the possibility that a chapter 7 bankruptcy trustee would consider such act to be a post-petition transfer of bankruptcy estate property.  The filing of the disclaimer should be construed as an act akin to the post-petition perfection of a security interest pursuant to section 546(b)(1) of the Bankruptcy Code.  As such, the “perfection” of the disclaimed interest should be shielded from the trustee’s avoidance powers under section 549.  While the filing of the disclaimer, makes the disclaimer irrevocable, the grant of such authority does not address the time period between the petition date and the testator’s death.  The Debtor must, therefore, execute a power of attorney authorizing the disclaimer beneficiaries to revoke the disclaimer at any time prior to death of the testator.  While a power of attorney may also be revocable at will, the revocability of the power of attorney ceases if coupled with an interest.  Hemphill v. Junious, 372 S.W.2d 580, 581 (Tex. Civ. App. 1963).  In this case that interest is the disclaimed inheritance and should therefore be irrevocable by a chapter 7 bankruptcy trustee.
In summary, the reader should note that the foregoing is little more than theory.  There is no case law to support the artifice that is created.  On the other hand, each component of the process, viewed separately, is independently supported by case law.  Further, it is not the intent of the author to convey any opinion regarding the best methodology when faced with the issues discussed herein.  As is more common than not, an individual debtor’s unique factual situation will dictate the appropriate path.  The trust of the matter is, it will often be much simpler if the testator works with the debtor to revise the will.  Where, however, it is not possible for a debtor to gain the cooperation of the testator [for whatever reasons] or the testator is no longer competent to execute a new will, the foregoing process may shield the inheritance from a bankruptcy estate.
DATED:  June 14, 2013