We’re all too familiar with the saying that only two things in life are certain: death and taxes. However, in law circles, another issue is never far away: Bankruptcy.

Whether it’s through inheritance planning, managing tax liabilities, or addressing financial crises, a significant part of legal advice revolves around mitigating the effects of these inevitable challenges. But what happens when they intersect? Specifically, can someone who has been declared bankrupt inherit money or property? Let’s look at how sequestration - the Scottish term for personal bankruptcy by formal court process - impacts your ability to benefit from an unexpected windfall or legacy.

The role of solicitors in inheritance and bankruptcy planning

Solicitors in Scotland play a vital role in protecting their clients’ assets. When preparing a will, for instance, a legal adviser doesn’t just ensure that the right people inherit - they also consider the wider implications. This could include the potential for inheritance tax, capital gains tax, or the possibility that the client, or their estate, could fall into bankruptcy.

Sequestration occurs when debts have become unmanageable, leaving the debtor unable to pay them in full or within a reasonable time. This can be initiated voluntarily by the debtor or forced by creditors seeking repayment. Once a bankruptcy order is granted by the court, control of the debtor’s financial affairs is handed over to a trustee, who takes charge of all assets and liabilities.

The trustee (often an accountant or lawyer) has a legal duty to act in the interests of the creditors. This means the debtor can no longer decide what assets to retain or manage, nor can they selectively exclude anything from the trustee’s control.

What happens to inheritances during bankruptcy?

Here’s where it gets tricky. Imagine you’ve been declared bankrupt, and during this period, you inherit money or property. Is it yours to keep? The short answer is no.

Scottish law stipulates that any assets or wealth acquired within four years of the bankruptcy’s start date automatically become part of the debtor’s estate. This includes inheritances, regardless of whether they were anticipated or come as a surprise.

Known informally as a “windfall,” such an inheritance must be disclosed to the trustee, who will use it to repay creditors. The trustee cannot exercise discretion or make exceptions; their primary responsibility is to recover as much as possible for the creditors. Failing to disclose an inheritance or attempting to mislead the trustee can lead to severe legal consequences, including criminal penalties.

Is timing everything?

If you’re in financial distress and expecting an inheritance, timing might offer a potential way to avoid sequestration. Delaying bankruptcy until you receive the inheritance could allow you to use the funds to pay off your debts and prevent sequestration entirely. However, this approach is fraught with challenges and risks.

For example, transferring the inherited money to family or friends in an attempt to protect it from creditors is unlikely to succeed. Trustees have the authority to investigate financial transactions made before the bankruptcy; therefore, they can reclaim any assets given away or sold at undervalue as part of an artificial attempt to avoid repaying debt.

Another suggestion might be to rewrite the deceased’s estate through a Deed of Variation, redirecting the inheritance to someone else. While this is theoretically possible, in practice, it’s unlikely to be effective, especially if the intention is to bypass the trustee’s claims.

The bigger picture: Debt and financial ruin

Bankruptcy, while a necessary legal remedy in some cases, is a stark reminder of the dangers of excessive debt. For many, it represents the culmination of financial difficulties that have spiralled out of control. An inheritance, often seen as a lifeline, can quickly be swallowed up by sequestration, leaving the debtor with little to show for it.

The emotional toll can also be significant. Inheriting money or property often coincides with the loss of a loved one, with the financial realities of bankruptcy then making an already difficult time even harder.

How to protect yourself

The best way to avoid the harsh realities of sequestration is to take proactive steps before debts become unmanageable. Seeking advice from a solicitor or financial adviser can help you explore options to restructure debt, manage repayments, and protect your assets.

If you’re already facing bankruptcy, understanding the legal implications is crucial. Be transparent with your trustee, and avoid any actions that could be construed as attempts to hide or divert assets. While there may be limited ways to protect an inheritance once you’re bankrupt, working collaboratively with your trustee ensures you stay on the right side of the law.