Gun Trusts Not Bulletproof in Bankruptcy

Of all the topics that is sure to incite impassioned disagreement in our current age of partisan disunity, the issue of guns must be near to the top of the list. While some see guns as a uniquely American scourge leaving untold tragedy and carnage in their wake, others view the right to keep and bear arms as the foundation of liberty and the only insurance against tyrannical government. For chapter 7 debtors in the latter category, having to turn over their guns to a panel trustee to administer as property of their bankruptcy estates is a waking nightmare: the government has come to take away their guns.

Several state exemption laws are very respectful of individual gun ownership. For example, the State of Iowa specifically exempts “[o]ne shotgun, and either one rifle or one musket.”[1] The State of Oregon provides that “[e]very citizen of this state above the age of 16 years shall be entitled to have, hold and keep, of the own use and defense of the citizen and shall have exempt from execution one rifle or shotgun and one pistol ... not [to] exceed $1,000.”[2] In all, 13 states provide explicit protection for firearms against creditors.[3]

Other states without specific exemptions for firearms have, in their exemption statutes, wild card exemptions that may be applied to firearms. Additionally, some states allow a debtor to elect to use the federal exemption statute, which also contains a wild card exemption. This leaves a number of states with no explicit protection for firearms, no wild card exemption, and no option to choose the federal exemptions.

Perhaps as a result of the often nonexempt nature of firearms, or perhaps for other unrelated reasons, chapter 7 panel trustees have begun to encounter a relatively new asset that debtors assert is beyond their reach: the gun trust.

A gun trust is just what it sounds like: a trust with a corpus consisting of guns. Like any other trust, a gun trust is formed by the settler of the trust, who appoints a trustee to administer the trust on behalf of the beneficiaries. It is most likely that the trust was created as a workaround of federal or state gun restrictions, rather than asset-protection.[4] For example, several types of weapons and accessories fall under the regulatory umbrella of the National Firearms Act.[5] Fully automatic rifles, short-barreled rifles and silencers cannot simply be bought in a gun store; they require lengthy application processes, the purchase of a tax stamp, and, at least until recently, the permission of the county sheriff before they can be owned.[6] Many states have strict limitations on the transfer of guns between individuals. In response, a niche market for lawyers developed around the creation of legal entities that could be exempted from many of these requirements, could allow several people to have legal access to the same guns without subjecting each person to the regulatory burdens, and could provide an efficient means of transferring firearms without breaking the law.

When the owner of an interest in a gun trust files bankruptcy, the question arises as to whether or not the trust becomes part of the estate. No published case law specifically addresses this question. However, because a gun trust is essentially just a trust with a specific type of corpus, the answer can be discerned by looking at the case law as it pertains to other trusts. The treatment of trusts in bankruptcy proceedings is highly dependent on state law. For example, the Tenth Circuit BAP looked to Kansas law to determine that “a trust beneficiary holds equitable title and the trustee holds legal title to property held by a trust[, t]herefore, the Debtors hold an equitable interest in the Real Property that is sufficient to make it property of the estate.”[7] The Ninth Circuit BAP decided that “where the debtor was in effect a beneficiary of a self-settled spendthrift trust by virtue of the power to use the trust assets for his own benefit, certain real property titled in the debtor as trustee of that trust could be reached by the debtor’s creditors under California law and, hence, was property of the estate.”[8]

Not all trusts are created equal. So-called spendthrift trusts are harder for creditors to reach because the interests of the beneficiaries are severed from the settler and the trustee of the trust. Conversely, in a self-settled revocable trust, the settler and the beneficiary, and more often than not the trustee of the trust, are all the same person. The settler of a gun trust that was created to deal with gun regulations likely wants to be included in the benefits of the trust and not relinquish management powers over the trust. Unless the settler established the gun trust with asset protection as a priority, the trust will probably be of a type that is more easily accessed by a panel trustee.

Even if state trust law makes it difficult to argue that the trust becomes property of the estate, another approach that a panel trustee could use to liquidate it is to exercise any powers the debtor may have. Whatever legal and beneficial interests the debtor has in the trust can be wielded by the panel trustee.[9] In the case of a revocable trust, if the debtor was the settler of the trust and retained the absolute right to revoke the trust, what is to stop the panel trustee from exercising the debtor’s revocation rights? Or, if the provisions of the trust allow the settler to replace the trustee of the trust, and the debtor is the settler, what would prevent the panel trustee from appointing himself trustee of the gun trust?

Conclusion

For gun owners in states that do not specifically exempt firearms, allow a wild card exemption or permit the election of federal exemptions, a gun trust may offer a false sense of security if not properly structured. Gun trust attorneys might not have much experience with bankruptcy exemptions, but they should familiarize themselves so as not to provide a faulty product to their clients if asset protection is expected. A good rule of thumb is this: The more legal and beneficial interests that the settler of the trust retains, the less protection the trust will provide from a diligent panel trustee in chapter 7 bankruptcy.