It is a commonly held misconception that when a person dies, his or her debts die with them. This is not the case unless specific provision has been made for it to happen, for example through a life insurance policy.
In fact debts will usually be paid from the assets of the deceased individual. If these assets, when realized, are insufficient to meet the individual’s debts and other liabilities in full, then the estate is insolvent.
Dealing with a deceased’s estate is going to be a testing time for the bereaved, but the situation will be far worse when the estate is insolvent. It goes without saying that everyone should strive to put their affairs in order before they die, but on those occasions where that hasn’t happened then it is vital that the Executors/Personal Representatives (PRs) verify the solvency status of the estate at an early juncture.
If the estate is insolvent then the provisions of any will made relating to the beneficiaries do not apply. The PR must resist the urge to administer the estate pursuant to the last will and testament of the deceased or the rules on intestacy. The estate should, instead, be administered under the provisions of the Administration of Insolvent Estates of Deceased Persons Order 1986 and section 421 Insolvency Act 1986. (IA86)
This is usually done in one of two ways:
The PR can apply for an Insolvency Administration Order (IAO). This is effectively bankruptcy for a deceased person but with additional provisions for items such as funeral, testamentary and administration expenses. The estate will be administered by a Trustee, often the Official Receiver, with the benefit of assistance and information from the PR.
The deceased’s creditors can also petition for an IAO. The estate is administered and distributed in the same way as a living bankrupt’s estate.
Informally without an IAO, by the PR using the principles and parameters laid down in the Insolvency Act. Whilst this can result in a greater return for the creditors, for example by saving certain charges levied by the Insolvency Service, as in the requirement to use its compulsory banking system, certain powers that a trustee would have, notably clawing back property that has passed by survivorship to any joint tenant(s)(see below) are not available and this may deter the creditors from cooperating on an informal basis.
Pitfalls for the unwary PR
When dealing with deceased estates, there is the possibility that family members or even professional advisors acting as PR to proceed with realization of assets and paying professional fees and expenses without having properly considered and appraised the full solvency position of the deceased estate.
PRs who fail to deal with the debt issues before paying professional fees or distributing to beneficiaries can be personally liable for what has been incorrectly distributed.
The insolvency of the estate may not be immediately apparent where, there are contingent or prospective liabilities that crystallize post death, for example bank guarantees from previous businesses or legal fees from disputes. Even professionals acting as PR are occasionally caught out by this.
Unknown debts, kept secret from family members, may arise
Often real property and certain other assets are held jointly by the deceased and others. These assets do not form part of the estate and instead pass, by survivorship, to the surviving joint tenant. The trustee of an insolvent estate, providing certain conditions are met, may seek to recover the value of the deceased’s interest in an asset that passes by survivorship by applying to Court. The Court may require the surviving partner to pay an amount up in compensation up to the value lost to the estate. This law (Section 421A of the IA86) can only be applied by a trustee, so an insolvency administration order would need to be in place. In purely practical terms it may well be that the surviving joint tenant in whom the property has vested by survivorship may not have the resources available to pay the “compensation” and the property in question may have to be sold to generate the funds required.
The Order of Priority set down by IA86 must be followed when distributing available assets in an insolvent estate. This applies in both formal and informal situations as described above. That order is:
- Secured Creditors
- Expenses of the Insolvent Estate (including the petitioner’s costs, capital gains tax and inheritance tax where applicable)
- Reasonable Funeral, Testamentary and Administration Expenses
- Preferential debts
- Ordinary (unsecured) debts
- Interest on preferential and ordinary debts
- Deferred debts
Note that in all cases reasonable funeral and administration expenses are paid before any other debts. They include the expense of the funeral, of obtaining a grant of probate or letters of administration, the payment by the representative of debts falling due after the death of the deceased (e.g. rent), the costs incurred by the representative in obtaining the advice of solicitors and counsel as to the administration or distribution of the estate and the expenses incurred by the representative in protecting the deceased’s estate (other than property specifically devised or bequeathed).
Whilst acknowledging that the PR of an insolvent estate does not legally need to be a Licensed Insolvency Practitioner, we believe that that person would need to have the requisite knowledge and understanding of bankruptcy procedures, processes and law in order to fulfil their obligations. Accordingly, we would recommend engaging a Licensed Insolvency Practitioner to assist the PR, whether they are family members or legal professionals.
We work courteously and respectfully in the knowledge that both debt and death are emotive subjects.
If you are in a position where you are dealing with the financial aspects of someone who has passed away or even want to recover a debt you are owed by a deceased debtor then please contact us on the number below.
Please call John Paylor on 020 3096 0750 if you would like to discuss your circumstances and how GBR can assist you.