Issues With Insolvent Estates

A legal personal representative (LPR) has an obligation to collect the assets of an estate and pay any estate liabilities from such assets before distributing the surplus to beneficiaries. 

Sometimes, however, there are insufficient assets in the estate to pay the estate debts.  This can simply be because the deceased did not leave sufficient wealth, or it can be unintentional where the deceased has made inter vivos gifts of assets prior to their death leaving a nominal amount in the estate which does not cover liabilities. Estates can also become insolvent with the effect of laws of survivorship where a surviving joint tenant may technically step up to take full ownership of most of the deceased’s assets outside the Will, leaving the estate technically unable to pay its debts.  Estates such as these are known as insolvent estates. 

An insolvent estate can be administered by the legal personal representative (that is, the executor appointed by a Will) (LPR) or by a trustee in bankruptcy pursuant to the Bankruptcy Act 1966 (Cth) (which can be the LPR or a creditor).  

But these estates will be administered differently to solvent estates and will need to take account of not only relevant successions laws but also the laws of bankruptcy. There are also special rules relating to life policies and superannuation.

Insolvency considerations for attorneys before death

Insolvency should also be considered before death if attorneys step in to take control of the affairs of its appointor where there are insufficient assets. When a power of attorney becomes operative, this usually comes at a very difficult and highly emotive time where the appointor/principal has suffered some loss of capacity. Too often we see attorneys, whose only priority is to assist their appointor (who is usually a close family member), step into a ‘caretaker’ role, including director roles without proper legal and accounting advice.

An attorney who steps into a director role of a company assumes all the duties and liabilities of a director at law, including the duty to ensure that a company does to trade whilst insolvent. A company is insolvent if it is unable to pay its debts when they fall due. Before an attorney, acting as a director, incurs new debts, they must consider whether they have reasonable grounds to suspect the company is insolvent or will become insolvent as a result of incurring the debt. Penalties for any breach apply, including civil penalties, compensation and criminal charges.

Any attorney looking to take on a director role should seek legal and accounting advice and should ensure that they then remain constantly aware and informed of the company’s financial position.

Administration of insolvent estate by LPR

If a deceased person was already bankrupt at the time of his or her death, then administration of the bankrupt estate will continue.

Otherwise, an LPR who discovers the estate is insolvent may either apply to administer the estate under the relevant succession laws and distribute the assets in the priority set out by the relevant succession laws or instead apply to the Court for a sequestration order making the estate bankrupt under the Bankruptcy Act 1966 (Cth). In the latter case, the LPR will generally have very little further involvement and will hand over control to the trustee in bankruptcy who will administer the estate in accordance with the relevant bankruptcy laws in terms of order of priority.

It is possible for a creditor (or group of creditors) who are owed more than the prescribed amount to make application for a sequestration order.

An important point to note is that an LPR should be made aware of the risk that they could be personally liable for debts if they incur costs on the estate after they were made aware the estate was insolvent. Accordingly, prompt action should be taken by an LPR to assess the position of the estate upon commencing their appointment.

In some cases, applying for bankruptcy may be preferential for creditors because bankruptcy laws sometimes allow access to certain assets (e.g. void transactions) that might not have otherwise be available. However, sometimes the costs to apply for bankruptcy may outweigh the eventual return so it becomes a weighing up exercise to decide on the best course based on the facts. For example, in smaller insolvent estates where there are very little assets and liabilities, we generally have found it is easier to contact all the creditors, advise them of the situation and ask the creditor to write off the debt. In these circumstances, apprised of all the facts, smaller creditors are usually quite sympathetic and co-operative.

If the LPR decides to administer the estate, he/she will generally be required to pay the funeral, testamentary and administrative expenses first, with the balance assets (if any) to be distributed according to bankruptcy laws.

Liability of LPR for deceased person’s debts

It is important to note that a person generally cannot ‘inherit’ liability of the deceased, except where it was already a joint debt or the beneficiary/LPR had guaranteed the liability of the deceased. However, an LPR can be personally liable in their role in administering an estate. Examples include:

  • An LPR may be personally liable for any contract they enter into after the death of the deceased.
  • LPRs can become personally liable for tax as an executor of an estate.
  • If an LPR distributes an asset before probate is obtained and all debts and taxes are paid.
  • If the LPR receives a notice of an undisputed debt but still proceeds to distribute assets.
  • If the LPR distributes an estate earlier than 6 months after the date of death where no notice of a family provision application has been received, or before 9 months if notice of an application is received or where that application has commenced in Court.

Accordingly, an LPR is generally protected by statute if they wait the relevant time periods, properly administer an estate and distribute an estate in good faith after paying all known debts.

In light of the above, a legal personal representative should ensure that all liabilities of the estate are determined as soon as possible.  As part of this process, they should advertise two notices:

  • a notice of intention to distribute the estate, which allows creditors to give notice of a claim. The legal personal representative is then entitled to require the creditor to take proceedings to prosecute their claim within six months, failing which the legal personal representative can apply to the court to make orders barring the claim. 
  • a notice of intention to apply for probate which includes a notice to creditors/beneficiaries in which they have a period of six months from the date of death to give the legal personal representative notice of their intended claim.

The above notices provide protection to the legal personal representative where the estate is administered outside of these timeframes/milestones.

What about superannuation and life policies?

An important point to note in insolvent estates is that there is statutory protection of superannuation and life insurance.  That is, under sections 249 (6), (7) and (8) of the Bankruptcy Act 1999 (Cth) superannuation and life insurance paid into an estate cannot be used to discharge debts.  This is a mechanism many people rely on to ensure their beneficiaries still receive a benefit after their passing, regardless of the state of their individual financial position.  Of course, adopting this as an estate planning strategy should only be undertaken under the guidance of an estate planning lawyer who has assessed your situation and determined that this is in fact the best course of action in your circumstances.   


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