How to deal with an insolvent estate

Not every estate is a windfall for beneficiaries. Some estates are insolvent, with more debts than assets. In such situations, what should an executor do—and more importantly, not do?

Landmines all over

“There are landmines all over the place,” says Mike Beishuizen, founder at Westcoast Wills & Estates in North Vancouver, who previously worked with the province’s Public Guardian and Trustee. “Instead of just sending creditors money, all of a sudden they’re involved in the process.”

That can make even the most straightforward decisions a source of conflict with creditors. “The executor has to be very careful about what’s an estate expense properly payable out of the estate—they could be contested by these creditors who have to sign off on everything.”

Beishuizen offers a hypothetical example of an estate with real estate: “Can you hire a cleaning company to come in, clean up the mess and remove all the property? Yes, because that’s a proper estate expense. But can you pay someone to repaint the place?” he asks. “When creditors review the accounting at the end of the process, they could say: ‘What’s that $5,000 bill for painting? I’m not going to allow that. That’s my money you’re paying out to this painter.’”

Insolvent estates: traps and landmines for executors

“Accidentally” accepting the job: Once an executor begins accessing bank information, advertising for creditors or other administrative duties, they are duty-bound to accept the role, even if they decide later to decline it.

Paying bills immediately: Creditors must be paid according to the legal order of priority, not on a first come, first served basis. Failure to do so could expose executors to personal liability for debt left unpaid.

Playing favourites with creditors in the same class: Creditors within the same class must be paid at the same time. If any creditors receive priority within the class (e.g., family members), the executor could be personally liable for unpaid debt.

Lack of communication: Failure to be forthcoming and transparent with creditors can cause conflict and hassles for executors, and can lead to delays, obstruction and legal challenges.

Failure to keep proper records: Creditors could challenge fees and expenditures associated with estate administration; failure to properly back up expenses with receipts and rationales could lead to the executor being unable to claim them against the estate.

Before paying creditors, executors must classify and organize estate debts according to their assigned legislative priority (see “Payment for insolvent estates”) and follow that official priority to the letter.

As Beishuizen explains, executors cannot negotiate individually with creditors who pester them, nor can they cut deals with creditors who are willing to receive smaller payment in exchange for quicker payment. “You have to pay all of the same class [of creditors] the same,” he says. “So if it works out that there’s enough to pay 80% of these claims, then you have to pay 80% of each claim. Or else one of the creditors could sue.”

Nobody’s happy

David Mifsud, founding partner of George Street Law Group in Hamilton, Ont., says that while an executor’s actual administrative duties are the same whether an estate has no assets or a billion dollars, the executor’s job is much more difficult with insolvent estates.

“There are more decisions to make,” he says. “You immediately need to apply more attention to who the creditors are, assessing what their debt is [and] where it would rank in priority of payment.”

That can cause stress for executors when informing creditors or beneficiaries that they’re going to get less than they expected. “Nobody’s happy with you,” he says.

Executors must fight the inclination to get the job done as quickly as possible. “You really want to get a lay of the land, and figure out what the assets and the debts are before you start paying things out,” Mifsud says. “If you’ve paid out an unsecured creditor in full and now you can’t pay out a secured creditor, that can expose [you] to liability.”

That’s why Mifsud says professional advice is a must. “There’s no rulebook that an executor can just pop out on how to deal with an insolvent estate and just check off the steps as you go.”

Given that legal fees are typically considered a reasonable expense for executors to pay—even if the estate is insolvent—most people prefer to pay a lawyer rather than expose themselves to liability, he says.

Payment for insolvent estates

The exact order depends on the province in which the estate is domiciled, so this should be viewed as a general list:

• Secured creditors—debts held against specific assets, or a class of assets (mortgages or car loans, for example). Because these debts are held against specific assets, pro-rating is not necessary (see point 6, below).
• Funeral expenses—note that these expenses must be reasonable.
• Estate administration expenses—payments to executors, lawyers and other professionals involved with administering the estate. In theory, executors could be personally liable for such expenses if paying them makes it impossible to pay secured creditors or funeral expenses (although this would be very rare in practice).
• Debts with legislative priority—these differ considerably from province to province, but may include child maintenance, rent, wages owed to employees, employment insurance, municipal taxes and other debts.
• Taxes—in some provinces (e.g., Ontario) there is ambiguity about whether federal tax receives priority over other unsecured creditors.
• Unsecured creditors—all other debts owed by the estate. Executors are required to treat unsecured creditors equally, and pro-rate payments for all debts.