Everything must go

The insolvent estate. Three words to strike fear into the heart of any private client solicitor. However, for most of us, insolvent estates have not been all that common; after all, the whole purpose of estate administration is to settle up the debts and pass assets to the beneficiaries, but, given that reasonable funeral, testamentary and administration expenses always have priority over unsecured creditors, should we be so hesitant?

Orderly fashion

If an estate’s assets are insufficient to pay all of its debts, including the funeral and administration expenses, it is insolvent. Beneficiaries will not benefit, nor will creditors be paid in full. The concern of the practitioner is to establish the order in which debts are paid out of the remaining estate. The estate can either be dealt with by the personal representatives informally (even where they have no financial involvement) or else by a more formal procedure involving an administration order. In the latter, an insolvency practitioner may be appointed to administer the estate and to investigate the deceased’s pre-death financial dealings.

Given the inflexibility of the definition of insolvency, the starting point is to always remember who your client is – the personal representatives of the estate – and their need to be protected. If they have no financial interest you might have to even address the question of whether they should act at all.
If there is any likelihood of this, do not allow them to fall foul of ‘intermeddling’ in the estate. Intermeddling involves the personal representatives exercising their powers in any substantial way before applying for and obtaining a grant of representation. Examples include disposing of assets (including chattels) and giving receipts for payment. Any such actions will prevent personal representatives being able to renounce probate and may even lead to them being cited to take out a grant by creditors.

Assuming that personal representatives do want to act, then remember that both they and you do have some responsibility to the creditors of the estate and that it is more than likely that only ‘reasonable’ administration expenses will be approved. Where there is a creditors’ committee, it is good practice to let them have a copy of the retainer correspondence and run prospective payment of expenses by the committee before proceeding. That way, it is most unlikely that you will face any challenge to your bills: cooperation always makes the process easier.

In the majority of cases insolvent estates will be administered by the deceased’s personal representatives out of court. Here, the procedure up to obtaining the grant is largely the same as in any administration, in terms of identifying the assets and liabilities. However, do not underestimate the difficulties you may face in obtaining accurate information. Very often there is some jostling for position between different creditors and, if there is any doubt of the accuracy of a response, continue to press for further information. In one extreme example, an insolvency practitioner we appointed on behalf of the estate had to threaten court action to a bank to obtain documentation supporting a valuation. Likewise, with debts, all are provable and if contingent must be estimated at an early point in the administration.

Small print

Occasionally, you may have to obtain a grant of representation for a creditor. This will involve ‘clearing off’ those with a prior entitlement such as executors and residuary beneficiaries. A creditor taking out a grant is in the same position as any other personal representative as regards other creditors and should be advised to take the same protective measures. One such measure involves the lodging of statutory notices.

The increasing cost of lodging the advertisements is a factor for personal representatives in solvent estates and can often result in a reluctance to use the protection offered. However, in insolvent estates, notices should always be lodged in the London Gazette and in a newspaper local to any land owned by the estate. Known creditors to an insolvent estate will expect to see these notices lodged and they should be placed in the press as soon as possible during the administration process.

Personal representatives are also ?duty bound to make such searches as ?‘an intending purchaser would be advised to make or obtain’ (Trustee Act 1925, section 27(2)(b)). This may include Land Registry and Land Charges searches against the name and assets ?of the deceased.
In cases of solvent estates, practitioners are also advised to carry out bankruptcy searches against the names of any beneficiaries due to receive in excess of a de minimis sum, say £1,000. The personal representatives need to be fully protected against any trustee in bankruptcy of a beneficiary in all estate administrations. As stated, administration of insolvent estates out of court remains the most common option.

However, the other methods of administration in cases of insolvency are by the personal representatives in accordance with an administration order under the directions of the county court or High Court or in bankruptcy. The latter involves an insolvency administration order in the Bankruptcy Court following a petition either by the personal representatives or any creditor with a sufficient debt to have supported a bankruptcy petition against the deceased had he or she still been alive (presently £750).

The estate vests in the official receiver until the trustee in bankruptcy is appointed to conduct the administration. The extent to which bankruptcy applies depends on the procedure followed and this will also affect the extent to which the pre-death actions of the deceased ?can be examined.

In order to protect personal representatives, when it comes to the distribution of assets, practitioners need to make reference to the order of entitlement. In more complicated estates, it is often everyone’s interest for the estate to appoint an insolvency practitioner to finalise the distribution. Personal representatives can be personally liable where the priority order has not been followed and a lower priority debt is settled in preference to one of a higher priority of which they are aware.
Likewise, if one debt in a particular class is paid, all the debts in that class should be paid. If there are insufficient funds to pay all of these the personal representatives may find themselves personally liable to all the disappointed creditors in that class, unless the debt discharged was paid in good faith at ?a time the estate was not believed to ?be insolvent.

Creditors are divided into secured and unsecured, the latter being further subdivided as set out below. Secured creditors can rely on their security and take no part in the division of other estate assets if a secured asset is sufficient to cover the debt. To the extent it does not, then the security can be realised and the balance due proved in the insolvent estate or a value can be set on the secured asset and the balance proved. This is a riskier option, as, although the secured asset does not have to be realised, if the asset is valued too high then a creditor could ultimately lose out; too low and the trustee in bankruptcy or personal representative can exercise the right to redeem the security at the value set.

Debt ladder

In terms of unsecured debts, these fall into three categories: specially preferred, preferential and ordinary. It is very unusual to find the first of these, which relates to such things as money or property in the estate as a result of the deceased having been an officer of a friendly society or subject to military law.

Preferential debts are more common, and include arrears of state and occupational pension scheme contributions and also arrears of employees’ wages. Specially preferred debts must be paid in full before all of the unsecured creditors, to the extent there are insufficient funds in the estate, then preferential debts and ordinary debts will abate proportionately. The last to be paid are any deferred debts, the most common of which being a loan from a spouse or civil partner of the deceased.

It is interesting how the treatment of interest differs according to the type of debt. If a debt carries interest it is payable as part of the debt to the date of death. Where the estate is administered according to an insolvency administration order, then interest is payable to the date of the order.

Preferential and ordinary debts are treated equally with regard to interest if there are any funds remaining in the estate.

Finally, no consideration of insolvent estates would be complete without looking at the treatment of joint assets. Any bankruptcy order made before death has the effect of severing the joint tenancy leaving the deceased’s share of the estate (. The position is less clear when a bankruptcy order is made in the estate and not before death. The courts refused to allow a post-death severance ( but section 12 of the Insolvency Act 2000 reversed this, with the result that in some cases a court has a discretion to order the surviving joint tenant to pay an amount not exceeding the value lost to the estate (the court assuming creditors’ interests to have priority). This does, however, only apply if an insolvency petition is presented against the estate after 2 April 2001 and before five years have elapsed from the date of death.

In these times of recession, issues with administering insolvent estates are likely to crop up with greater frequency. Provided practitioners proceed with caution, take proper advice and remember their responsibility to personal representatives and creditors alike, there is no reason why they should not take on this lucrative type of work.

Michele Todd is a partner at hlw Keeble Hawson LLP