An estate is deemed to be bankrupt when the total value of its debts and liabilities (including conditional and future liabilities) is greater than the total value of its assets. A bankrupt estate is often a very daunting prospect for the executors or administrators (the PRs). The task of administering such an estate is challenging and often fraught with pitfalls. What should the PRs look out for?

If I was to provide some top tips for those potentially faced with insolvent estates, I would say the following are my top 3:

1 – Identify if the estate is insolvent early, so as to avoid problems later.

If you are put in charge of an estate that is being pursued by one major creditor, often the HMRC, check whether there are charges, particularly second and third charges over the deceased’s property and/or there are pending disputes as to the ownership of the deceased’s assets. A debt to the tax man need not be the evidence that the deceased was bankrupt. However, all factors listed above are signs of potential problems with solvency. Do not ignore them!

2 – Do not pay anyone anything, until you know what all the assets and liabilities of the estate are.

There is always an urge to pay a creditor or a beneficiary who is pursuing “what is theirs” a bit aggressively. However, the approach of “I will get rid of problem one and deal with the rest later” will not pay off!

When the estate is insolvent, the PRs are obliged to pay the liabilities and debts in a specific order:

a) Costs and expenses of administration are payable before any creditors

b) Funeral expenses are payable as a priority debt, i.e. before payments to any unsecured creditor. Sometimes, the funeral expenses will be payable even before a payment to a secured creditor is made. This is when e.g. the estate has only secured creditors.

c) Secured creditors are those whose debt is secured by e.g. a charge on a specific asset. They get paid out of that asset. If the value of the asset is not sufficient to satisfy the debt, any unpaid balance of the debt becomes an unsecured debt.

d) Unsecured creditors are all the other creditors whose debts are not a priority or are not secured. If the assets of the estate are not enough to pay all, the unsecured creditors get paid on a pari passu This means that if a debt to Mr X constitutes 70% of all unsecured debts, Mr X will receive 70% of what is left in the estate (after payment to the groups as set out above).

e) Beneficiaries get their legacies only if there are assets left in the estate after payment to all secured and unsecured creditors. In other words, when an estate is bankrupt, the beneficiaries will get nothing!

The consequences of getting the above wrong may be catastrophic. If a PR pays a debt to an unsecured creditor in full, he is obliged to pay the liabilities due to all the other creditors in full. The liability is a personal one. If you have paid out 100% of any debt, you may have to refund the balance over the % that should have been distributed. Hence, if the assets in the estate are not sufficient, the PR will be personally liable for any balance due to the creditors.

3 – Do not incur costs and expenses, which are not recoverable

The bankruptcy of the estate takes effect at the date of death. Hence, all transactions made from the date of death until the date of the Insolvency Administration Order are void. This means all payments of the PRs’ costs are void, unless they are validated by the court.

As we know from case law, the court will not validate expenses which were not incurred for the benefit for all creditors and beneficiaries of the estate (i.e. increased the estate’s assets or reduced liabilities).

This may sometimes be tricky. For example, it may be tempting to have an argument with a major creditor who makes exaggerated demands. After all, if you win the argument, you will benefit the estate (and thus all its creditors and beneficiaries). Well… true, but you must always consider the risks involved in such an approach as well.

In Re Vos [2006] BPIR 348the Lloyds Bank was pursuing an individual for debts. The person died and his executor continued the fight. He hired solicitors to do that and paid those solicitors for their service, as is usual, with the estate’s funds. The estate was held insolvent. How surprised were both the executor and his legal advisers, when the court held that the payments received by the solicitor were not “in return for beneficial services rendered to the estate”. As such they ought to be paid back to the estate with interest.

For general advice on how to manage the risks involved in administering a bankrupt estate or for an article on what may be the alternative to administration of a bankrupt estate by the PRs, please look out for my further blogs on the subject.