Red zone

The first tip is that it may be better to decline to act. Personal representatives (PRs) risk personal liability if they pay creditors in the wrong order, and professionals acting in the administration will not necessarily be paid.

Unfortunately, it may not be apparent at the outset that an estate is insolvent. PRs may have taken out a grant or, in the case of an executor, accepted office by intermeddling before becoming aware the estate is insolvent. Estates may appear large but have unexpectedly large liabilities lurking. The Jimmy Savile estate is a high-profile example of an estate with hidden liabilities. You need to be cautious.

Will you get paid?

As a result of section 35(3)(b) of the Trustee Act 2000 (TA 2000), a solicitor’s charges, whether made under an express charging clause or the statutory power contained in section 28 of the TA 2000, are “administration expenses”, rather than a legacy. As such, they have priority for payment. However, the estate may be too small to cover them. Therefore, if there is a chance that an estate will be insolvent, assess the risk before committing a substantial amount of time to the estate. Professional executors, and indeed other executors, may want to renounce.

There is also a danger that if a trustee in bankruptcy (TIB) is later appointed, professional charges may not be ratified by the court: see below.

When is an estate insolvent?

An estate is insolvent if the assets are insufficient to pay all the funeral, testamentary and administration expenses, debts, and liabilities. The beneficiaries of the deceased’s will or those entitled under the intestacy rules will receive nothing, and the creditors of the estate will not all be paid in full.

The administration of insolvent estates is governed by the Administration of Insolvent Estates of Deceased Persons Order 1986. The 1986 order creates some difficulties because, instead of containing a complete code applicable to insolvent estates of deceased persons, it contains numerous paragraphs “modifying” the provisions of the Insolvency Act 1986 (IA 1986) that apply to living debtors. Unfortunately, it is often not clear how the modifications take effect.

Who administers an insolvent estate?

There are three possibilities:

1. The most economic and straightforward method is for the deceased’s PRs to administer the estate under a normal grant of representation. Creditors are entitled to take a grant, and this is often the best option. There is no need for the person appointed to be a qualified insolvency practitioner (article 4(3) of the 1986 order).
2. The court can take over the administration by making an administration order under part 64 of the Civil Procedure Rules, but it will rarely do so.
3. The estate can be administered by a TIB following an insolvency administration order made by the bankruptcy court. Creditors or PRs can petition and, in either case, the order vests the estate in the Official Receiver, pending the appointment of a TIB.

In general, it does not matter whether the estate is administered by a TIB or by the deceased’s PRs because, whoever administers, the same rules apply to (a) the respective rights of creditors, (b) provable debts, (c) the valuation of future and contingent liabilities, and (d) the priority of debts.

However, TIBs have the following additional powers, which may be useful.

Challenging lifetime transactions

The IA 1986 gives TIBs power to challenge transactions: made at an undervalue (section 339); preferring some creditors over others (section 340); or made for the purpose of putting assets beyond the reach of creditors (section 423).

PRs have no such powers, but where PRs start the administration, they (or others) can make an application for a TIB to take over.

Disclaiming onerous property

A trustee can disclaim onerous property even if they have gone into possession, attempted to sell it, or in some other way exercised rights of ownership (section 315 of the IA 1986). Examples of onerous property would be unprofitable contracts, a lease with expensive obligations or contaminated land.

Dealing with the deceased’s interest in a dwelling house

Third parties may have an interest in assets of the deceased (typically, a spouse in the matrimonial home). PRs and TIBs can apply to the court for an order for sale (under section 14 of the Trusts of Land and Appointment of Trustees Act 1996). Where TIBs apply more than 12 months after the deceased’s property vested in them, the court will assume, unless there are exceptional circumstances, that the interests of the creditors outweigh all other considerations (section 335A(3) of the IA 1986).

Where the application is made by PRs, there is no such assumption, so they may have more difficulty.

Claiming property passing by survivorship

Re Palmer (Deceased) (A Debtor) [1994] Ch 316 held that jointly held property passed to the co-owner on death as usual and was not available to the administrator of the estate. The effect of this decision was reversed by a new section 421A inserted into the IA 1986. The TIB of a deceased insolvent can now apply to the court within five years from the death to recover the value of the deceased’s share from the surviving joint tenant. The court must have regard to all the circumstances of the case, including the interests of the creditors and the surviving joint tenant. Unless the circumstances are exceptional, the court must assume that the interests of the creditors outweigh all other considerations.

Dangers of the backdating rules

These rules present risks for professional advisers (and recipients of estate assets).

When a bankruptcy order is made against a living debtor, all property belonging to the bankrupt at the date of the order vests in the TIB. Section 284(1) of the IA 1986 provides that any disposition of property made by the debtor between the date of the presentation of the bankruptcy petition and the making of the order is void, unless ratified by the court. Typically, a disposition will be ratified if it can be shown that full value has been given and the debtors’ creditors are likely to benefit from the disposition.

In the case of living debtors, these provisions are uncontroversial. It is hardly surprising that a debtor’s assets are not freely disposable after presentation of a bankruptcy petition.

In the case of deceased debtors, however, Registrar Baister held in Re Vos; Dick v Kendall Freeman [2006] BPIR 348 that the backdating is to the date of death. Thus, all property vested in the deceased at death vests in the TIB, and any disposition of property by the deceased’s PRs after death is void. The court can ratify payments made, but it will only do so where the payments made were proper and in the interests of the estate.

In Re Vos, Registrar Baister refused to ratify substantial payments to solicitors, including sums for defending litigation with Lloyd’s and a petition to wind up the estate (for which he said there was “no conceivable justification”). He ordered the firm to repay the estate with interest. He suggested that the proper course for PRs of a possibly insolvent estate is to make a Beddoe application to obtain court sanction for significant expenditure in advance.

Williams v Lawrence [2011] EWHC 2001 (Ch) demonstrates the long fuse of the backdating rules. A Lloyd’s name died in 1994 at a time when he had substantial losses and was negotiating with Lloyd’s. His only remaining asset was the family home owned jointly with his wife. His son and family had moved into the property in 1986 and spent a significant amount making the property suitable for joint ownership.

The son and widow were the executors of the estate and sold the deceased’s interest in the house to the son at a price which was a significant undervalue if the title was unencumbered, but correct if, as they contended, the son (i) had been given a lifetime right of occupation, and (ii) had a 15% beneficial interest in the property representing the amount spent on alterations.

Because of protracted litigation over the position of Lloyd’s names, an insolvency order was not obtained against the estate for 13 years.

The backdating rules meant that the sale of the deceased’s half share was void, unless ratified. His Honour Judge David Cooke could only make a ratification order if the family was able to show that the price paid was a proper one. He held that there was no evidence of the granting of an occupation right, and that the mere expenditure of money on someone else’s property was insufficient to create a beneficial interest. Consequently, he refused to ratify the sale.

Order of payments

The statutory order for payment of creditors is:

1. funeral, testamentary and administration expenses; and
2. the bankruptcy order as set out in sections 328 and 329 of the IA 1986, which is as follows: (a) preferred debts, (b) ordinary debts, and (c) deferred debts.

PRs who do not follow the statutory order incur personal liability for ‘superior’ debts which are left unpaid. Therefore, if there is any possibility that an estate may be insolvent, the PRs should observe the statutory order.

With the exception of preferred debts within each category, the debts rank equally and, if the assets are insufficient to meet the debts of one category in full, all debts in that category abate proportionally.

Preferred debts are divided, as from 1 January 2015, into two categories: (1) ordinary preferential debts which rank equally among themselves, and (2) secondary preferential debts which rank equally among themselves after the ordinary preferential debts. See section 386 of the IA 1986, as amended.

Ordinary preferred debts are set out in paragraphs 8-5B of schedule 6 to the IA 1986 (such as contributions to occupational pension schemes; remuneration of employees for the four months before death); and deposits covered by the Financial Services Compensation Scheme (FSCS). Secondary preferential debts are listed in paragraphs 15BA and 15BB of schedule 6 and are amounts owing to one or more eligible persons in respect of an eligible deposit in excess of any compensation payable under the FSCS.

Ordinary debts are all other debts which are not deferred. Any surplus remaining after the payment of preferred and ordinary debts is used to pay interest on preferential and ordinary debts from death till payment (preferential and ordinary debts rank equally for this purpose).

Deferred debts are debts owed from a person who (whether or not the deceased’s spouse at the time the credit was provided) was the deceased’s spouse at the date of death.

Secured creditors have priority over all others, to the extent that they can obtain payment from their security.

Personal liability of PRs for unpaid debts

If PRs pay an inferior debt knowing of the existence of a superior debt, they become personally liable to pay the superior debt.

They also incur personal liability if they pay one creditor in full when there are insufficient assets to pay all creditors in that class. However, in this case, there is a defence if payment was made in good faith at a time when they had no reason to believe that the estate was insolvent (section 10 of the Administration of Estates Act 1971), unless they took out the grant as a creditor. However, it does not protect PRs who had any reason to believe that the estate was insolvent.

Conclusion

Don’t rush to take out a grant. If there is any risk of insolvency, follow the statutory order for payment of debts, and make sure that any payments made can be justified as for the benefit of the estate, in case a TIB is appointed and ratification is required.

Finally, don’t forget to consult the Law Society’s helpful practice note on administering insolvent estates, which has recently been updated.