As the cost-of-living crisis and talks of another recession increasingly hit the headlines, Roman Kubiak, partner and head of the Contested Wills, Trusts and Estates team at Hugh James, and Emily Peacock, trainee solicitor, discuss the thorny topic of debts, insolvency and the duties of personal representatives.

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Acting as a personal representative can be challenging at the best of times.

Throw in a long list of creditors understandably eager to recover what’s owed to them and potential insolvency and that role can become significantly more tricky.

Practitioners should therefore think carefully and carry out their due diligence before agreeing to act as personal representatives.

Similarly, contentious practitioners need to have a working knowledge of the potential impact of debts on an estate administration and prospective settlement, with abatement and outright failure of gifts a real possibility.

Is the estate solvent?

Section 421(4) of the Insolvency Act 1986 defines an estate as being insolvent “if, when realised, it will be insufficient to meet in full all its debts and other liabilities.”

It follows, then, that where an estate is insolvent the beneficiaries stand to receive nothing while not all the creditors will receive the total amount due to them.

Other than secured debts (which take overall priority), even in the case of an insolvency, funeral, testamentary and administration expenses take priority over any unsecured debts with the accepted position being that, of those expenses, funeral costs likely trump the others (provided those funeral costs are objectively reasonable) (see Re Walter, Slocock v Official Receiver [1929] 1 Ch 647).

As to testamentary and administration expenses, these are construed broadly to include “the costs of the executors and other parties in an administration suit” (see Sharp v Lush (1879) 10 Ch.D. 468).

Thereafter, the order of priority for payment of debts is as follows:

  • preferential debts – these include state and occupation pension scheme contribution arrears, employee wage arrears and levies on coal and steel production, with all three ranking equally together
  • ordinary debts – essentially all other debts other than funeral, testamentary and administration expenses, secured or preferential debts
  • interest on preferential and ordinary debts – contrary to the order above, interest on these debts ranks equally
  • deferred debts – finally we have deferred debts which include loans or payments due on terms according, or with reference, to profits and loans from a spouse or civil partner

Practitioners should heed caution, therefore, if asked to assist in an estate administration where there is a risk of insolvency and/or the full list of creditors is not yet known. In such a case it is reasonable to request funds on account before being engaged.

Likewise, practitioners should be wary of taking any active steps in administering the estate for fear of intermeddling and, in turn, inadvertently assuming the role, responsibilities and duties of an executor.

Where the estate is, at any of the above stages, insufficient to meet the debts, then the debts in each class ’abate’, that is to say reduce proportionately on a ’pence in the pound’ basis.

Where a personal representative fails to observe this order of priority or pays any creditors in a class in full to the detriment of other creditors in that class, they face the prospect of being personally liable to the other creditors in that, or any superior, class.

Indeed, in the cases of a truly insolvent estate personal representatives owe a fiduciary duty not to the beneficiaries but to the creditors.

Defences are available to personal representatives who either fail to settle debts or observe the above order of priority, though these are limited. of insolvent estates are limited.

Section 27 of the Trustee Act 1925, which practitioners will know offers protection to personal representatives who place notices in the Gazette, can assist where unknown creditors (where the personal representative is not, or should not reasonably have been, on notice) who have not responded to the notice within two months, bring claims.

Likewise, where a personal representative settles a debt in full, in good faith that the estate has sufficient assets, and subsequently discovers that the estate is insolvent, they can avoid liability to the other creditors in that class under section 10(2) of the Administration of Estates Act 1971.

The Law Society issued some helpful guidance on this in December 2019 and practitioners are advised to review that if faced with a potentially insolvent estate too.

Who should act?

Of course, there is no obligation on a person to take up the role of personal representative, provided they have not intermeddled.

Indeed, subject either to clearing off those with a higher entitlement to a grant or passing them over under section 116 Senior Courts Act 1981, it is open to creditors to take on the administration of the estate. This is often overlooked but can be useful in cases where the estate is clearly insolvent.

Otherwise, what help is available? Well, broadly there are three options:

  1. to administer the estate as usual, paying heed to the order of priority. This is known as administration ’out of court’;
  2. to administer the estate under directions by the court by way of an ’administration order’ under rule 64.2(b) of the Civil Procedure Rules; or
  3. under an insolvency administration order (IAO) which essentially places the estate in bankruptcy and which can either be made by the personal representatives or any creditor whose debt meets the relevant threshold.

Solvent abuse

And where do the various beneficiaries in a solvent estate faced with debts stand?

In cases of intestacy, whether the estate is solvent or not, and subject to ensuring that the above order is satisfied, the position is relatively straightforward inasmuch as the entire ’pot’ is first used to settle any debts with the net estate then being split in accordance with the intestacy provisions laid out in section 46 Administration of Estates Act 1925.

In testate estates it’s common to see clauses providing for specific and pecuniary legacies followed by a clause dealing with the residuary estate, often providing for the payment out of it of debts, funeral and testamentary / administration expenses.

In such cases, and absent contrary provision in the will, therefore, it is the residuary estate which is first used in settlement of any such debts, adhering to the order laid out above.

What if the residuary estate is insufficient to meet the debts? Well, in that case, and, again, absent contrary intention in the will, the order in which the estate and gifts under a will are applied is laid out in Schedule 1, Part II of the Administration of Estates Act 1925.

The order of priority in such cases, therefore, is broadly as follows:

  • any property passing on a partial intestacy i.e. undisposed property;
  • the residuary estate;
  • any property specifically directed to be used towards the settlement of debts;
  • any property charged with or subject to a charge for the payment of debts;
  • pecuniary legacies;
  • specific legacies, which then abate rateably according to their value; and
  • property subject to a general power of appointment.

Credit where creditor’s due

While it can be easy to see estate creditors as a nuisance or a faceless entity greedily looking to take funds from the beneficiaries, it’s perhaps worth heeding the words of Mr Justice Twomey in the High Court of Ireland decision of ESL v JH [2021] IEHC 383 in which we were supporting the English executor.

The question before the court in that case was whether the Irish court could prevent the transfer of assets of an ancillary administration of the deceased’s estate in Ireland to the principal administration of his estate in England.

In ultimately determining that it could not, the learned judge remarked that:

“equity does not, in this Court’s view, mean that this Court should exercise its discretion in favour of a child of a testator, to the detriment of the creditors, simply because she is a minor who is dyslexic and on the autism spectrum or in favour of a separated wife, simply because she works in a low paying job. This is because those creditors, who unlike E or P, are actually out of pocket as a result of their dealings with J, may themselves be, or have families relying upon them who are, in similar or worse circumstances than E or P and they may be just as worthy recipients of money from J’s estate.”