INSOLVENT ESTATE – WHEN DEBTS EXCEED ASSETS

An insolvent estate has debts in excess of decedent’s assets. This means that not every debt can be paid in full. Pennsylvania law determines the order that debts are paid and, ultimately, the amount. Surviving spouses and children often worry about their responsibilities for debts that the estate cannot pay. Generally, this is not a problem. This is a brief overview of what usually happens and why.

Usually, a decedent’s creditors only can reach assets in the decedent’s estate. A number of assets are exempt from claims of creditors or are not part of the estate. Therefore, creditors cannot pursue these. Examples include a life-insurance policy owned by the decedent naming a beneficiary other than the decedent or the estate. In addition, property owned with someone else having the right of survivorship is not part of the estate. These usually are removed from the estate when determining its solvency.

Responsibilities of the Personal Representative

The estate’s personal representative – the executor when a Will is being probated or the administrator when there was no Will – determines if an insolvent estate is involved. This is done before paying debts or making distributions. An insolvent estate adds difficulty to the personal representative’s job. Since one of the first responsibilities being the payment of the deceased individual’s debts, the personal representative review all claims against the estate. Next, the order in which the creditors will be paid is determined. Gathering the estate’s assets to use  to make the payments is another crucial task.

The personal representative quickly learns if the estate is insolvent. If it is insolvent, this individual should not make distributions to heirs or beneficiaries. Doing so can lead to liability for debts that otherwise could have been paid.

Section 3392 – Classification of Debts & Priority of Payment

With an insolvent estate in Pennsylvania, you have to look to the law for guidance regarding payment of debts. Section 3392 of Title 20 of Pennsylvania’s Consolidated Statutes sets out classifications of various types of debts and the order in which these are paid.

While there are 7 categories listed in Section 3392 (“Classification and order of payment”), there is an additional one given preference over these. These are claims that the federal government may have for taxes owed to it. Generally, the phrase, “subject to any preference given by law,” gives top priority to federal tax debts subject to liens. As the personal representative of an estate, you must look for these before paying other debts. Otherwise, you could be responsible for paying the debts that have priority due to the mistake of paying debts of lower priority instead.

Section 3392 is important when there is an insolvent estate, but it applies to all estates. This is especially important since an estate that looks solvent may be viewed differently after all claims against the estate have surfaced. You cannot pay claims of a lower classification before all claims of higher classifications are paid in full. Also, with an insolvent estate, when you reach the classification at which there are not sufficient assets to pay all claims, you would make partial payment for each claim using the same proportion throughout that class. Any classes below this would have to go unpaid.

As for the classes themselves, the first category to be paid involves the costs of administration of the estate. This includes filing and related fees (such as advertising the estate). Other administrative costs that Pennsylvania gives top priority include legal fees and the personal representative’s compensation. Second in the list is the family exemption, which is cash or property with a value of up to $3,500 that can be claimed by a surviving spouse or children and parents of the decedent who resided in the decedent’s household.

After this, priority is given to funeral and burial costs as well as the cost of medicine used by the deceased person during the final 6 months of life. Medical, nursing, and hospital services during this period also are in this category, along with money for services provided by any employees of the decedent during these 6 months. The final part of this category are services provided by Medical Assistance in the last 6 months of life.

The fourth priority for payment is the cost of a grave marker. Then, priority is given to any rent owed for the decedent’s residence during the 6 months immediately prior to death.

Listing 5.1 (actually the sixth priority) involves claims made by Pennsylvania and its political subdivisions. Finally, there is a catchall category of all other debts and claims, which would include such items as credit-card debts solely in the decedent’s name. If there are sufficient assets in the estate, the personal representative should work to pay all of the above debts as soon as possible. Then, the assets that remain can be distributed to heirs or beneficiaries (depending on whether there is a valid Will).

Possible Liability of Third Parties for the Estate’s Debts

However, when an insolvent estate may exist, not all claims and debts can be paid from its assets. This can raise a question that is important to various parties interested in the estate: can someone other than the decedent be held responsible for debts that cannot be paid by the estate? The answer is a qualified “yes.”

Again, remember that executors and administrators can be responsible for debts in some circumstances. To avoid this, they cannot distribute assets from an insolvent estate since they face personal liability for the debts that cannot be paid as a result. A distribution from an apparently solvent estate is an “at-risk” distribution because there can be claims that become known after the distribution. An executor runs the risk of being responsible for paying any amount of a claim that the money received by the beneficiary could have paid. With “at-risk” distributions, a personal representative generally wants to be protected by an “indemnification agreement.” This means the recipient agrees to reimburse the estate if this is needed to pay its debts.

When faced with an insolvent estate, the personal representative often seeks the court’s protection before acting. In this situation, you should not consider paying debts of the insolvent estate unless you obtain court approval of a petition under Section 3392. This will prevent you from being held responsible for paying the debts personally.

There also are some situations when others can be held accountable for debts in the name of the deceased person. While creditors may have more incentive to pursue third parties in an insolvent estate, the debts may be enforceable under any circumstance. You always will be liable for a debt on which your name appears as a co-signer or guarantor. Charges that you made on a decedent’s credit card can leave you with responsibility for that debt.

As for spouses or children, liability usually follows a similar course. In other words, surviving spouses and children generally are not responsible for debts solely of the deceased spouse or parent. However, when both spouses sign a note for a loan, for example, the estate and the surviving spouse are liable for the debt, even if only one spouse received its benefits. Also, if a surviving spouse or child signed a contract as a guarantor when the decedent needed medical care, liability for any unpaid debt likely remains. An important point that runs throughout all of this is that creditors want to be paid and potentially will look at all possible sources when a decedent leaves an insolvent estate.