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What Happens to a Bankrupt Estate after Death?

It is a common misconception that debt dies with an individual. Contrary to popular belief, debts are instead passed onto the estate and become the responsibility of the executors of the deceased’s will. This short guide explains what happens to a bankrupt estate after a death. 

If a deceased person had debts that were greater than the total value of their assets, their estate is insolvent. In this situation, money is owed to the creditors before any potential beneficiaries of the will can receive anything. The rules of bankruptcy also apply to insolvent estates, meaning that the debts must be paid in a specific order of priority.

The administration of an insolvent estate is governed by the Administration of Insolvent Estates of Deceased Persons Order 1986, which dictates how to manage the estate’s debts. It is vitally important that executors carry out certain aspects of this process in the appropriate order so that they avoid any potential legal pitfalls.

Below, we detail the information you might need to help you deal with a bankrupt estate after death. If a loved one has passed away and you need advice in relation to the grant of probate or dealing with their debts, our expert probate solicitors can assist you. You can contact us by completing the enquiry form or by calling 0151 666 9090.

Bankruptcy rules on death

When a person dies, their debts are not wiped clean. Instead, the debts are passed onto the estate. Some of the debt might be covered by an insurance policy, or it may be transferred to the deceased’s partner if it is held jointly. Debts held in the sole name of the deceased have to be repaid from the estate, however.

An executor of the estate can apply to the bankruptcy court for an Insolvency Administration Order (IAO), which is comparable to a debtor’s petition for bankruptcy. When doing so, the executor must demonstrate that it is “reasonably probable” that the deceased’s estate is insolvent. They must show that the debt owed would have been sufficient enough to declare bankruptcy had the deceased been alive.

If a bankruptcy order was made against the individual prior to their death, the bankruptcy order should proceed as normal after the death. Otherwise, the rules under the Administration of Insolvent Estates of Deceased Persons Order 1986 should be followed.

Insolvency Administration Orders can be presented to the court by:

  • An executor
  • A creditor or creditors jointly
  • A temporary administrator
  • A liquidator
  • Where the deceased entered into a voluntary arrangement, the supervisor of that arrangement or a creditor bound by it
  • The official petitioner, where the deceased person was subject to a criminal bankruptcy order.

Are you responsible for paying any debts of the deceased?

If you have been appointed as an executor, it is your legal responsibility to pay any debts of the deceased. You must not distribute any money or property to the beneficiaries before all debts have been paid. As the executor of the estate, you must also show you have made every effort to inform as many people as possible about the death, to give people the best chance to come forward with a claim.

The debts are to be paid off from the estate. Debts are not usually inherited by family if they are in the sole name of the deceased. There are two key exceptions to this rule, however: 

  • Where a third-party guarantor on one of the deceased’s loans would make that person the sole party that is liable for the total remaining debt.
  • Any money that has been “gifted” to family or friends in the seven years prior to their death can be viewed by the courts as an attempt to avoid paying creditors.

This means that as an executor, you are not automatically liable to pay off any debts that are not covered by the estate, and this should not factor into your decision to become an executor in a loved one’s will.

Are there any limitations when dealing with the deceased’s finances as an executor?

There are a few potential legal pitfalls that executors need to be wary of when dealing with the deceased’s finances, particularly if they are in debt. The first thing you should be aware of is the order in which creditors need to be paid. This order is verified by law and if it is found that the executor has not followed this process afterwards, they could be held financially liable for any other debts. The order is as follows:

  1. Secured Debts - Creditors whose debts are secured over a particular asset. Most commonly, this is a mortgage
  2. Funeral Expenses - The deceased is then allowed to pay for any basic funeral expenses
  3. Testamentary Expenses - These include any fees or payments incurred by any representative when administering the deceased’s estate. Examples might be solicitors’ and insolvency practitioners’ fees.
  4. Preferential Creditors - This includes individuals or organisations that have priority in being paid money. An example of this might be employees, if the deceased employed people.
  5. Unsecured Creditors - Creditors that have lent money without obtaining any specified assets as collateral.
  6. Interest due on unsecured loans
  7. Deferred debts - For example, loans between members of the family

Unfortunately, this long list often means there is nothing left over for any beneficiaries of the estate, despite what is written in the will. 

Can you add provisions into your will to account for the potential that you might go bankrupt?

No. When someone dies their debts become a liability on their estate, even if they could predict the insolvency when they were alive. After the death, the executor then becomes responsible for paying any outstanding debt. You cannot add provisions into your will to account for any potential bankruptcy in the future.

In addition to this, the Administration of Insolvent Estates of Deceased Persons Order can apply to those who die insolvent, but also to those who die after a bankruptcy petition has been presented against them whilst alive, but has not yet been determined.

The only real provision you can make if you do believe you will die insolvent is to ensure that your estate is as easy to manage as possible for whoever picks up the responsibility after you die. This includes noting down all of the debts, all of your bank accounts, any passwords, and any other useful information that will help the executor after you have passed away.

Is there a difference between an insolvent estate and a bankrupt one?

Insolvency is the financial state in which a company or individual is unable to pay their debts on time. Bankruptcy is the legal process when an individual has been declared insolvent. In this sense, there is a difference, but it is mostly to do with the legal processes, and both phrasings of the matter mean that the estate owes more than it is worth. 

A bankrupt estate may be administered by its appointed executor, who has to apply insolvency rules in the administration process. The executor can also relieve themselves of this responsibility by applying for an Insolvency Administration Order (IAO).

The main difference between this Order and a bankruptcy order is that the duty falls on the executor to pay off any debts, rather than the deceased. Generally speaking, the bankruptcy provisions apply equally in the case of an IAO.

How can Percy Hughes & Roberts help? 

At Percy Hughes & Roberts Solicitors, we have a team of dedicated probate solicitors who are ready to help you resolve your queries relating to this area of the law as quickly and effectively as possible.

If you need assistance in dealing with the debts of an estate, obtaining a grant of probate or letter of administration, or simply want advice on dealing with the probate process, our wills, trusts, and probate solicitors have a wealth of experience. They can help you through what can be a difficult time, dealing with estate and trust property and complex estates.

If you would like to contact one of our expert probate solicitors you can do so by calling 0151 666 9090 or by completing the “Get in touch” form on this site.

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