What is an Insolvent Estate and how should they be administered?

What is an insolvent estate?

An estate is insolvent if the total value of its assets is insufficient to pay its debts and liabilities. Where an estate is insolvent or is likely to become insolvent, Personal Representatives (PRs) should act quickly to obtain advice on the prospect of an estate being found to be insolvent and how to administer the estate if it is insolvent.

How can an insolvent estate be administered?

There are three possibilities:

1. PRs can administer an insolvent estate out of court. The PRs gather in the estate assets and administer them as required by relevant legislation, which we discuss below. This is the most common method of administration of insolvent estates.
2. PRs can administer an insolvent estate under the court’s direction. Where there are concerns or doubts as to the solvency of a deceased person’s estate, the PRs can apply for an administration order from the court under CPR 64 directing them as to how the estate should be administered.
3. A trustee in bankruptcy can administer an insolvent estate under an Insolvency Administration Order (IAO) made by the court under section 421 of the Insolvency Act 1986. PRs or creditors would need to present a bankruptcy petition to court seeking an IAO vesting the estate in an Official Receiver, who would be appointed as trustee in bankruptcy. The estate would then be administered in a very similar way to a bankruptcy. A key benefit of an IAO is that a trustee in bankruptcy can use their wide statutory powers to investigate transactions prior to the deceased’s death and recover assets belonging to the estate.

Whose interests take priority?

Crucially, unlike solvent estates, insolvent estates must be administered for the benefit of the estate’s creditors, rather than for the benefit of the estate’s beneficiaries, until the debts and liabilities are paid. This is because bankruptcy rules apply to insolvent estates. Broadly speaking, the order of priority for payment of an insolvent estate’s debts is:

1. secured creditors;
2. funeral, testamentary and administration expenses;
3. preferential creditors;
4. secondary preferential creditors;
5. unsecured creditors;
6. interest due on unsecured loans; and
7. deferred debts.

This order applies irrespective of the method of administration used.

If there is a surplus, that will be paid to the PRs to be distributed under the terms of the Will or the intestacy rules.

What are the risks to PRs?

Insolvent estates can present various challenges and risks to PRs. For instance, PRs who distribute assets to beneficiaries without having paid all of the estate’s debts and liabilities could be personally liable for devastavit (wasting estate assets). Moreover, if PRs have disposed of estate property prior to the making of an IAO, those dispositions will be void and PRs could be personally liable to reimburse the estate unless they were made with the court’s consent or are subsequently ratified by the court under section 284 of the Insolvency Act 1986.

Closing thoughts

PRs should bear in mind that an estate could be insolvent if its assets are insufficient to pay its debts and liabilities. PRs should obtain appropriate advice as soon as possible to mitigate the risk of administering an insolvent estate improperly. If you have any questions or need any advice on insolvent estates, please contact Lucinda Brown or Cheryl Gayer.