01 January 2010 Issue 1 Margaret Rintoul

Bankruptcy and estates

The best practice for distributing an estate where insolvency is a factor.

Estate planning and administration is generally focussed on dealing with the transfer of wealth, but inevitably there are cases where the estate being administered is insolvent, or a beneficiary is insolvent and has to be accommodated, either at the planning level or at the administration level or both. It is a harsh reality that every estate planner encounters clients trying to protect their estates from creditors or trying to protect their own assets from being taken by the creditors of their beneficiaries. Similarly, every estate lawyer administering estates from time to time encounters bankrupt estates, beneficiaries who are bankrupt or insolvent with creditors more than happy to take over whatever is earmarked for the beneficiary, and less frequently, trustees who are, or become, bankrupt.

Estate planning for insolvent beneficiaries

Frequently a concerned testator who knows that an intended beneficiary is, or is likely to be, in financial difficulty, wants to ensure that his own estate will not be seized by the creditors of an insolvent beneficiary. Where this is a known concern at the time of making a will, the testator will probably want to insert a fully discretionary trust for the benefit of the financially fragile beneficiary. That way the assets of the estate can be controlled by the estate trustee to ensure that they are only paid to the beneficiary, or perhaps to his or her family, and are therefore not available for seizure by creditors. Often called a ‘Spendthrift Trust’, such a trust can be very useful to protect the financially fragile beneficiary and his or her family, and to protect the estate assets from outside claims. However, creating such a trust requires care to ensure that it cannot be attacked by creditors or bankruptcy trustees of a beneficiary. At a practical level the beneficiary cannot be a trustee of his or her trust, and there needs to be complete discretion to the trustee to pay to the initial beneficiary, to withhold funds or to pay them to others, such as the immediate family of the beneficiary, or more importantly to pay specific essential costs of the family of the beneficiary. Basically there cannot be any part of the benefit that the beneficiary or her trustee in bankruptcy could point to as being unequivocally due to that beneficiary without the exercise by a trustee of a discretion.

A potential beneficiary who knows that she may be about to go bankrupt may well want to go to her parents and any other parties likely to be leaving her benefits by will and simply ask to be taken out of the estate, at least until it is clear that the financial crisis is past, at which time perhaps the will can be changed yet again to include that beneficiary again.

Administration of an insolvent estate

The opposite issue facing executors or estate trustees, and their professional advisors, is what to do when it is clear that the estate itself is bankrupt, so that the assets will not pay the debts, or at least will not pay debts and cover all of the benefits anticipated under the will.

In Ontario an executor or Estate Trustee is primarily guided in the administration of an estate by the terms of the Estates Administration Act and the Trustee Act. In terms of dealing with the creditors of an estate, and particularly how to cope with a shortfall in the assets, the relevant statutory terms are Trustee Act R.S.O. 1990 c. T.23 ss. 50, to 59 inclusive and Estates Administration Act R.S.O. 1990 c. E.22 ss. 9, 11, 23, 26. The basic steps to be taken can be outlined as follows.

Trustee is in the position of the deceased in terms of payment of debts

This may seem fairly basic, but in dealing with the debts of the estate, only the estate assets (those which belonged to the deceased and could be used by him for debts) are available to pay creditor claims. As long as the trustee does not distribute estate assets to beneficiaries in advance of paying debts, neither the trustee nor the beneficiaries assume any personal responsibility for debts.

Priority of payment of debts s. 50 of the Trustee Act gives no priority to debts to the Crown, principally taxes in advance of other unsecured creditors. Secured creditors rank ahead of Crown debts in an estate as in any other insolvency. In reality, federal income tax debts will wind up being paid ahead of unsecured creditors, despite the terms of s. 50 of the Trustee Act, due to the results of a Divisional Court decision from 1986 in a case of Wright v. Canada (1986) 56 O.R. (2d) 636, overturned by 62 O.R. (2d) 737, where a trial level decision that the federal Crown could not be allowed priority was overturned at the Divisional Court. Therefore if there are unsecured creditors plus income tax debts for taxes already in existence at the date of death, or arising as a result of the death, the tax debts will wind up being paid ahead of the other unsecured debts.

Advertisement for creditors will allow the trustee to distribute the estate before waiting a full year in the case of an intestacy (Estates Administration Act s. 26) and distribution can be made on the timetable set out in the advertisement. Advertising for creditors is the only reliable way for a trustee to be able to go forward with assurance that all of the debts to be paid are properly accounted for. A trustee who has advertised for creditors and has determined the claims put forward within the time specified, can pay those debts and then confidently proceed to divide the estate among the creditors. If debts are actually known to the trustee, but are not formally claimed in response to the advertisement, the trustee must still deal with those debts of which he or she has actual knowledge, along with those that come forward as a result of the advertisement.

Secured creditors have first priority to the extent of their secured debts and unsecured portions rank pro rata with the other unsecured creditors (s. 57).

Limitations periods and creditor claims. If claims against the estate were statute-barred prior to death, they remain so after death. No claims by creditors can be successfully advanced after two years following the death, due to a two year limitation period for claims by and against estates.

Funeral bills have priority for payment ahead of all other debts, provided they fall within the realm of being ‘reasonable’, based on the size of the estate and the station in life of the deceased. For example, a cemetery marker is not considered an essential funeral expense. Chernichan v. Chernichan Estate [2007] A.J. NO. 1429, 43 E.T.R. (2d) 30 (AQB). The priority for funeral expenses has been generally accepted for years and is supported by the bankruptcy legislation as well. A recent case in Ontario, McLennan v. McLennan [2000] O.J. No. 3286, [2000] O.T.C. 566, 36 E.T.R. (2d) 145 confirmed that funeral bills and administrative expenses take priority over other unsecured debts. ‘It is clear law that if there is a deficiency of assets to meet all the creditors’ claims, the deceased’s funeral expenses, testamentary expenses and the costs of the administration take priority over other debts.

Ademption of bequests: administration where debts exceed bequests/legacies

Where the estate is not sufficient to pay the debts and all bequests, but there are enough assets to pay the debts with some assets left over, the estate trustee must deal with the beneficiaries on the basis that either they do not receive anything, or that their shares are reduced, depending on the type of benefit that particular beneficiary has received. If there is enough in the estate to pay all debts, but not enough to pay all of the beneficiaries’ benefits under the will, the estate is handled according to the following formula:

  • debts are paid in full, by liquidating the residue first (i.e. all of the assets that are not otherwise specifically mentioned for bequests and legacies, including real estate that is not part of any specific bequest)
  • cash legacies are reduced pro rata if there is money remaining after the debts are paid, if there is still money left over after liquidating the residue amounts and paying off all debts
  • general legacies (eg. the contents of an identified bank account) are paid if the debts have been satisfied out of the residue assets. If the residue is fully liquidated and there are still debts, the assets otherwise used for general legacies are liquidated and the remaining debts paid. Any amount left over is divided pro rata among the beneficiaries who would have received the general legacies
  • specific bequests of personal property (personal property that is specifically bequeathed will be liquidated to pay debts only if all other liquid assets of the estate have been exhausted)
  • specific bequests of real estate (real estate that was specifically bequeathed to a beneficiary will only be required to be sold to meet debts if there are no other assets to cover them).

The net result is that specific land, such as the family home, that has been bequeathed to beneficiaries specifically, and personal property like furniture and family heirlooms that has been left to named beneficiaries, will only be liquidated to pay debts if all other assets have been liquidated and paid out first to meet the debts.

Assets not available for creditor claims

Assets passing outside of estate, such as life insurance and registered funds payable to named beneficiaries, are exempt from debts of the estate: see Amherst Crane Rentals Ltd. v. Perring [2004] O.J. No. 2558, 241 D.L.R. (4th) 176, 187 O.A.C. 336 and Insurance Act R.S.O. 1990 c. I.8 s. 196. The exemption applies to outside creditors of the estate. Claimants under support claims against the estate, and claims that assets are held in trust for the benefit of other beneficiaries, are not affected by the Amherst Crane decision as it relates to registered funds (McConomy Estate v. McConomy [2009] O.J. No. 741 (OSCJ).

Income taxes owing on registered funds payable to a named beneficiary/annuitant are the joint and several obligation of the estate and the named beneficiary: Income Tax Act s. 160.2 (1) and (2). To the extent that the estate assets are depleted, the beneficiary will be liable for the remaining tax liabilities.

The estate is liable for taxes owing on registered funds payable to a named beneficiary/annuitant to the extent that assets are available in the estate (Banting v. Saunders Estate [2000] O.J. NO. 2817 (Ont. S.C.J.)

Creditors do not have claims against jointly held property that has passed by survivorship to a joint owner, if the creditor did not have a judgement or other lien that could have attached the interest of the deceased before death.

Bankruptcy of an estate trustee

An estate trustee who declares bankruptcy during the course of the administration is not automatically excluded from continuing as estate trustee. Creditors of a bankrupt estate trustee have no claim on the estate assets.

Bankruptcy of a beneficiary

A beneficiary that is already an undischarged bankrupt at the time of the death, or who becomes bankrupt shortly after the death, will have to report the estate interest as one of the assets in his own bankruptcy, and the estate trustee will be obliged when the estate is administered, to deliver the bankrupt beneficiary’s share to his or her bankruptcy trustee.

This has been a very general overview of some of the issues facing estate planners and administrators, and clearly any specific situations have to be examined on their own merits before making any decision as to a strategy.

This article is based on a presentation at the STEP National Conference, Toronto 2009.


Margaret Rintoul