Executors of an estate are entrusted with several duties upon an individual’s death. Among those duties include the determination of all debts and liabilities of the deceased at the time of death and the payment of such debts and liabilities. Where the debts of an estate exceed its assets, such that the estate lacks sufficient assets to pay all of its debts in full, the estate is said to be insolvent.1 Where an estate is determined to be insolvent, the named executor under a Will must decide whether to administer the estate as an insolvent estate, or to petition the estate into formal bankruptcy proceedings.
Whether an estate is solvent or insolvent, exposure to personal liability is always a factor to consider before accepting the role of executor. However, where an estate is insolvent, the risk of exposure to personal liability tends to be greater than in the case of a solvent estate, as, beyond the ordinary tasks of administering the estate, the executor must manage the order of payment of the debts of the estate, the priority of the creditors of the estate, and the interests of the beneficiaries of the estate.
This article addresses some of the tips and traps which executors of insolvent estates should be aware of and which may all lead to personal liability: (1) paying beneficiaries before creditors; (2) paying some creditors before others; and (3) the priority of tax liabilities.
Exposure to Personal Liability
An executor is not automatically liable for the debts of a deceased person by virtue of being his or her executor. However, as part of the executor’s fiduciary role, the executor is responsible for paying the debts of the estate using the estate’s assets. Where an executor fails to appropriately apportion available assets among the deceased’s creditors, or where an executor distributes any part of the estate to the beneficiaries without first ensuring that all of the creditors are paid in full, the executor may attract personal liability. For example, an executor who distributes assets of an estate to the beneficiaries while knowing of a creditor’s outstanding claim, is personally liable to the creditor.2
Paying Beneficiaries before Creditors
Executors have an ongoing, fiduciary obligation to pay all of the debts of an estate and to protect the creditors of an estate.3 The assets of an estate must be used to pay creditors of the estate before any distributions can be made to beneficiaries. “If an executor distributes any part of an estate to the beneficiaries before the debts owing to creditors are settled, the executor becomes personally liable for those debts, up to the amounts distributed to the beneficiaries.”4
Debts of an estate are not only the debts of the deceased, but also include costs incurred by the executor in the course of administering the estate, such as legal fees and executor compensation. As a result, sometimes an estate only becomes insolvent as administration costs are incurred. Before distributing any assets of an estate to the beneficiaries, an executor should ensure there is an adequate reserve kept in the estate to avoid having to answer personally to third party creditors and to ensure the legal fees and executor compensation are accounted for. If there is any doubt as to whether the estate will have sufficient funds to pay all debts, distributions to the beneficiaries should be postponed.5
Paying some Creditors before Others
An executor does not have the ability to prefer certain creditors of an insolvent estate over others if those creditors fall within the same ranking priority. This principle is set out in section 50 of the Trustee Act, R.S.O. 1990, c. T.23 (“Trustee Act”) and section 5 of the Estates Administration Act, R.S.O. 1990, c. E.22. However, certain debts and expenses are entitled to priority of payment from the estate. Executors are required to settle debts in the following order of priority: (1) reasonable and necessary funeral expenses; (2) testamentary expenses6 and costs of administration7; and finally, (3) all other debts proportionately, including provincial Crown debts.
Some important rules of thumb to bear in mind:
The common law and statutory law establish an order of assets from which to settle debts owing to the creditors of an estate: (1) personal property which has not been bequeathed; (2) real estate devised to pay debts; (3) real estate not so designated; and finally, (4) legacies (first, general legacies, and then specific legacies).11
An executor administering an insolvent estate ought to consider obtaining legal advice to ensure assets are liquidated in the proper order and creditors are paid in order of priority.
Priority of Tax Liabilities
The law is unsettled on the priority of payment of taxes owing to government authorities. “The Bankruptcy and Insolvency Act specifically ranks municipal taxes, which are distinct from provincial or federal taxes, equal to debts owing to unsecured creditors.”12 Similarly, section 50(1) of the Trustee Act ranks “debts due to the Crown” among those owing to unsecured creditors, but it is unclear whether debts to the federal Crown are equivalent with those owing to unsecured creditors or whether they, not bound by this provincial statute, enjoy priority of payment.13
“In practice, debts owing to tax authorities are generally prioritized over other unsecured creditors. However, given the uncertainty in the law on this point, an executor would be advised to notify unsecured creditors that (a) the estate does not have sufficient assets to pay all debts in full; and (b) the executor intends to pay the taxes owing before any other debts. Such notice provides the other creditors with an opportunity to consent to the order of payment or to raise any objections they may have.”14
Accepting the role of executor of an insolvent estate should not be done on a whim. Once the executor begins carrying out his or her duties as executor, he or she is then duty-bound to complete the role, absent court approval to resign. Where the insolvency is complex or contentious, it may be worthwhile to assign the estate into bankruptcy, rather than to assume the appointment. Prior to accepting the role of executor of an insolvent estate, it would be prudent to obtain legal advice to understand the risks that may accompany the job.
Executors who do accept the position should be careful not to distribute the assets of the estate hastily. Depending on the estate and the debts owing, there may be secured creditors or other creditors, such as tax authorities, whose debts owing should be prioritized. In addition, creditors of the same class, must be paid proportionally where the assets of the estate are insufficient to satisfy all debts in full. Failure to maintain an even-hand among creditors of the same class could expose the executor to personal liability.
Bottom line: Do your due diligence, ask questions and then some more questions before accepting the executorship of an insolvent estate.
About the Author
Brittany Sud is an Associate at Miller Thomson LLP and a member of their Private Client Services Group and their Social Impact Group. Brittany’s practice focuses on estates and trusts, including both planning and administrative matters, as well as taxation as it relates to those areas. She also advises charities and not-for-profit organizations on various matters to achieve their mission. Brittany is a member of the OBA Charity and Not-for-Profit Law Section Executive, the OBA Young Lawyers’ Division and the Society of Trust and Estate Practitioners (STEP). She has been an active participant at UJA and the Jewish Foundation, Brittany is a Lion of Judah and is part of the Jewish Foundation’s Professional Advisory Committee.
1 It should be noted that an insolvent estate is legally different than a bankrupt estate. A bankrupt estate is one that has gone through the formal process of declaring bankruptcy under the Bankruptcy and Insolvency Act, R.S.C., 1985, c. B-3 (“Bankruptcy and Insolvency Act”).
2 Commander Leasing Corp. v. Aiyede (1983), 16 E.T.R. 183 (Ont. C.A.); Berry, Re (1981), 10 E.T.R. 152 (Ont. H.C.).
3 Ontario (Attorney General) v Ballard Estate (1995), 6. E.T.R. (2d) 311 (Ont. Gen. Div.).
4Gillian Fournie, de Vries Litigation LLP, “Insolvent and Bankrupt Estates” (May 26, 2015), online: https://devrieslitigation.com/insolvent-and-bankrupt-estates/.
6Testamentary expenses include costs incurred by the executor while administering the estate, such as legal costs for any legal advice obtained or for any legal actions brought or defended on behalf of the estate.
7Costs of administration refer to the reasonable compensation of the executor. Executors acting properly are entitled to their full costs, charges and expenses out of the estate in priority to other interests, including creditors and beneficiaries, even if the estate is insolvent.
8Godkin v Watson (1915), 9 O.W.N. 251 (Ont. C.A.).
9Section 50(1) of the Trustee Act protects the rights of secured creditors.
10Note: The priority of debts to be paid differs for insolvent estates and estates that are declared into bankruptcy. For example, the payment of spousal and child support arrears takes priority over the payment of federal income taxes under a bankrupt estate.
11Anne E. P. Armstrong, Estate Administration: A Solicitor's Reference Manual (Toronto: Thomson Reuters, 1988) Chapter 3 at 3.17.5 – Insolvent Estates and the Priority of Claims.
12Supra note 4.
13Carmen S Thériault, Widdifield on Executors and Trustees, 6th ed (Toronto: Thomson Reuters, 2002) Chapter 3 at 3.8 – Priority of Claims and Insolvent Estates.
14Supra note 4.