A Practical Approach To Administering Insolvent Estates

Reflective of the current economic climate practitioners are witnessing an increase in the number of insolvent estates coming across their desks.

1. Introduction:

Consequently, practitioners will have to become familiar with and apply the rules of bankruptcy as they relate to estates. This article sets out in general terms the sources of law involved, how and when the fact of insolvency is established, what property is included in administering an insolvent estate and the order of payments on distribution. Particular attention will be given to the relevant case law regarding statute barred debts and contested claims. The approach taken endeavours to be as practical as possible where the context permits.

2. Sources of Law:

The Budd Report[1] stated that the main objectives of the bankruptcy legislation were:

i) to secure equality of distribution and to prevent any one creditor obtaining an unfair advantage over the other

ii) to protect bankrupts from vindictive creditors by freeing them from the balance of their debts where they are unable to pay them in full and to help rehabilitate them

iii) to protect creditors not alone from debtors who prior to bankruptcy prefer one or more creditors to others but from the actions of fraudulent bankrupts

iv) to punish fraudulent debtors.

In essence, the law attempts to strike a balance between the competing interests of creditors on the one hand and the protection of legitimate debtors on the other.

The sources of bankruptcy law in the context of insolvent estates are: section 46 Succession Act, 1965 Act (the 1965 Act), the First Schedule to the 1965 Act, the Bankruptcy Act, 1988 (the 1988 Act), Order 79 of the Rules of the Superior Courts and relevant case law.

3. Establishing Insolvency:

Insolvency may be apparent at the time the Inland Revenue Affidavit is returned for marking or may become apparent at any time during the administration but prior to distribution. Practitioners may find that during the currency of an administration the underlying value of estate assets may have fallen relative to the values as returned. This has become particularly apparent recently in the case of realty and equity investments. Administrations may average 8 months which is an uncomfortably long time in a falling market.

Where an estate is insolvent the order of distribution is prescribed by Part I of the First Schedule. It provides that:

i) The funeral, testamentary and administrative expenses have priority. Testamentary expenses obviously include those associated with extracting a grant of representation or sale of estate assets and also any litigation costs relevant to the administration subject to judicial discretion and the rules regarding taxation of costs. It may be necessary to sell estate property to fund these items of expenditure. [2]

ii) Subject to the above the laws of bankruptcy will apply where the date of death is substituted for the date of adjudication.

The effect of bankruptcy is that all property of the deceased vests in the official assignee (i.e. the personal representative) as at the date of death. [3] Nominated funds and property passing by survivorship will not form part of the estate assets available to creditors. Similarly for joint accounts where a presumption of advancement exists and a resulting trust does not operate. Monies wrongfully paid to beneficiaries would have to be refunded to the estate.

Consideration of such means of transferring assets should form part of every inter vivos wealth protection strategy. However, such dispositions within two years of bankruptcy i.e. death are void[4] and within 5 years are voidable if it can be proved that at the time the deceased was unable to pay his debts as they fell due without recourse to the property involved. It is essential that any wealth protection or estate planning strategy be put in place in a timely manner when clients’ intentions are beyond reproach.

In addition, the bankruptcy rules regarding fraudulent preferences apply. Section 57 of the 1988 Act effectively prevents the personal representative from preferring one creditor over another. A practitioner who, for example, gives an undertaking to a bank to discharge indebtedness inconsistent with the order of priority may find himself the subject of an action in negligence on the part of the bank as the undertaking may be deemed a fraudulent preference and consequently void. In the case of apparently solvent estates such undertakings should not only be given subject to receipt of funds but, perhaps, to the estate being solvent up to the time the undertaking can be discharged as otherwise the rules of bankruptcy will determine priority.

4. Methods of administering an insolvent estate:

There are two methods. Firstly, a bankrupt’s estate may be wound up with the assistance of the court and an official assignee duly appointed. Any creditor interested in the deceased’s estate or the deceased’s personal representative may apply. Secondly, the personal representative can administer the estate himself by applying the bankruptcy rules regarding, inter alia, the order of priority. This article deals with the latter option which in practice tends to be the more cost efficient and quicker. The personal representative will find that he is trustee for the beneficiaries[5] but also trustee for any creditors[6]. In effect, the personal representative should consider himself as having a statutory role and must administer an estate in accordance with probate law and practice, tax law and bankruptcy law. There is certainly a case to be made for the appointment of professional executors.

5. Order of payment:

When an estate is solvent it does not matter in what order creditors are paid provided all are paid in full.

However, for insolvent estates the order of priority is crucial. Overriding priority is given to funeral, testamentary and administration expenses otherwise nobody might bother to attempt to wind up insolvent estates. These will generally comprise legal fees for administering the estate, selling estate property and taking and/or defending any litigation touching the estate. The costs of an administrator ad litum appointed by the court pursuant to section 27 of the 1965 Act to defend proceedings against an estate would also be covered and indeed legal fees incurred in selling estate assets to cover legal fees and debts. Any funeral expenses should be reasonable given the insolvency of the estate

Next in the line of priority are preferential debts such as taxes or social insurance contributions payable to the State and also obligations in the form of wages payable to the deceased’s employees. If there are insufficient funds to discharge these liabilities they will abate accordingly as they have equal priority.

After preferential creditors come secured creditors who have a number of options. They can rely on the secured property in full satisfaction of the debt. Alternatively, they can realise the security and, if the sale proceeds are insufficient to discharge the indebtedness, they can prove for any shortfall as an unsecured creditor, or, they can require the property to be valued and if the value does not cover the indebtedness they can enter a claim for any shortfall without having to sell the property. Finally, they may surrender the security and prove for their debt as an unsecured creditor.

After secured creditors come unsecured creditors who are normally divided into two categories. Creditors who were owed money by the deceased during his life time will have priority over those with claims after the date of death. If there are insufficient funds to discharge these liabilities in each class they will abate accordingly.

6. Statute barred claims:

The issue usually to be determined is: whether there was a cause of action surviving against the deceased at the date of death.

Section 8 of the Civil Liability Act, 1961 states that on the death of a person all causes of action subsisting against him at the date of death shall survive against his estate. Section 9 provides that:

‘No proceedings shall be maintainable in respect of any cause of action whatsoever which has survived against the estate of a deceased person unless either-

(a) proceedings…were commenced within the relevant period and were pending at the date of death, or

(b) proceedings are commenced in respect of that cause of action within the relevant period or within the period of two years after his death whichever period expires first.’

The operation of section 9 is conditional on section 8 applying in the first instance and in default the usual periods of limitation as prescribed in the Statute of Limitations Act, 1957 will apply.

There are two areas in practice which cause particular difficulties for practitioners or should I say banks. They are guarantees and mortgages.

(a) Guarantees: The liability under guarantees is typically secondary in nature. The guarantee may provide that the guarantor shall be deemed to be in default if called upon by the bank to make payments in accordance with the guarantee and fails to do so. For example, if an individual personally guaranteed the debts of a company with which he was connected and a bank had demanded payment under a personal guarantee and payment was not forthcoming and the individual died then this liability would constitute a cause of action surviving against the deceased at the date of death and section 9 would apply accordingly. The bank would have the lesser period of 6 years from the date of demand under the guarantee or two years from date of death to issue proceedings against the estate. If no proceedings issue in time the bank’s claim would be statute barred.

Taking the example further; if, on the other hand, no demand was made of the deceased during his life time then section 8 and, consequently section 9, do not operate. The bank will have six years to sue for breach contract from the date of demand after death.

The following is an example of the typical relevant wording used in a guarantee:

‘In consideration of the Bank agreeing at my request to give time or make or continue advances or otherwise give credit or afford banking facilities for so long as the Bank may think fit to the Borrower....I hereby agree to pay and satisfy to the Bank on demand all sums of money which are now or shall at any time hereafter be owing to the Bank anywhere on any account… provided that the total amount recoverable from the Guarantor shall not exceed the sum of €CAP together with interest…’

Emphasis is mine.

(b) Mortgages: Generally, standard form mortgages provide that non-payment of any instalment due under the mortgage coupled with a demand shall constitute a breach. Some mortgages provide that mere non-payment for a period certain constitutes a breach. In any case, the wording of any special and general conditions attached to a loan offer will have to be considered as these will be incorporated into the mortgage and any inconsistency will operate against the bank contra proferentum.

If mere non-payment by an individual during their life is a breach and that person dies then the bank has the lesser period of 6 years from the date of non-payment (default) or two years from date of death to issue proceedings against the estate.

If non-payment coupled with a demand for payment constitutes a breach and there is non-payment and a demand during the mortgagor’s lifetime then the bank has the lesser period of 6 years from the date of demand or two years from date of death to issue proceedings against the estate. The general limitation provisions will apply, in this particular case, if there is non-payment but no demand made inter vivos and death follows.

The following is an example of the wording used in a pro forma mortgage in defining default:

‘If the Mortgagor fails to pay or discharge within 3 months of the due date any money payable by him or any obligation or liability payable by him from time to time to the Lender.’

The facts of Bank of Ireland v O’Keeffe[7] are illustrative. On the 18 November, 1980 MO’K guaranteed to pay, on demand, the debts of B. Ltd. MO’K died on the 11 February, 1982. A first and only demand for payment was made on 6 May, 1982 and proceedings issued on foot thereof on 19 February, 1985. Barron J held that no cause of action was subsisting against the deceased at the date of death. He stated[8] that:

‘The claim which is brought is one which was not maintainable until after demand made and no cause of action could have arisen until such demand was made-see In re: J Brown’s Estate[9]. In that case there was a joint and several covenant in a mortgage by the deceased and his son to pay the principal on demand…Several years after [the deceased’s] death a demand was made against his estate on foot of the covenant. It was held that no cause of action existed whereby the plaintiff could sue either the deceased or his estate until demand had been made. Since this demand was not made until after the death of the deceased, it follows that there was no cause of action subsisting against him at the date of death’

The result was that the relevant period (6 years from 6 May, 1982) of limitation prescribed by the 1957Act applied.

Barron J stated[10] obiter that:

‘it does seem quite clear from the provisions of s.9 that the relevant period referred to in s.9, sub-s. 1 includes not only the basic period of limitation laid down by the statute but also the extension of such basic period by reason of such matters as acknowledgement in writing, mistake etc.’

In The First Southern Bank Limited v Eileen Maher[11] DM executed a promissory note on the 14 November, 1980 which was repayable by monthly instalments and provided that in the event of non-payment of any of the instalments the whole sum remaining payable would become immediately due together with interest. On 4 December, 1980 DM executed a mortgage over his lands in the plaintiff’s favour as security for any monies owing to the plaintiff. No money was ever paid on foot of the promissory note. DM died on the 21 July, 1983. The plaintiff demanded repayment of the total amount due under the note from DM’s estate and proceedings issued on 27 February, 1989. The defendant argued that the claim was statute barred and the plaintiff argued that demand was a prerequisite to enforcement of its security.

Barron J dismissed the plaintiff’s claim on the basis that as soon as default was made on the first instalment (30 June, 1981) the monies became due and owing. It was at this time that the statute began to run against the plaintiff. As the plaintiff had a cause of action subsisting against DM at the date of his death and that since no proceedings were brought within two years of death (being the lesser of the two relevant periods) the plaintiff’s claim was statute barred by virtue of section 9 (2).

Barron J said that:

‘The cause of action based on the promissory note being based upon contract would have survived against the estate of Daniel Maher and the relevant period in relation to it would have been six years. As this latter period would not have expired within two years of his death, the period within which proceedings should have been brought against the estate of Daniel Maher on foot of the promissory note was a period of two years from the date of his death.’

Barron J conducted an analysis of the security documentation. He said:

‘In my view the draftsman of the security document was not sure what he was seeking to achieve…There is nothing in the deed to suggest that such security could not be enforced until the demand was made. The document could have provided that…no proceedings could be brought to raise the security until a demand had been made’.

The security document did provide that demand for payment would constitute default but only did so in respect of certain transactions and not the indebtedness under the promissory note with the result that default arose automatically one month after non-payment.

In Allied Irish Banks plc v Philip English[12] the deceased guaranteed any sums due or to become due and owing by his son to the limit of £3,000 with interest from the date of demand. A demand was made on the 12 April, 1985 and the bank never sought to enforce the guarantee while the deceased was alive. The deceased died on the 18 February, 1987 and proceedings issued on 28 September, 1989. Whilst the decision turned largely on the fact that the bank had not advised the elderly deceased to obtain independent legal advice at the time the guarantee was executed Sheridan J did say obiter that the present case was distinguishable from the Bank of Ireland v O’Keeffe case as the demand in the present case was made during the lifetime of the deceased and therefore a cause of action had accrued and was subsisting as at the date of death. Consequently, sections 8 and 9 would have applied and as the bank did not issue within 2 years of death (being the lesser period) its claim would have been statute barred. Sheridan J continued by stating that during the two year period after death the liability to the bank was acknowledged in the CA24. He observed that:

‘It would certainly have been arguable… that the entry in the schedule of assets within the period of two years from the date of death…might well be construed as an acknowledgement but determination of this question will have to await another time.’

As can be seen the definition and circumstances surrounding events of default under security documentation is crucial and determines what provisions apply. It is the duty of a personal representative, where appropriate, to challenge third party claims especially where they might be statute barred. However, I submit that acknowledging a statute barred debt in the CA24 will cause the period of limitation to re-commence and practitioners and personal representatives may find themselves open to an action in negligence on the part of disappointed beneficiaries and perhaps other legitimate creditors who may find that the amount of their recoverable entitlement/debt is reduced or wiped out as a consequence of the acknowledgement.

It is submitted that the common law doctrines regarding mistake and legal disability have not been displaced by section 9 and in particular the use of the words ‘any cause of action whatsoever’. Whilst sections 8 and 9 attempt to create certainty regarding claims against deceased’s estate that certainty would perhaps result in greater injustices if the doctrines of mistake and legal disability and indeed acknowledgement were to be displaced. Best practice would suggest that any debt that is seriously disputed should be recorded as such in the CA24 and perhaps accompanied with a letter to Revenue explaining the situation. This will keep the personal representative’s options open. Such a notation and any explanatory letter will ultimately become a matter of public record as the Probate Office will require production of any document referred to in the CA24. It may well be that an attempt to file a corrective affidavit noting a debt as ‘disputed’ subsequent to a third party assertion that a debt has been acknowledged in the first/previous CA24 may not be sufficient in equity to stop the doctrine of acknowledgement from operating.

Where it is apparent or obvious that an estate in insolvent creditors will no doubt do all they can in an attempt to increase their share in a distribution of available assets or indeed may try and ‘jump priority’. For example, creditors may seek to maintain claims based on resulting or constructive trusts which become constituted prior to death with the result that any assets the subject of such a valid claim would not comprise estate assets available for orderly distribution. Section 44(4)(a) of the 1988 Act specifically states that property held by the bankrupt/deceased in trust for another is not to be reckoned in the orderly distribution.

7. Conclusion:

Generally until relatively recently practitioners need only have concerned themselves with probate law and practice and the related areas of trust, succession and tax law! The result of falling values in the majority of asset classes is that probate practitioners will be expected to correctly apply the bankruptcy regime to insolvent administrations. With less to go around estates will become subject to an even higher level of scrutiny or interest on the part of third parties. Care needs to be taken that practitioners’ are not exposed to an action in negligence with the result that their insurance becomes available to discharge indebtedness which would otherwise have been the responsibility of a deceased’s estate.