What is an insolvent estate?

Insolvent estates occur when the assets from a deceased estate are insufficient to pay out the liabilities and expenses, and money is owed to the creditors.

The administrator/executor or the legal personal representative (LPR) is responsible for administering the deceased estate.

Laws governthe priority and order in which a creditor is paid.

Administering an Insolvent deceased estate

The LPR administering the estate can choose how to proceed. Insolvent deceased estates are managed under the Probate and Administration Act 1898 (NSW) or the Bankruptcy Act 1966 (Cth)

The person administering the deceased person’s estate will need to apply to the court and distribute the estate as per the jurisdiction and priority set out in the NSW administration laws.

The Bankruptcy Act

The Bankruptcy Act 1966 (Part XI) allows the Federal Circuit and Family Court to appoint a bankruptcy trustee to administer an insolvent deceased estate.

The administrator of deceased estate can apply to the Federal Court of Australia for an administrator’s petition Order to make the estate bankrupt. The administrator may also be required to submit an affidavit, a statement of affairs, and prove that the deceased met the Australian connection requirements.

A bankruptcy trustee is appointed, assets are liquidated and are distributed to creditors in order of priority.

Two or more creditors can apply for a creditor’s petition in some circumstances if the deceased debtor owes a creditor at least $10 000. Once the creditor gives the official receiver a copy of the administration order, the bankruptcy is registered on the National Personal Insolvency Index.

If the deceased person was already bankrupt on their death, the official receiver may continue to administer the bankrupt estate.

Bankruptcy rules on death

When someone dies, all liabilities in the deceased’s sole name will have to be repaid from the estate.

When dealing with insolvent deceased estates, the priority matters. Bankruptcy rules are applied when paying a creditor. Under the Bankruptcy Act, the administration of an estate is managed in a similar way to management of property of a living bankrupt. To avoid being personally liable for mishandled money, the executor or administrator must follow a specific order of priority.

Creditors can be secured, preferential or unsecured.

The order of priority for payments is:

1. Secured creditor;
2. Funeral expenses;
3. Testamentary and administrative expenses;
4. Preferential creditor;
5. Unsecured creditors;
6. Interest on unsecured loans;
7. Other debts;

Inheriting personal debt – what is your liability?

The assets of a solvent estate must first be used to pay any outstanding debts, followed by distribution to beneficiaries of any surplus.

However, if the estate is insolvent and there are insufficient assets to cover all the debts, a beneficiary does not inherit the deceased person’s debt unless:-

1. the debts are held jointly, or
2. they have guaranteed payment of the deceased person’s debt.

Debts are not inherited by beneficiaries, other than:

1. If the deceased’s loans had a third party guarantee, then the third party would be liable; and
2. If the deceased gifted money within seven years before death, it may be considered avoidance of paying creditors.

What about life insurance and superannuation?

Certain assets of a deceased estate are preserved and not available for the creditors. Life insurance policy proceeds are not allowed to be used to pay estate debts unless:

1. They are funeral or testamentary expenses; or
2. the Will or previous contractual agreements direct otherwise.

If the deceased held superannuation benefits and life insurance funds, the payments are distributed as per:

1. the nominations in the policy; or
2. the deceased’s Will directive; or
3. intestacy laws.

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