DEALING WITH CREDITORS IN FORMAL PROBATE

Although there may be room for compromise, your late spouse’s debts are not automatically extinguished at his death. How and when creditors are paid depends on a number of factors including whether they are “secured” or “unsecured,” known or unknown, and whether your spouse was the sole obligor of a debt. The probate code contains notice procedures that must be strictly followed to guarantee that creditor’s claims are completely extinguished.

As with most things in life, when paying creditors timing is everything. You shouldn’t pay creditors or beneficiaries too quickly. You need to be sure that each creditor has an enforceable claim and that the estate has sufficient assets to pay all creditors in full. Beneficiaries should be paid only when all creditor claims are finally determined. The risks are high.

You, as the personal representative, can be personally liable to either creditors or beneficiaries if you fail to properly assess their relative entitlements. By following the instructions in this Step Four and Step Five, you can protect yourself from liability.

First, you remain personally responsible to repay home loans and other debts for which you co-signed. Additionally, “secured” creditors, such as mortgage companies and other lenders, have a mortgage, “lien,” or other security interest securing their loan. If a secured creditor is not paid, they can pursue the secured assets directly. For example, a mortgage company will bring a foreclosure action on real estate for which they hold a mortgage. A car loan or leasing company will simply come and take the car. Your spouse’s “unsecured” creditors can make a claim against your spouse’s probate estate or his trust during the publication period described below.

You may wonder: “How do creditors know when someone dies?” The short answer is: “You tell them.” As personal representative, you must make a reasonable attempt to locate creditors. Most creditors can be located from a simple review of your spouse’s incoming mail or his checkbook. You might also consider contacting a credit agency to run a credit report. Known creditors must be sent a Notice to Known Creditors.

In most states, known creditors have four months from their receipt of the Notice to Known Creditors (or four months from the date of the published Notice to Creditors (described below), whichever is longer), to file their claim against the estate, or be forever barred.

You must also publish a Notice to Creditors in a legal newspaper in the county of your spouse’s residence to inform unknown creditors of his death. In most states, unknown creditors have four months from the date of the published notice (the “publication period”) to file a claim against the estate, or be forever barred. Merely publishing the claims notice in the newspaper will not bar the claim of a known creditor or a creditor you should have known about. Such creditors may have up to six years to pursue their claims.

Therefore, if in doubt, send a notice. Sending notice reduces the claim period for both known and unknown creditors from the normal six year “statute of limitations” (the period a creditor has to bring a lawsuit to collect its debt) to four months. Although the notice requirements may seem like an added burden, in reality they provide closure and certainty. You can rest assured knowing that no creditor will come out of the woodwork after the publication period has passed and you have disbursed the estate.

As personal representative, you may allow or disallow claims. Allowed claims are simply paid. Disallowed claimants must receive written notice of the disallowance. Failure to disallow a claim is a deemed acceptance (state laws vary as to how much time must pass before a deemed allowance occurs). A disallowed creditor must file a lawsuit to further pursue its claim.

COMPROMISING CLAIMS

If the estate contains only illiquid, or not readily available, assets such as real estate, you should contact creditors and ask them to wait until funds become available. Many creditors will be willing to either wait for full payment, or negotiate a quick settlement of the debt. Credit card companies, for example, are often willing to accept a lesser sum, say 80%-85% of the debt in exchange for immediate payment.

If the estate’s assets are insufficient to pay all creditors, state law determines which creditors get paid first. Except as provided below, neither you (acting in your fiduciary) nor any beneficiary is personally obligated for your late spouse’s personal debts.

If the estate does not contain sufficient assets to pay all creditors in full, the probate code dictates the following priority of claims:

1. Funeral and burial expenses, and administrative expenses such as the personal representative’s fees, attorney fees, and accountant fees. Since funeral and burial expenses are given such high priority, it is usually safe to pay them as soon as possible.
2. Statutory allowances such as the homestead exemption and the family allowance (see Step Five, below) that provide immediate living expenses to the surviving spouse and children of the decedent.
3. State and federal taxes. You will be personally liable if you distribute the estate’s assets before tax obligations have been paid in full.
4. Medical/hospital bills related to you spouse’s last illness.
5. All other claims on a pro rata basis.

Property passing by operation of law is not subject to the claims of your late spouse’s individual creditors. For example, life insurance proceeds are not part of your spouse’s probate estate and therefore are not subject to creditors’ claims (unless the proceeds pass to his estate or his revocable trust).

Similarly, joint property with full rights of survivorship passes directly to the joint owner, outside of the decedent’s estate and is generally not subject to creditors’ claims (except secured creditors with a lien or other security interest in the joint property). However, property in your spouse’s revocable trust is subject to such claims.

PERSONAL LIABILITY OF THE PERSONAL REPRESENTATIVE

Generally, as personal representative you are not liable for your late spouse’s individual debts, or for debts incurred in the administration of the estate (such as funeral, attorney, accounting, and appraisal fees). However, you may become personally liable if you breach one of the fiduciary responsibilities described earlier in the chapter, or if you distribute estate assets to yourself or other heirs at the expense of valid creditor claims.

Beneficiaries can be quite anxious to receive their inheritance, exerting subtle and not so subtle pressure on you to “hurry things up.” If bold, they may even outright ask, “When do I get my money?” You must resist the temptation to appease such heirs, so as to avoid personal liability. Rather than have to ask heirs to return improperly paid distributions, it is cheaper and easier to postpone distributions until all estate liabilities are identified and quantified.

You may decide to make interim distributions to heirs at any time, but you should postpone final distributions until the publication period ends, and all tax returns are filed and accepted by the taxing authorities.

CREDITORS AND INFORMAL PROBATE

With the exception of the closing procedure for informal estates (see Step 5, below), creditors are treated the same in formal and informal probate.

DEALING WITH CREDITORS IN TRUST ADMINISTRATION

In most states, revocable trusts may elect, but are not required, to utilize the creditor notification procedure. If a trustee chooses not to utilize the notification process, creditors have up to six years to present their claims, rather than only four months. The procedural requirements for notifying potential creditors are virtually the same for trusts as for probate estates. The same rationale for time limiting claims also applies.