Insolvent Estates

One of my post popular blogs was about insolvent (i.e. “BANKRUPT”) probate estates. Here are my notes from Tuesday’s NBI seminar on the topic. If you want to discuss short sales, upside down houses, forced mortgage reductions, dealing with reverse mortgages after death or just dealing with estates that have a lot of creditors Contact Me!  -John

  1. Insolvency

An estate is insolvent if, at fair valuations, the sum of the estate’s debts is greater than all of the estate’s assets (Cal Civil 3439.02).

  1. The key issue with insolvent estates is not distributing any assets or paying any creditors until all liabilities, creditors and the like have been fully determined.  Then, once determined there will not be enough assets, petition the Court for proper distribution.  This can be done in the final report to the Court.
  2. Priority of payment of creditor claims.  PC 11420 sets forth the order of payment of the decedent’s debts, expenses of administration and charges against the estate.  If the estate is insolvent and there are insufficient assets to pay general debts, it may be necessary for the PR to pay a portion of each general debt, pro rata.  PC 11420 provides:

(a) Debts shall be paid in the following order of priority among classes of debts, except that debts owed to the United States or to this state that have preference under the laws of the United States or of this state shall be given the preference required by such laws:
(1) Expenses of administration. With respect to obligations secured by mortgage, deed of trust, or other lien, including, but not limited to, a judgment lien, only those expenses of administration incurred that are reasonably related to the administration of that property by which obligations are secured shall be given priority over these obligations.
(2) Obligations secured by a mortgage, deed of trust, or other lien, including, but not limited to, a judgment lien, in the order of their priority, so far as they may be paid out of the proceeds of the property subject to the lien. If the proceeds are insufficient, the part of the obligation remaining unsatisfied shall be classed with general debts.
(3) Funeral expenses.
(4) Expenses of last illness.
(5) Family allowance.
(6) Wage claims.
(7) General debts, including judgments not secured by a lien and all other debts not included in a prior class.
(b) Except as otherwise provided by statute, the debts of each class are without preference or priority one over another. No debt of any class may be paid until all those of prior classes are paid in full. If property in the estate is insufficient to pay all debts of any class in full, each debt in that class shall be paid a proportionate share.

  1. Compromise of claims.  If it is to the advantage of the estate, a PR may compromise or settle a claim against the estate (PC 9830).  However, if the time for filing creditor’s claim has not expired, authorization by Court order is required for a compromise or settlement of a claim.
  2. Governmental Claims. In my personal experience the Department of Health Services will not invoke it’s possible priority under PC 11420(a). However, in a recent phone conversation with a Franchise Tax Board employee they told me the FTB had invoked it recently in a case in Placer county. Thus, paying attention to the FTB debt is extremely important for many reasons.
  3. Fraudulently conveyed assets.  If there is a deficiency of probate assets the creditor’s can require the PR to recover assets fraudulently conveyed by the decedent before death (PC 9653).  This would apply if the decedent made a fraudulent conveyance or made a gift of property in contemplation of death.
  4. PC 10361 is a little used section related to selling over-encumbered real estate in a probate. It can be used to reduce the mortgage lien in an amount equal to costs of administration related to the sale (such as attorney fees!).  It is a great tool to bring in for houses of decent value, that are upside down, when there are little or no other probate assets.

California Probate Code Section 10361   (a) If encumbered property is sold, the purchase money shall be applied in the following order:

   (1) Expenses of administration which are reasonably related to the

administration of the property sold as provided in paragraph (1) of

subdivision (a) of Section 11420.

   (2) The payment of the expenses of the sale.

   (3) The payment and satisfaction of the amount secured by the lien

on the property sold if payment and satisfaction of the lien is

required under the terms of the sale.

   (4) Application in the course of administration.

   (b) The application of the purchase money, after the payment of

those expenses set forth in paragraphs (1) and (2) of subdivision

(a), to the payment and satisfaction of the amount secured by the

lien on the property sold shall be made without delay; and, subject

to Section 10362, the property sold remains subject to the lien until

the purchase money has been actually so applied.

  1. Exhibit JBP-9  is a sample schedule of distribution from an insolvent case.  The case turned out to be totally insolvent but notice if any money had been left at line 15 it would have been distributed pro-rata amongst the general creditors.

PRACTICE POINTER:  When I see a case is possibly heading toward insolvency I often recommend waiting until the final petition to deal with all creditors.  That way you can clearly lay out in one place who is entitled to what.  Additionally, that would be noticed for everybody to show up in Court if they disagree.

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