Ironically, insolvent estates are often more time-consuming, nuanced, and complex than solvent estates. This increased complexity stems from two primary factors. First, the procedural intricacies involved in providing notice to creditors under Article 14 of Chapter 28A and navigating the rules for presentation and payment of claims under Article 19 of Chapter 28A are nuanced. Additionally, the legal framework surrounding which assets are readily available to the personal representative, which assets require court intervention to access, and which are entirely exempt from claims is complex.
Understanding Estate Insolvency
Typically, insolvency refers to a situation where liabilities exceed assets or cash flow. In estate administration, however, the concept is more nuanced and depends heavily on which assets are accessible to the personal representative without significant expense or court involvement. There are two types of insolvent estates. Truly insolvent estates, where debts exceed all assets (including those not readily accessible). In these cases, it may be best not to open an estate at all. Probate-insolvent estates, where debts exceed the assets readily available to the personal representative. This is the more common scenario and the focus of this blog.
Determining and Managing Claims
The first step in administering a potentially insolvent estate is to identify and reduce claims. If the estate is likely to be insolvent, strict adherence to creditor notice procedures is crucial. North Carolina law requires publication of a general notice to creditors. In addition, direct notice to all known or reasonably ascertainable creditors is required. These known or ascertainable creditors have ninety days from the date of the mailed notice if later than the deadline in the general notice to creditors. Serving notice promptly is critical, as any creditor who fails to timely file a claim is barred. Many valid claims are lost simply because creditors miss this deadline. Providing proper notice is sufficient to begin barring claims, and doing so early and carefully streamlines the entire administration process.
Classifying Claims by Priority
After the statutory periods expire, the personal representative can disregard untimely claims, classifying them into nine statutory priority classes. For example, Fifth Class Claims, which include North Carolina state taxes, must be paid in full before paying lower-class claims. Some claims arise after death, such as estate-related loans or other contracts with the personal representative. These are generally barred if not filed within six months of the contract or claim arising and can typically be anticipated and planned for in advance.
Additionally, one of the complexities involved in estate insolvency is that the claims of creditors do not encompass all the expenses of the estate. Before any claims are paid, costs of administration must be paid, which include court costs, legal fees, appraisals, tax return preparation and the like. Costs of administration are often a moving target and accrue during the course of the estate and, therefore, they must be estimated with reasonable precision to ensure that practical and economical decisions are made in dealing with an insolvent estate.
Evaluating Available, Limited Purpose, and Exempt Assets
Once claims are known and prioritized, the next step is to evaluate estate assets. Assets readily available to the personal representative include the following:
- The decedent’s solely owned bank accounts without beneficiaries
- Tangible personal property and automobiles
- Joint accounts, stocks, or investments without rights of survivorship
- Real estate devised directly to the estate or personal representative
- The decedent’s solely owned stocks/investments without beneficiary designations
- Cash, checks payable to the estate, and other miscellaneous personal property like LLCs or other business interests
Due to the prevalence of beneficiary designations and rights of survivorship, the pool of readily available assets has significantly decreased in recent decades. Real estate devised to the estate or personal representative is also uncommon. However, if the above assets are sufficient to cover all claims and costs of administration, the probate estate is solvent, and administration proceeds smoothly.
If the estate lacks the assets listed above to cover claims and costs of administration, the next source is real estate not devised to the estate or personal representative. To access such real estate, the personal representative must initiate a special proceeding to pull the real property into the estate for payment of claims. This process requires notice to heirs/devisees and, if granted, must comply with the judicial sale statute including upset bid periods and court approval. While this procedure is well defined and generally a formality, it adds significant time and expense to estate administration. Alternatively, the personal representative may allow heirs/devisees to sell the real property privately outside of the estate and loan a portion of the proceeds to the estate to pay claims and costs of administration. However, this is risky as the personal representative accepts personal liability up to the value of the real property released if the heirs/devisees do not loan the necessary funds to the estate. Therefore, this is typically only prudent with a written agreement in place.
Assets available to the personal representative for a limited purpose include the following:
- Payable-on-death (POD) savings accounts
- Gifs causa mortis made by the decedent
- Joint bank accounts, investments or stock with rights of survivorship
- Securities with beneficiary designations
These assets pass outside of probate and are not automatically accessible to the personal representative. There is no codified process to “claw back” these assets into the estate. Further, beneficiaries or joint owners gain immediate access without consent from the personal representative. By the time the probate estate solvency is assessed, those funds may be spent or otherwise inaccessible. In practice, unless the beneficiaries or joint account owners are cooperative (e.g., children of the decedent or the personal representative), pursuing these assets can require costly and time-consuming litigation, often outweighing the potential recovery, especially if the estate is only marginally insolvent.
Some assets are completely exempt from creditor claims, including qualified retirement accounts (e.g., IRAs, 401(k)s), life insurance proceeds, life estates in real property, tenancy by the entirety real estate, joint real estate with rights of survivorship, and spousal allowances (statutory year’s allowance). These assets are never available to satisfy estate debts and should be carefully identified early in the administration.
Strategic Options in Insolvency
After evaluating timely claims and available assets, the personal representative must develop a strategy. On option is to hold the estate open to allow potential assets to surface or for creditors to negotiate. The personal representative may also proactively negotiate by contacting creditors, explaining the solvency issue, and requesting reductions. The personal representative can also scrutinize claims for errors, inflated charges, or procedural defects. If a claim is inaccurate, the personal representative may, after attempting to seek correction with the creditor, reject it in whole or in part. Creditors can dispute rejections through legal action, but often lack the resources or incentive to do so, especially for small claims.
In many ways, an estate has significant leverage when negotiating with creditors. There is no personal credit score at stake with a deceased individual. The estate can remain open for a year or more, with no defined deadline for paying debts. Creditors are often motivated to settle quickly and are often not familiar with state specific probate laws. Additionally, personal representatives have broad discretion to review and reject claims.
Conclusion
Insolvent estates, especially probate-insolvent ones, require careful analysis, strategic planning, and a thorough understanding of the probate process. The complexities lie not just in the claims themselves, but in identifying which assets are reachable, which are not, and how to balance debt resolution with administrative efficiency.
Given the legal and procedural challenges involved, a skilled probate attorney is essential for efficiently administering an insolvent estate and minimizing the risk of error or unnecessary expense.
About the Author:
Andrew M. Brower is a Board Certified Specialist in Estate Planning and Probate Law at Law Firm Carolinas.