Dealing With Creditors During the Probate Process
by Don Drake, Connelly Law Offices, Ltd.
"For May, we are going to focus on the issue of probate, which, according to more than a few families, has been known to create horror stories," stated professional fiduciary and certified elder law Attorney RJ Connelly III. "To be clear, probate, if done right, doesn't need to be nightmare-inducing, but there are many reasons for such stories."
"First, many decedents have made no preparations for their death, making their affairs, in many cases, difficult to deal with," said Attorney RJ Connelly III. "In these situations, the personal representative or executor, who is the person who is overseeing the estate after death, will often have difficulty in tracking down the assets of the decedent because records are not easily accessible. This is why a comprehensive estate plan should be in place."
"Secondly, horror stories can occur because of familial infighting," continued Attorney RJ Connelly III. "Unfortunately, heirs and even personal representatives/executors may steal from the probate estate due to greed or emotional ties to items. This leads to internal strife among families and can even result in criminal charges being filed. The person who does the stealing justifies their actions by claiming the relative would have wanted them to have the item. In other cases, honest disagreements may occur and need to be resolved by the probate court."
"And terrible experiences may occur because individuals decide to attempt probate independently when not qualified. Families have also hired attorneys with no experience in the probate court to save money and, in the end, spend unnecessary funds because the unqualified attorney made mistakes that forced the process to extend additional months or even years."
"With that said, there are legal techniques that can avoid probate and eliminate the possibility of experiencing such terrible stories," stated Attorney RJ Connelly III. "These techniques not only keep the estate from public proceedings but are also a great strategy to avoid unnecessary taxes and the need to seek court approval for every step taken. This will also save the family frustration and, in many cases, significant attorney and court fees. We will discuss these issues in blogs during May, but in today's offering, we will focus on navigating the initial phases of the probate process, specifically, dealing with creditors."
At death, the personal representative/executor must formally notify all creditors. This action is one of the first steps in the probate process. This is usually as simple as placing a notice of death in a local newspaper(s) to which creditors can respond and file a timely claim to the probate court for estate payment of the claim.
Outstanding debts typically include credit card payments, mortgage, car payments, insurance, real estate taxes, utility bills, medical and funeral expenses, and other legal debts incurred but not yet paid. The probate timeline for creditors to file such a claim does vary by state. But on average, the creditor’s window of opportunity is three to six months to submit formal claims to the estate for payment.
If there is no contest over the debt, the personal representative/executor will pay the outstanding bill with estate funds, and the creditor will receive payment in full, which completes the claim.
"Those acting as a personal representative /executor must do their due diligence when it comes to seeking out any outstanding creditors," said Attorney RJ Connelly III. "Assets should not be distributed to beneficiaries before the balance of the estate’s taxes and all outstanding debts are entirely paid or dismissed by the probate court. It is the responsibility of the personal representative/executor to cover all estate expenses, and if mistakes are made, the personal representative/executor may become personally liable for deficiencies in estate debt payments unless beneficiaries return their portions of inheritance to cover those outstanding debts."
If the decedent’s property does not go through the probate process, creditors’ claims remain pursuable for longer. This is due, in part, to the fact that there is no legal requirement to notify creditors of a person’s death, and if not done, it could drag the process out.
By the time a creditor may learn of the death, the debt might be so small they are unwilling to pursue its collection. A creditor may find a tax write-off of bad debt more advantageous than chasing down repayment that is not cost-beneficial.
In other cases, an estate may not have liquid assets yet hold real property with enough value to cover the outstanding debt claim if sold. Valuable inheritable property can be lost to a forced sale to cover creditor claims in probate court.
A creditor forcing this type of sale drags out probate proceedings, incurring additional costs, and secured creditors receive priority over unsecured creditors. Banks are the primary secured creditors a personal representative/executor may need to contend with.
"So, suppose a person dies with substantial debt, and there are limited assets to cover these debts," said Attorney RJ Connelly III. "In these situations, the estate is deemed insolvent, and there is a generally accepted prioritization of debt payment by all states. A personal representative/executor should always pay debts in order of a state’s recognized priority list. Otherwise, debts that may be dismissible, pro-rated, or forgiven may receive payment, while secured debts never go away.”
It is essential to understand the priority order for estate debts. Below is a general list of the debt priorities, understanding that some states may have different priority lists.
Administrative costs – Common costs include court fees, filing fees, notice costs, attorney’s fees, and the administrator’s commission.
Family exemptions – Many states will provide for payments to help family members handle their living expenses during the estate’s probate. This family exemption usually gets high priority to lessen financial stress as a family mourns the loss of their loved one.
Funeral and burial costs – These expenses address funeral and burial costs by state law. Costs of cremation, interment, urns, markers, and associated funerary service costs are permissible as part of funeral and burial costs.
Government debts – Income, property, and estate taxes take priority over other debt obligations.
Final medical bills – The decedent’s final sickness or injury is prioritized over other unsecured debts. Some hospitals will reduce final medical bills if the newly negotiated amount is paid promptly and in full.
All other claims – States usually do not prioritize these other more general unsecured debts. Some cases permit debt payment based on the filing date of claims, and other times debts may be pro-rated.
Assets such as retirement accounts and insurance proceeds with a designated beneficiary receive different treatment and provide more protection from creditors. The same holds for an irrevocable trust which, upon death, also is protected from creditors. A beneficiary designation and specific trust entity can help to shield an estate from a heavy debt burden.
"When someone dies, their estate assets must be secured and eventually distributed according to the existing Will or state intestate laws," said Attorney RJ Connelly III. "Another vital function of the estate is for the personal representative/executor to ensure the decedent's genuine debt obligations receive payment. When an estate has sufficient assets to pay all outstanding debts, payment can occur in any order. If the estate leans to insolvency, the personal representative should withhold asset distribution to heirs until the probate court approves the debt fulfillment priorities."
"The process of probate can be tricky, and the more assets and debts involved, the more mistakes can be made. I strongly recommend using an experienced and knowledgeable elder law attorney to avoid problems and make the probate process as smooth as possible."