Insolvent Estates in Ontario: Which Debts Get Paid First

Sometimes the bills left behind add up to more than the estate is worth. That is called an insolvent estate. If you are the estate trustee, this is a stressful position, because you have to decide who gets paid and in what order.

This article explains the order that applies when an estate is in bankruptcy, the general rules for paying debts, and the traps to avoid. It does not replace advice. Whether bankruptcy is the right route depends on the facts, and a lawyer or licensed insolvency professional can help you decide.

Who pays the debts, and what family owes

The estate trustee is responsible for paying taxes, bills and other debts. With a will, the estate is normally distributed after assets are liquidated and funeral, burial and debts are paid. Beneficiaries are paid only from what is left.

A person who co-signed or guaranteed a debt is liable only if they signed, because that follows the contract. Ontario's collection rules say a collector must not collect or try to collect a debt from a person it knows, or reasonably ought to know, is not liable for it [O. Reg. 103/06]. Collectors may generally contact a spouse or relative only in narrow cases, such as when that person guaranteed the debt.

The priority order in a bankruptcy

When an estate is in bankruptcy, section 136(1) of the Bankruptcy and Insolvency Act sets the order of payment, subject to secured creditors. Secured creditors, such as a mortgage lender with a claim on the home, generally deal with their security separately.

If anything remains after creditors and costs are paid, the surplus goes to the legal personal representative or heirs of a deceased bankrupt.

Outside bankruptcy: rateable payment and risks

Outside bankruptcy, the Estates Administration Act says the residuary property is applied rateably to debts, funeral and testamentary expenses and administration costs, unless the will shows a contrary intention. The exact order among different kinds of debt in a non-bankrupt insolvent estate is a legal question, so do not pay selectively without advice.

Beneficiaries who already received a share must refund their rateable part of a debt that is established later. A personal representative who has given the notices the court would direct may distribute after the notice period and is not liable to a creditor whose claim they had no notice of. Creditors can still follow the assets into the hands of those who received them.

A court can relieve a trustee from personal liability for a breach of trust if the trustee acted honestly and reasonably and ought fairly to be excused. That is a safety net, not a plan.

• Do not distribute to beneficiaries until you know what the debts are.
• Do not pay one creditor in full ahead of others without advice.
• Keep records of every payment, notice and decision.
• Remember that taxes are a debt too, and a representative who distributes before a CRA clearance certificate can be personally liable for unpaid tax, up to the value distributed.

Assets that may not be part of the estate

Some assets may pass outside the estate. Where a beneficiary is designated and the insured dies, life insurance money is not part of the estate and is not subject to the claims of the insured's creditors. If no designated beneficiary survives, the money is payable to the personal representative and falls into the estate. RRSP proceeds paid to a designated beneficiary are likewise removed from the estate and not available to its creditors.

There are limits. Amounts payable under a beneficiary designation and life insurance proceeds are treated as part of the estate when a dependant makes a support claim. Whether a particular asset is safe from creditors depends on the facts.

What to do next

• Secure the assets and make a list of everything the deceased owned.
• Gather statements for every debt, including mortgages, credit cards, taxes and funeral bills.
• Do not make distributions to beneficiaries yet.
• Keep funeral and administration receipts, since these rank early in a bankruptcy.
• Note any beneficiary designations on insurance and registered plans.
• Meet a lawyer or licensed insolvency professional to decide whether the estate should be dealt with in bankruptcy.

Frequently asked questions