When an Ontario Estate Can't Pay All Its Debts: Insolvent Estates

Sometimes the debts a person leaves behind are larger than everything they owned. If you are the estate trustee, or a family member waiting on an inheritance, that situation raises hard questions: who gets paid, who gets nothing, and whether you could be on the hook.

This article explains the general rules in Ontario in plain language. Every estate is different, so if the debts look larger than the assets, talk to a lawyer or accountant before you pay or distribute anything.

Debts come before beneficiaries

When a person dies in Ontario, their property passes to the estate trustee, who holds it as trustee for the people legally entitled to it, after the deceased's debts are paid. In other words, creditors are dealt with before beneficiaries receive anything.

Unless the will says otherwise, the debts and the funeral and testamentary expenses are paid out of the residuary estate, shared rateably according to the value of each part. Mortgaged property is different. If the deceased did not show a contrary intention, that property is primarily liable for its own mortgage debt, so whoever inherits it generally takes it subject to the mortgage.

How an insolvent estate pays its creditors

If the assets are not enough to pay all the debts, the Crown's debts, the personal representative's debts and other creditors' debts are paid proportionately, with no debt ranking ahead of another. Those other debts include judgment debts, specialty debts, simple contract debts and certain damages claims.

Secured creditors are the exception. The equal-sharing rule does not affect any lien the deceased gave over their property during their lifetime, so secured creditors keep their security.

The bankruptcy option

Under the federal Bankruptcy and Insolvency Act, the executor or administrator of a deceased insolvent person may make an assignment of the deceased's property for the general benefit of creditors. This appears to need the court's permission, so confirm with a lawyer whether that applies to you.

In the bankruptcy of a deceased person, reasonable funeral and testamentary expenses incurred by the legal representative are paid first, ahead of the trustee's costs and the other preferred claims. This is subject to the rights of secured creditors.

What may stay out of creditors' reach, and who is not liable

Where a beneficiary is designated on a life insurance policy, the insurance money is not part of the insured's estate and cannot be claimed by the insured's creditors from the time of death. If the insured named their own estate or personal representative instead, the proceeds are paid into the estate and that protection does not keep them from creditors.

Outside debts the survivor signed for themselves, such as joint debts or guarantees, the Family Law Act does not make a spouse liable for the other's debts. One exception is necessities of life: during cohabitation, a spouse can make both spouses jointly and severally liable to a third party, unless the other spouse notified the third party that this authority was withdrawn. Whether a particular debt falls into one of these categories depends on the facts.

Protecting yourself as estate trustee, and next steps

An estate trustee can face personal risk. If you give notice to creditors of the kind the court would have directed, you may distribute once the time in the notice has expired, taking account of the claims you know about, and you are not liable to a creditor whose claim you had no notice of at the time. That protection covers only claims unknown at the time, and you must still have regard to the claims you do know about.

You must also obtain a clearance certificate from the CRA before distributing property you control. If you distribute without one, you can be personally liable for unpaid amounts, but not for more than the value of the property distributed. The certificate is requested on Form TX19 only after the returns are filed and the notices of assessment received.

• List every asset and every debt, and note which debts are secured.
• Do not pay beneficiaries or distribute property until debts are understood.
• Check whether any life insurance or plan has a named beneficiary other than the estate.
• Consider giving notice to creditors before distributing.
• File the tax returns and request the CRA clearance certificate before distributing.
• Speak with a lawyer about whether a bankruptcy assignment makes sense.

Frequently asked questions