Estate trustees have an ongoing fiduciary obligation to pay all estate debts in full. This means that trustees handling insolvent or bankrupt estates must be extra cautious when administering the estate. It's always a good idea to consult a professional in these situations.
Insolvency vs. Banruptcy
Before we dive in, we need to review the terminology. An insolvent estate lacks enough assets to pay all of its debts in full. A bankrupt estate has gone through the formal process of declaring bankruptcy under the Bankruptcy and Insolvency Act (the “BIA”).
Consideration 1 - Who do you pay first?
The estate trustee must pay the creditors of the estate before the beneficiaries (and publishing a notice to creditors is an important part of this process). Otherwise, the estate trustee risks liability for paying the estate debts up to the amount paid out to the beneficiaries.
If the estate has declared bankruptcy, the estate trustee is well advised to consider section 136 of the BIA, which dictates the order in which the debts of the estate is paid. Regardless of whether the estate is insolvent or bankrupt, they are required to pay the reasonable funeral and testamentary expenses first.
Consideration 2 - What are the tax consequences?
When an estate is insolvent, tax payments are typically given priority over unsecured creditors. When there are outstanding tax payments, it would be prudent for the estate trustee to contact the estate’s unsecured creditors and inform them that the estate has no money to pay all the debts in full.
The trustee should then inform the unsecured creditors that they are planning on paying the estate taxes before paying other debts. This ensures that the creditors of the estate are aware of the state of affairs and gives them a clear opportunity to raise any disagreements they may have with the estate trustee.