Creditors’ Claims

Terms:

Nonclaim statutes:
Statutes that provide that all claims against an estate must be presented to the personal representative or filed with the probate court within a certain time period or be forever barred from being paid.

Unsecured creditor/loan:
Credit is extended to the borrower based on his or her creditworthiness. There are no assets pledged to back up the debt in case the borrower defaults on the loan. Credit card debt is the most common type of unsecured loan.

Secured creditor/loan:
If the borrower defaults on the loan, the creditor can take the collateral (specific asset) in lieu of cash payment on the debt. Typically, secured loans are used in the purchase of cars or real estate.

Exoneration of lien doctrine:
A doctrine that allows an administrator of an estate to pay off an outstanding lien on devised property so that the beneficiary can receive the asset without the burden of a mortgage or other lien.

Contingent claims:
A claim is considered contingent if no one can ascertain at the decedent’s death whether the claim will ever become due.

Insolvent:
An inability or lack of means to pay debts.

States have different requirements regarding giving notice to creditors after the decedent’s death. The notice can be general, such as publication in a newspaper of general circulation or personal notice directly to known and ascertainable creditors. See, e.g., Tulsa Professional Collection Services, Inc. v. Pope, 485 U.S. 478 (1988).

For unsecured creditors, most states have nonclaim statutes, which give creditors a certain amount of time to submit a claim. See, e.g., Fla. Prob. Code § 733.702 (three months); Mo. Rev. Stat. § 473.360 (six months). After the cutoff date, they are barred from pursuing the claim further. Since the personal representative’s term is limited, the time for submission of a claim is also limited, to facilitate winding up of the decedent’s estate in a timely manner.

For secured creditors, the personal representative must give them personal notice of the estate administration, typically by registered or certified mail. In response, the creditor can accelerate the debt (i.e., request full payment immediately, although the debt is current), thereby giving the personal representative the option of paying the debt out of the general assets of the estate or selling the property and applying the net sales proceeds to the debt.

Example: When Wesley died three months ago, he owned a personal residence. He had purchased the home five years ago for $200,000. At the time of his death, he still had 25 years left to pay off the mortgage; the balance was $130,000. Today, the home is worth $250,000. When his lender, Fleet Bank received notice of Wesley’s death, it put in a claim to receive the entire $130,000 outstanding mortgage. Since there were adequate funds in the estate to pay the balance, the personal representative sent a check to Fleet Bank for $130,000.

Sometimes, if the home must be sold, the proceeds are insufficient to satisfy the debt. The creditor can obtain the balance from the general assets of the estate; however, the character of the claim changes. Rather than being a secured creditor, with a higher priority of payment if the estate is insolvent, the creditor is relegated to the status of a “general” or “unsecured” creditor. As such, if the estate is insolvent, the creditor would likely receive less than the full amount of the claim.

As an alternative to accelerating the note, the secured creditor can maintain the security interest in the property and continue to receive payments, albeit from the beneficiary instead of the decedent. This might be an attractive option where the market value of the property greatly exceeds the outstanding mortgage and/or the interest rate the bank is receiving on the note is higher than the current prevailing rate. Although the devisee is not personally liable for the debt, the secured creditor still has the option of foreclosure on the property for nonpayment.

Example: When Wesley died three months ago, he owned a personal residence in San Francisco, CA. He had purchased the home 25 years ago for $25,000. At the time of his death, he still had five years left to pay off the mortgage; the balance was $4,000. Today, the home is worth $450,000. When his lender received notice of Wesley’s death, it decided not to put in an immediate claim for the $4,000 balance. Wesley’s will devised the residence to his only son, Ruben, who eagerly took over the payments. As long as Ruben remains current on the loan, the lender will not exercise any remedial actions, such as foreclosure, on the property.

Generally, the personal representative still has the option to pay off the mortgage from the residuary estate, which is commonly the case in jurisdictions that recognize the common law “exoneration of liens” doctrine. This doctrine allows the executor to pay off the mortgage from the property of the estate so that the beneficiary of the property can receive the property free of the lien.

Survival of claims

At common law contract claims generally survived the death of the debtor and could be enforced against and by the personal representative. Tort claims did not. Today, most jurisdictions have extended the same type of survival to various tort claims.

Example: Two months ago, Audrey’s neighbor, Gwen, had been injured on Audrey's property. To recover the cost of her medical treatment, Gwen sued Audrey for the $1,000. Before the case was settled, Audrey died. In most jurisdictions today, this type of tort claim would survive Audrey’s death and Gwen could receive reimbursement for her medical expenses from Audrey’s estate.

Contingent claims

A claim is considered “contingent” if no one can ascertain at the decedent’s death whether the claim will ever become due. Again, states vary in their treatment of contingent claims under their respective nonclaim statutes. Some states require that the claim be presented before the cutoff date of the nonclaim period, or else be barred. Other jurisdictions do not require the creditor to take any action during this period. Instead, if the claim becomes certain, the creditor can sue the distributees for the money. In either case, there are, of course, the general statutes of limitations that determine when the claim is barred.

Priorities for payment of claims in insolvent estates

Statutes fix the order in which claims against the estate are to be paid. The following payment scheme is representative:

(1) Administration expenses;

(2) Funeral expenses and expenses of last illness (up to a stated dollar amount);

(3) Family allowance;

(4) Debts given preference under federal law, such as tax claims;

(5) Secured claims (up to the value of the security interest);

(6) Judgments entered against the decedent during his lifetime; and

(7) All other claims, such as unsecured creditors.

See, e.g., Cal. Prob. Code § 11420; Fla. Prob. Code § 733.707.

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