What happens if a deceased estate is insolvent?

Families dealing with an estate that owes more than it owns tend to fear the wrong thing. They worry that the children will inherit the debt. That is not how it works.

They then underestimate the real consequence, which is that the will becomes irrelevant, the house may have to be sold, and nobody receives anything.

When an estate is insolvent

An estate is insolvent where its liabilities exceed its assets. The test is done on what the estate actually contains, which is where families are most often surprised:

A retirement fund death benefit is not an estate asset. It is distributed by the fund's trustees under section 37C and never enters the estate, so it is not available to creditors. Our guide on how retirement fund benefits are paid explains why.

A life policy paid to a named beneficiary is not an estate asset either. It pays the nominee directly.

So a family can find that the estate is insolvent while substantial money is paid out to individuals, and that this is entirely lawful. Those payments are outside the estate and beyond the reach of estate creditors.

The converse also applies. A policy payable to "the estate" rather than to a named person falls in, and is available to creditors.

What the executor must do

Section 34 of the Administration of Estates Act 66 of 1965 sets the procedure.

Where an estate appears to be insolvent, the executor must report the position to creditors in writing, informing them that unless a majority in number and in value of all creditors instruct him in writing, within a period of not less than 14 days, to surrender the estate under the Insolvency Act, he will proceed to realise the assets and administer the estate.

Creditors whose claims amount to less than R1 000 are not counted in the number, although they still count in value.

That gives two possible routes, and the choice belongs to the creditors rather than to the family.

Route one: administration continues

If the creditors do not instruct a surrender, the executor carries on. Assets are realised, and the estate is distributed applying the order of preference in the Insolvency Act 24 of 1936 within the ordinary liquidation and distribution account process.

This is the more common route and the less expensive one, which matters because every rand spent on the process is a rand that does not reach a creditor.

Route two: surrender and sequestration

If the creditors so instruct, or in appropriate cases on application to the High Court, the estate is surrendered and dealt with under the Insolvency Act, with a trustee appointed in place of the executor.

Creditors sometimes prefer this where they want the investigative powers the Insolvency Act provides, particularly where there is a suspicion that assets were disposed of before death or that transactions can be set aside.

The order of preference

Whichever route is followed, creditors are not paid equally. There is a fixed order, and the practical shape of it is:

The costs of administration come first, including the executor's or trustee's remuneration, the Master's fee, and the costs of realising the assets.

Secured creditors are paid from the proceeds of the asset over which they hold security. A bond holder is paid from the house; a bank financing a vehicle is paid from the vehicle. Where the security does not cover the debt, the balance falls to the bottom of the queue with everybody else.

Preferent creditors follow, in a statutory sequence that includes certain employee claims and certain taxes.

Concurrent creditors, meaning ordinary unsecured creditors, come last and share whatever remains proportionally. In most insolvent estates they receive a fraction of what they are owed, and frequently nothing.

Heirs receive nothing, because there is nothing left. Inheritance is what remains after debts, and here nothing remains.

What the family is not liable for

This is the fear that brings people to ask the question, so it is worth stating plainly.

Heirs are not personally liable for the shortfall. An estate's debts are the estate's. Where the assets run out, the unpaid balance is not transferred to the children or to anybody else who would have inherited.

The exceptions are where somebody has taken on the liability independently:

A surety. If you signed surety for the deceased's debt, you are liable on your own contract, and death does not release you.

A joint debtor. A jointly held account or loan makes you liable for the whole of it.

A spouse married in community of property. A joint estate means the debts were always joint, and a surviving spouse in community is in a fundamentally different position from any other family member.

Our guide on what happens to your debt when you die covers this from the debtor's side.

What happens to the house

The question everybody actually wants answered.

Where the estate is insolvent, the house is an asset to be realised, and a surviving family living in it has no right to keep it merely because it is their home. If it is bonded, the bond holder is paid from the proceeds.

Three things are worth knowing.

Bond cover may change everything. Many home loans carry life cover that settles the bond on death. Check before assuming the house is lost, because an estate that looks insolvent on paper is sometimes solvent once the bond is settled by the policy.

The occupants still cannot simply be removed. An eviction requires a court order under the PIE Act whoever the owner is, and our eviction checker sets out what that involves.

An heir can sometimes buy it. Where a family member can raise finance, purchasing the property from the estate at a proper value keeps it in the family and pays the creditors, which is an outcome everybody prefers to an auction.

If you are the executor

Being the executor of an insolvent estate is an exposed position and it should not be taken on casually.

Do not distribute anything. An executor who pays an heir and then discovers the estate cannot meet its debts is personally exposed to the creditors.

Do not pay creditors out of order. Paying a sympathetic creditor ahead of the statutory sequence is a personal liability.

Follow section 34 properly. Report in writing, give the period, and keep proof.

Get advice early. The costs of doing this properly come out of the estate ahead of the creditors, and they are far smaller than the cost of doing it wrongly and being sued personally.

Where a spouse was married in community of property

This is the situation most often misunderstood, and it produces the harshest outcomes, so it is worth separating out.

In a marriage in community of property there is one joint estate. The debts are joint debts and the assets are joint assets, and death does not retrospectively divide them into his and hers.

The practical consequence is that the whole joint estate is brought into the administration. The surviving spouse's half is not shielded from the deceased's creditors, because the creditors were always creditors of the joint estate. A surviving spouse can therefore lose assets they think of as their own to debts they think of as their late partner's.

Two things follow. A surviving spouse in community of property who is told that an estate is insolvent should take advice immediately rather than waiting for the account, because their own position is directly affected. And anybody considering how they are married should understand that this is one of the real consequences of the regime, which our guide on antenuptial contracts sets out.

The mirror point is also true: where the joint estate is solvent, half of it already belongs to the survivor and was never the deceased's to leave to anybody.

Worked example

This example is illustrative. A man dies owning a house worth R900 000 with a bond of R820 000, a vehicle worth R110 000 with R140 000 outstanding on the finance, and R6 000 in the bank. He owes R190 000 on credit cards and personal loans, and the funeral cost R40 000. His will leaves everything to his two children.

Assets are R1 016 000. Liabilities are R1 190 000, plus administration costs. The estate is insolvent.

The executor reports to creditors under section 34 and gives them the statutory period to instruct a surrender. They do not, so administration continues.

The house is sold and the bond holder is paid. The vehicle is sold and the financier is paid what it realises, with the R30 000 shortfall dropping into the concurrent claims. Administration costs come off the top. The funeral account, the credit cards and the personal loans share what is left, which is very little.

The children receive nothing, and the will has made no difference to anything. What they do not have is any personal liability for the R174 000 shortfall, unless one of them signed surety.

Had there been bond cover on the home loan, the arithmetic would have been entirely different: the R820 000 liability would have fallen away, the estate would have been solvent, and the children would have inherited a house.