How are debts paid after death?

The Victorian Law Reform Commission is reviewing how assets are designated to pay the debts of an estate, as part of its current review of a number of succession law matters.
The Commission is keen to hear the views of members of the legal profession with experience in this technical area.

Application of estate assets to the payment of debts out of solvent estates
The debts of the estate must be paid before benefits under the will are distributed. This can be characterised as a two-stage process. Initially, a personal representative may pay debts out of whichever property is to hand, usually cash or an easily saleable asset. This ensures that creditors are paid quickly and in full, where possible. 

However, to ensure that the burden of the debts is not borne arbitrarily by those whose gifts are easily disposed of, the personal representative must then reconcile the debt payments to the assets of the estate to determine which assets should be applied and in what order, and whose entitlements should be reduced accordingly.

This ‘marshalling’ process is done in the order specified by part II of the second schedule of the Administration and Probate Act 1958 (Vic).

The second schedule order of application contains seven categories of property. The debts must be applied to each category of property in turn until fully satisfied.
1. Property undisposed of by will.
2. Property specifically given or directed to be sold, for debt payment.
3. Property charged with, or given subject to a charge for debt payment.
4. Property not specifically given but included in a residuary gift.
5. The pecuniary legacies fund.
6. Specific gifts.
7. Property appointed by will under a general power.

Under this system, a gift to a beneficiary that was initially used to pay debts can be reinstated in full or in part. In this way, the process of bringing the burden of debts into line with the statutory order ensures that people who inherit easily saleable assets are not unfairly disadvantaged. 

In other jurisdictions, the orders are not dissimilar to the Victorian order, and have been described as archaic and of unjustifiable technicality.

Contrary intention
Assets are applied to debts in accordance with the order of application unless there is evidence that the will-maker expressed a contrary intention. The current order causes confusion in determining what will constitute sufficient contrary intention.

A will-maker would likely assume that, if they set aside specific property to pay their debts, that property¬, rather than the property identified by the statutory order of application¬, will be the primary fund for debt payment. However, this is not necessarily the case.

Confusion arises because property set aside for debt payment also comprises two categories of the statutory order. Property in these categories is second and third in line for debt payment under the Victorian order, after property undisposed of by will.

This is a Catch-22 situation. A will-maker’s decision to set aside property for payment of debts could be construed as an intention to vary the statutory order. However, this designated property is included in the order itself, as property in categories two and three could only exist if there were a clause in the will putting them into those categories. This causes a tension.

The Victorian Courts have acknowledged this tension, and have in the past avoided the problem where possible by first construing the will to see if there is room for the statutory order to operate at all. As explained by Justice Dean in Re Williams ([1950] ALR 751, 757), if the order is displaced then the question of how it operates simply does not arise.

However, this approach does not resolve the significant ambiguity underlying the operation of the current statutory order. Given that most personal representatives undertaking this process will not be legal professionals, it is desirable that the legislation governing debt payment be clear and relatively simple to follow.

National Committee on Uniform Succession Laws

In 2009, following major reform in Queensland, the National Committee proposed a model order of application.

The Committee took the view that when the will-maker charges or leaves property to pay debts, he ‘means what he says’. Accordingly, in the model order, such property is the first category of asset to be depleted (not second and third, as in Victoria). This change removes the need to determine whether setting aside property to pay debts will oust the order. Such property will be drawn on first regardless.

The model reduces the number of categories to three, reflecting the Committee’s view that that the shorter the list, the easier it would be to understand out of which property to pay debts.

Practitioner views

Later this year, the Commission will be issuing a consultation paper and inviting submissions.  The paper will be posing questions such as:
• In modern practice, do will-makers have regard to the categories in the second schedule when disposing of their assets?
• Is the National Committee model a viable alternative to the current order?

If you would like to make a submission, you can request a copy of the consultation paper, or view it online.

The terms of reference are available at www.lawreform.vic.gov.au.

Related Project: 
Subtitle: 
Article originally published in the Law Institute Journal
Date published: 
25 Jun 2013

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