April 28, 2011

Insolvent or Underwater Estate

In light of recent economic times, I have received phone calls from individuals who were the potential beneficiaries of an estate, albeit an insolvent or underwater estate. 

These people were left with the dilemma of either administering or not administering the decedent’s estate. By no means is this post intended to apply to all situations involving an insolvent estate. Instead, this post is merely to highlight some relevant laws that may factor into a decision to administer an insolvent estate.

First, a person needs to recognize if they are obligated to administer the decedent’s estate because they are liable for the decedent’s debt. If the person is not liable for the decedent’s debts, then there is really no rational reason to administer an insolvent estate hold sentimental reasons. 

The general rule is that a person is not liable for the debts of another. 

However, there are a few exceptions to this general rule. First, a spouse may be liable for the debts of the deceased spouse due to California’s community property laws. For example, if the deceased spouse incurred a substantial amount of hospital bills, it is likely that the surviving spouse would be liable for this. Second, a joint account holder would be liable for the debts of the other joint account holder. For example, if two people signed up for a credit card together, both would be liable for the debt even if one party did not incur any expenses. Third, a person may be liable for the debt of another if they act as a guarantor. A guarantor is somebody who will answer for the debt, default, or miscarriage of another. CC §2787. A common guarantor situation is where a person promises to guaranty a mortgage loan because the lender would not extend credit to the borrower without the inclusion of a guarantor. If none of these exceptions apply, then it is likely that the person will not be liable to pay the decedent’s debt and thus would not be forced into administering the decedent’s estate.

Second, a person needs to determine if in fact the estate is insolvent. 

Just because a home might be underwater does not necessarily equate to an insolvent estate. For instance, even though a home might be underwater, there may be additional assets such as a bank account or shares of a publicly traded company which could make the estate solvent. Thus, it is important for any person when looking at a potentially insolvent estate to view the estate through a comprehensive lens and not become fixated on one asset, namely an underwater home.

Third, the person need to recognize the process it would take to transfer the assets from the decedent. 

The reason for this is because some people might be willing to take on an insolvent estate, which may include a home that could later appreciate. Consequently, many assets can easily be transferred absent probate or trust administration whereby the transfer is done quickly and cheaply. For instance, a bank account can basically be transferred via a death certificate if there is a pay-on-death beneficiary. Moreover, real property held in joint tenancy can be transferred by recording an affidavit of death of a joint tenant with the local county recorder’s office. 

However, certain assets require probate or trust administration for transfer. For example, a home solely titled in the name of the decedent will require a probate to transfer title of the home. Since probate takes at least 9 months in most California counties to finish, this serves as a significant drawback for the person who wants a smooth and easy transfer.

Fourth, the person needs to realize that inherited assets are taken subject to pre-existing liabilities. 

A person is not allowed to abuse the estate administration process by taking only the decedent’s assets but disregarding the decedent’s debts. For instance, assume that a person was the beneficiary of a piece of real property that was underwater by $125,000 but was also the pay-on-death beneficiary of a $75,000 bank account. The person’s intent was to disregard the home entirely but acquire the bank account. In this case, the lender may be permitted to pursue this person to satisfy the home loan through the bank account because it was arguably a victim of fraud. Prob C § 5202.