Who gets paid in an insolvent estate?

Some individuals are appointed as Estate Trustees and, after determining the debts owed by the Estate, discover that the Estate does not have enough money to pay its creditors leaving the Estate Trustee to question who should get paid.

There are laws regarding who is entitled to be paid first when an estate is insolvent (unable to pay all of its debts). An Estate Trustee of an insolvent estate must decide whether to administer the estate as an insolvent estate, or to place the estate into bankruptcy. In either case, the Estate Trustee must determine the priority of payment, as the failure to pay creditors in the proper order could result in personal liability to the trustee.

If the estate is administered simply as an insolvent estate, the order of payment is:

1. reasonable and necessary funeral expenses;
2. testamentary expenses and costs to administer the estate (including payment of the compensation for Estate Trustee and legal fees);
3. all other debts proportionately, including provincial Crown debts (it is unclear whether federal crown debts such as federal income taxes receive a priority over other creditors in this category).

If the estate is placed into bankruptcy, section 136 of the Bankruptcy and Insolvency Act dictates the order that debts are to be paid. As with an insolvent estate, bankrupt estates are required to pay the reasonable funeral and testamentary expenses first. Secondly, the costs for administering the estate (including compensation for the Estate Trustee and legal fees) get paid. Other specific costs such as wages or commissions owed then can get paid.

The most significant change when paying debts of a bankrupt estate as opposed to an insolvent estate is that the federal crown (including federal income tax payments) does not receive any priority under a bankrupt estate and is treated like any other unsecured creditor that has no priority.

Given the potential exposure a trustee faces if the order of payment is not made correctly when dealing with an insolvent estate, trustees may wish to retain legal counsel to assist them.