What to do when creditors are knocking at your door

With few exceptions, when clients meet with us to prepare their estate plan, they hope that the value of their estate will be greater when they pass away than the value at the time they are planning. I’ll have few clients here and there that want to “spend it all”, but these clients are in the minority. With proper planning, we can help our clients leave an inheritance for their chosen family, friends or charity – a legacy that can make a difference in the next generation of their family or friends. However, sometimes we will administer an estate that has more debts than it does assets because of medical bills, unexpected death or just poor financial planning. We call these upside-down estates.

You might think that if an estate is upside-down, it is best to run as far away as possible and hope the problems go away, hope that the collection agencies stop calling. The likelihood of the problem just going away is slim, but remember, unless you yourself are also on the hook for the debt, simply because you are the executor, the surviving spouse, an heir, or a friend, does not make you personally responsible for a debt. But you may be able to still do a lot with this type of estate.

It is the upside-down estate that benefits the most from proper probate planning and intentional choices during the administration. Arizona has intentionally made laws that deal with the situation where debt is a major feature of a person’s estate. The reason for this is that we as Arizonans have a public policy interest in making sure that the family and friends of a deceased person have been taken care of. It reduces the likelihood of someone needing government assistance, reduces the involvement of government in managing assets and encourages people to take care of someone’s last interests.

The first two things to evaluate in an upside-down estate are who are the creditors and what kinds of debt is involved. Not every debt needs to be paid off immediately. For example, student loan debt is discharged at death. Secured debt such as a mortgage will be paid off when the asset is sold. And unsecured debt such as your credit cards are paid off with sufficient assets in an estate. Our role in the administration is to guide clients on how to correspond with creditors to ensure 1) they are a valid creditor; 2) how to allow or disallow a claim; and 3) how to resolve the debt. Once we know who the creditors are and what debt is involved, we will come up with a strategy to maximize the upside-down estate.

We have many different techniques in our tool bag to maximize an upside-down estate. First, if needed, we may advise a client to delay opening probate until two years have passed from the date of death. This is called a tardy probate. In Arizona, if a probate is opened after the two year anniversary, we do not have to give creditors a chance to make a claim and the assets pass directly to the heirs. Evaluating if this is an option takes careful consideration such as the obligations of a family member or friend to continue to pay bills of the estate during the two-year waiting period, or the hardship to the family at the delay of selling or collecting assets. One of our

attorneys can discuss with you the consequences of a tardy probate and if that is a strategy that should be utilized in your case.

Another technique we often utilize is to ensure that the spouse and children of a decedent receive their “statutory allowances”. Statutory allowances are amounts designated by law that the family can receive from an estate before creditors. This goes back to our public policy concerns mentioned above. First, the State doesn’t want a spouse or child to be without assets to provide for their monthly expenses. This would ultimately burden our society if families lost everything to creditors. Second, the State anticipates that an administration takes time and allows for families to get a stipend for the first year to cover expenses until a distribution can be made. By utilizing the statutory allowances, the family of a decedent may receive up to $37,000 from the estate before creditors are paid. Statutory allowances are complicated and affected by distributions made outside of an estate through assets such as IRAs, life insurance or pension. It is important to include this discussion in the overall strategy of the upside-down estate administration.

Making sure to pay compensation to an executor of an estate is another effective strategy to avoid paying creditors. The probate laws require that expenses of administration are paid before creditors. This means that compensation and legal fees are paid first and if there are funds left, creditors may be paid. If the surviving spouse is the executor of the estate, this is a way make sure cash from the estate goes to family over creditors. This compensation does count as income to the personal representative; but we will ensure that their compensation is reasonable and is considered in light of other income or personal tax liability.

Finally, if there are still creditors left and assets to pay them, we have a list of priority that determines which creditors are paid first. The list goes as follows:

1. Costs and expenses of administration.
2. Reasonable funeral expenses: if a family member has paid for funeral expenses, they should be reimbursed for these expenses before other creditors that follow. 3. Debts and taxes with preference under federal law: federal income and estate tax 4. Reasonable and necessary medical and hospital expenses of the last illness, including compensation of those attending him: like funeral expenses, if a family member paid final medical bills or care, they can be reimbursed. This also includes hospitals, hospice, emergency services, etc.
3. Debts and taxes with preference under the laws of the state: income taxes payable to Arizona or other states.
4. Finally, all other claims: credit cards, other medical bills, outstanding debts, etc.

As you can see there are a lot of things to consider and plan for with an upside-down estate. The strategies listed above are just a few that we consider when administering an estate like this. We understand that losing a loved one is difficult and if you add dealing with creditors to the burden, it can be overwhelming. Additionally, creditors often prey on this vulnerability and use scare tactics to bully family members into paying a debt. We always recommend meeting with an experienced probate lawyer before making any decision to pay off debts, sell assets or open probate. Time is often your friend in these matters and better planning will lead to a better result.

It is important that you seek legal counsel from a firm that specializes in Arizona probate administration. Our firm also has the experience of knowing when to implement various strategies to maximize an upside-down estate.