Administration of estates - Handling secured and unsecured d...

Learning Outcomes

This article explains the administration of estate debts, including:

• Distinction between secured and unsecured debts in estate administration
• Treatment of secured debts under section 35 Administration of Estates Act 1925 and exoneration by contrary intention in a will
• Statutory order of payment of debts and expenses
• Statutory order for the application of assets to debts under section 34(3) AEA 1925 (undisposed-of property, residue, property given/charged for debts, fund for pecuniary legacies, specific gifts, and appointed property)
• Abatement of legacies and the treatment of demonstrative legacies
• Creditor classes and the order of distribution in insolvent estates under insolvency rules, including pari passu payment of unsecured creditors
• Duties and potential liabilities of personal representatives (PRs), and protective measures such as section 27 Trustee Act 1925 notices and prudent timing to guard against Inheritance (Provision for Family and Dependants) Act 1975 claims

SQE1 Syllabus

For SQE1, you are required to understand the legal rules and practical procedures for handling debts during estate administration, with a focus on the following syllabus points:

• the distinction between secured and unsecured debts in an estate
• the statutory order of payment of debts and expenses
• the duties and liabilities of personal representatives when settling debts
• the treatment of insolvent estates and the application of insolvency rules
• the rights of creditors and the effect of failing to follow the statutory order
• the incidence of liabilities in solvent estates under AEA 1925 s34(3) and the treatment of secured debts under s35
• the concept of abatement of legacies where assets are insufficient after payment of debts and expenses
• protective measures for PRs, including section 27 notices and timing of distribution in light of possible family provision claims.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the difference between a secured and an unsecured debt in the context of estate administration?
2. In what order must debts and expenses be paid from an estate under the Administration of Estates Act 1925?
3. What are the consequences if a personal representative pays beneficiaries before settling all debts?
4. How are insolvent estates administered, and which rules apply to the order of payment?

Introduction

When a person dies, their estate must be used to pay outstanding debts and liabilities before any distribution to beneficiaries. Personal representatives (PRs) are responsible for identifying, prioritising, and settling these debts in accordance with statutory rules. Failure to comply with the correct order of payment can result in personal liability for the PRs. In solvent estates, PRs must also understand the statutory order for the application of assets to satisfy debts. In insolvent estates, insolvency law governs the priority among categories of creditors.

Key Term: secured debt
A debt backed by a specific asset of the estate (the security), such as a mortgage or charge, giving the creditor a preferential claim over that asset.

Key Term: unsecured debt
A debt not backed by any specific asset of the estate, such as credit card balances or utility bills. The creditor has no security and must rely on the general assets of the estate for repayment.

Key Term: statutory order of payment
The legally prescribed sequence in which estate expenses and debts must be paid, as set out in the Administration of Estates Act 1925 and related legislation.

Key Term: personal liability (of PRs)
The risk that PRs must pay estate debts out of their own funds if they distribute assets to beneficiaries before all debts are settled.

Key Term: insolvent estate
An estate where the total debts and liabilities are greater than the value of the assets.

Secured and Unsecured Debts

Debts owed by an estate fall into two main categories: secured debts and unsecured debts. The distinction determines both the creditor’s rights and the order in which debts are paid.

A common secured debt is a legal mortgage over the deceased’s home. In general, secured creditors may look to their security and realise it if necessary. In administration, the mortgage debt is primarily borne by the charged asset, unless the will or another document shows a clear contrary intention.

Key Term: exoneration of secured debts
The principle (AEA 1925 s35) that a beneficiary who takes an asset subject to a mortgage must, by default, take it with the burden of the debt, unless the will expressly directs that the mortgage is to be paid from other estate assets (for example, “free of mortgage” or a direction specifically referring to the mortgage).

The default rule is that a gift of mortgaged property passes subject to the mortgage (section 35 Administration of Estates Act 1925). A general direction to pay debts out of residue is not enough to exonerate; there must be a specific reference to the mortgage or a clear direction that the gift is “free of mortgage”. If exoneration applies, the burden of the secured debt falls elsewhere, typically on residue, before specific gifts are disturbed by the statutory order of application.

Unsecured debts include personal loans, credit card balances, tax liabilities payable by the estate, household bills, and professional fees. These are paid from the general estate after funeral and administration expenses are met, following the correct statutory framework.

Worked Example 1.1

A deceased leaves an estate worth £300,000. There is a mortgage of £100,000 on the house, credit card debts of £20,000, unpaid utility bills of £2,000, and funeral expenses of £5,000. How should the PRs pay these debts?

Answer:
The PRs must first pay the funeral expenses (£5,000), then settle the mortgage (£100,000) from the proceeds of the house (the secured asset). Next, they pay the unsecured debts: credit cards (£20,000) and utility bills (£2,000). Any remaining assets can then be distributed to beneficiaries.

Worked Example 1.2

The will gifts “my house at 1 High Street to Alice.” The house is subject to a £150,000 mortgage. There is no general direction about debts, and residue goes to Ben. In a variation, assume the will says “my house at 1 High Street to Alice free of mortgage.”

Answer:
On the original facts, Alice takes the house subject to the mortgage burden; section 35 AEA 1925 applies, so the mortgage is primarily borne by the house and Alice faces the debt or reduced equity. On the variation, the phrase “free of mortgage” is a contrary intention: the mortgage must be discharged from other estate assets (normally residue) before Alice’s gift is transferred unencumbered.

The Statutory Order of Payment

PRs must pay debts and expenses in a strict order set out by statute. This ensures fairness among creditors and protects PRs from personal liability if followed correctly.

The general order is:

1. Funeral, testamentary, and administration expenses (including reasonable funeral costs and costs of obtaining the grant)
2. Secured debts (to the extent of the security)
3. Preferential debts (such as certain taxes or employee wages, if applicable)
4. Unsecured debts (all other debts not falling into the above categories)
5. Deferred debts (debts payable after all others, such as interest not yet due)

In addition to the order above, two related frameworks are important:

• the statutory order for the application of estate assets to paying debts in a solvent estate (AEA 1925 s34(3)), and
• the priority among creditor classes in an insolvent estate (by insolvency legislation).

In solvent estates, section 34(3) AEA 1925 prescribes which assets must be used first to meet debts and expenses. Broadly:

• property undisposed of by the will (retaining a fund for pecuniary legacies)
• residue (retaining any fund for pecuniary legacies not already provided)
• property specifically given for the payment of debts
• property charged with the payment of debts
• the fund retained to meet pecuniary legacies
• specific devises or bequests (rateably according to value)
• property appointed by will under a general power (rateably according to value)

This order is about the incidence of debts on assets, not about creditor priority. It is subject to contrary intention in the will. It often means residue bears the primary burden in a solvent estate, before specific gifts are disturbed.

Key Term: abatement
The proportional reduction of legacies when the estate assets are insufficient to satisfy all gifts after paying debts and expenses. Specific legacies are paid before general legacies; demonstrative legacies are treated as specific to the extent of the identified fund.

Key Term: preferential creditor
A creditor whose claim has statutory priority over ordinary unsecured creditors in insolvency (for example, certain employee remuneration or protected deposit claims), paid after funeral and administration expenses but before ordinary unsecured creditors.

Worked Example 1.3

A PR distributes the estate to beneficiaries before paying a £10,000 tax bill. HMRC later demands payment. What is the PR’s position?

Answer:
The PR is personally liable to pay the £10,000 tax bill from their own funds, as they failed to settle all debts before distributing the estate.

Exam Warning

If PRs do not follow the statutory order of payment, or distribute assets before all debts are paid, they risk personal liability—even if they acted in good faith.

Worked Example 1.4

The will contains: specific legacy of “£5,000 cash in my safe to James”; a general pecuniary legacy of £5,000 to Nora; and residue to Rita. Estate assets: undisposed-of bank account £3,000, residue £10,000, the safe contains £5,000 in cash. Debts and expenses total £12,000. How are assets applied?

Answer:
Apply the AEA 1925 s34(3) order of application. First use undisposed-of property (£3,000) and residue (up to £10,000), totalling £13,000, to pay debts and expenses (£12,000). The specific legacy (£5,000 in the safe) remains intact, so James is paid in full. The general pecuniary legacy to Nora abates and cannot be paid (no assets remain after debts and the specific legacy). Rita receives nothing.

Duties and Liabilities of Personal Representatives

PRs must:

• identify all debts and liabilities owed by the estate
• pay debts in the statutory order before distributing assets to beneficiaries
• ensure secured creditors are paid from their security (and follow any contrary intention stated in the will)
• pay unsecured creditors from the general estate assets
• apply estate assets in the correct order under AEA 1925 s34(3) in solvent estates

If PRs pay beneficiaries before settling all debts, they may become personally liable to unpaid creditors. PRs owe fiduciary duties and must act with reasonable care and skill in managing estate assets, preserving value and avoiding waste. The primary duty to “collect and get in” the estate and administer it according to law is set out in AEA 1925 s25. If a breach causes loss, PRs can be liable for devastavit.

Key Term: devastavit
A PR’s breach of duty resulting in loss to the estate (for example, distributing prematurely or failing to settle liabilities), exposing the PR to personal liability.

The court has discretion to relieve a PR from personal liability if satisfied the PR acted honestly and reasonably (Trustee Act 1925 s61). PRs can reduce risk by:

• advertising for unknown creditors under section 27 Trustee Act 1925 and waiting the prescribed notice period (minimum two months) before distribution
• delaying distribution for at least six months from grant to guard against family provision claims under the 1975 Act
• retaining sufficient funds if early distribution is required
• seeking directions from the court if in doubt

PRs often need to raise money to pay debts and expenses. They have statutory powers to sell estate assets (including land), mortgage or otherwise realise funds. PRs should consider:

• any will provisions directing the source of payment
• beneficiaries’ wishes regarding retention or sale of particular assets
• tax impacts of sales
• liquidity: if most assets are non-cash, PRs may need to sell property or investments to meet liabilities promptly

Worked Example 1.5

PRs obtain a grant where liabilities total £83,500. Assets: a home (free of mortgage) £365,000, savings £40,000, investment portfolio £35,000, car £5,000. How do PRs raise funds?

Answer:
There is sufficient value but limited liquidity (£40,000 cash). PRs should use their power to sell appropriate assets (for example, part of the investment portfolio and/or the car) to meet the liabilities. They must observe any will direction about the source of payment, consult residuary beneficiaries, and consider tax impacts. They should avoid selling specific gifts unless the statutory order of application requires it.

Rights of Creditors

Creditors may:

• submit claims to the PRs for debts owed
• require information about the estate’s assets and liabilities relevant to their claim
• challenge transactions made by the deceased intended to defeat creditors in an insolvent estate context (for example, transactions at undervalue—seek advice under the Administration of Insolvent Estates of Deceased Persons Order 1986 and Insolvency Act 1986)

PRs should consider placing statutory advertisements (section 27 notices) to notify potential creditors and protect themselves from unknown claims.

Key Term: section 27 notice
A statutory advertisement placed by PRs to notify unknown creditors of the estate, limiting the PRs’ liability for undiscovered debts after distribution. Notices are typically placed in the London Gazette and a local newspaper, requiring claims to be lodged within at least two months.

If a known creditor or beneficiary cannot be found, PRs should not rely on section 27 notices alone. Options include retaining a reserve, taking indemnities, purchasing missing beneficiary insurance, or applying for a Benjamin order (a court order permitting distribution on the basis a missing person is presumed dead), which affords fuller protection to PRs.

Insolvent Estates

An estate is insolvent if its liabilities exceed its assets. In such cases, special rules apply. PRs must administer insolvent estates in accordance with the Insolvency Act 1986 and the Administration of Insolvent Estates of Deceased Persons Order 1986. The general order of priority is:

• secured creditors (to the extent of their security, often outside the pool available to unsecured creditors)
• funeral, testamentary, and administration expenses
• preferential creditors (for example, certain elements of employees’ remuneration and protected deposits)
• ordinary unsecured creditors (paid pari passu—proportionally)
• deferred debts (for example, certain spousal loans)

Key Term: pari passu
The principle that creditors of the same class share available funds proportionally when the estate is insufficient to pay them in full.

Secured creditors may realise their security (for example, the mortgagee may exercise a power of sale). PRs must not pay any creditor in full unless all creditors of a higher or equal class can be paid in full. If in doubt, PRs should seek professional advice or apply to court for directions. Beneficiaries receive nothing in an insolvent estate.

Worked Example 1.6

An estate has assets of £50,000 and debts of £120,000: a mortgage of £30,000, unpaid wages of £10,000, and £80,000 in credit card debts. How should the PRs proceed?

Answer:
The mortgagee (secured creditor) is paid first from the secured asset. Next, unpaid wages (preferential creditor) are paid. The remaining assets are distributed proportionally among the unsecured creditors (credit card companies). No assets are available for beneficiaries.

Worked Example 1.7

Estate assets: £20,000 cash. Liabilities: funeral/administration expenses £5,000, preferential debts £6,000, ordinary unsecured debts £50,000, deferred debts £3,000. No secured creditors. How are payments made?

Answer:
Pay funeral and administration expenses first (£5,000), leaving £15,000. Next, pay preferential debts in full (£6,000), leaving £9,000. The remaining £9,000 is distributed pari passu among ordinary unsecured creditors (total £50,000). Deferred debts receive nothing.

Summary Table: Order of Payment (Solvent vs Insolvent Estate)

In solvent estates, the table above reflects the general order in which categories of expenses and debts are settled. Separately, the statutory order for applying assets to meet those payments (AEA 1925 s34(3)) determines which parts of the estate bear the burden first (often residue), subject to contrary intention in the will and the treatment of secured debts under AEA 1925 s35.

Key Point Checklist

This article has covered the following key knowledge points:

• The distinction between secured and unsecured debts in estate administration
• The statutory order of payment of debts and expenses
• The duties and potential personal liability of personal representatives
• The rights of creditors to claim and challenge transactions
• The special rules for insolvent estates and the application of insolvency law
• The incidence of debts on assets in a solvent estate under AEA 1925 s34(3) and treatment of mortgages under s35
• Protective steps for PRs, including section 27 notices and prudent timing of distribution

Key Terms and Concepts

• secured debt
• unsecured debt
• statutory order of payment
• personal liability (of PRs)
• section 27 notice
• insolvent estate
• exoneration of secured debts
• abatement
• pari passu
• preferential creditor
• devastavit