Who Gets Priority? Beneficiaries vs. Creditors of an Estate

Significant debts owing by a deceased will often impact the gifts that were bequeathed to the estate’s beneficiaries. Sometimes, creditors’ priority over the estate’s assets means that beneficiaries only receive a fraction of what the deceased bequeathed to them. Other times, if the estate is insolvent or bankrupt, beneficiaries will receive nothing. It is important that beneficiaries and estate planners are aware of what priority creditors have over the estate’s assets, and how each testamentary gift is impacted.

Estate Trustee’s Authority to Pay Estate Debts

The Trustee Act, R.S.O. 1990, c. T.23 sets out a general scheme for an estate trustee to prioritize the payment of an estate’s liabilities. The estate trustee may pay or allow any debt or claim on any evidence that they think sufficient.¹ Further, if the Will authorizes the estate trustee to execute the trusts and powers thereof, they have wide discretion to settle the debts of the estate.²

Unless a contrary intention appears from the Will, the estate trustee is permitted to pay the debts of the estate in the following order:

1. Payment of reasonable funeral expenses;
2. Testamentary and administration costs, including the estate administration tax (i.e. probate fees) and compensation for the executor/estate trustee;
3. All other debts proportionately, including provincial Crown debts.³

The residue of the estate is typically applied rateably, according to their respective values, to the payment of the deceased’s debts, funeral testamentary expenses and the costs and expenses of administration of the estate.⁴ This is subject to the rule that the proceeds of sale of a property are primarily liable to pay any mortgages owing on that property.⁵

Abatement of Bequests

Where the estate is solvent but there are insufficient funds to pay all of the testator’s debts as well as the gifts set out in the Will, then the principles of abatement apply to rateably reduce the testamentary gifts based on the type of gift.

Often the priority of abatement is outlined in the Will. Where it is not outlined in the Will, or no Will exists, then the order of abatement is the following:

1. Gifts of residuary personal property;
2. Gifts of residuary real property;
3. General legacies, which include pecuniary bequests from the residue;
4. Demonstrative legacies (i.e., bequests from the proceeds of a specific asset or fund not forming part of the residue);
5. Specific bequests of personal property; and
6. Specific devises of real property.⁶

Therefore, where the estate has significant liabilities and will be required to pay creditors prior to distribution of the assets of the estate, those beneficiaries of specific bequests of personal or real property are more likely to retain the full value of those gifts than those with only a residual interest in personal or real property.

Insolvent & Bankrupt Estates

Where the estate is insolvent, the common law and legislation establishes a similar priority to that of abatement from which the estate’s assets are to be applied against its debts: (1) personally (i.e. personal moveable property that is not real estate) which has not been bequeathed; (2) real estate devised to pay debts; (3) real estate not so designated; (4) general legacies; and (5) specific legacies.⁷

In the event that the deceased’s estate is bankrupt, then s. 136 of the Bankruptcy and Insolvency Act, R.S.C., 1985, c. B-3 applies to determine the priority of creditors. First, as with insolvent estates, the reasonable funeral and testamentary expenses are paid.⁸ Then, the expenses regarding the administration of the estate, including the expenses and fees of the trustee and legal costs, are to be paid.⁹

Where the trustee requires guidance from the court regarding the management or administration of an estate, including issues regarding payments to creditors, they may bring an application for directions under Rule 65 of the Rules of Civil Procedure, R.R.O., Reg. 194, in respect to any question relating to the administration of the estate.

Conclusion

A beneficiary’s entitlement to a bequest can be dramatically reduced depending on the debts owed by the estate, and the type of bequest. Where the estate’s liabilities are significant, beneficiaries with a residual interest in personal property (e.g. funds in a bank account) are more likely to have their gift reduced than a beneficiary of specific real property. In any case, beneficiaries of an estate with significant liabilities should be prepared for the possibility of the value of their gift significantly decreasing. Likewise, those considering how to optimally plan their estate ought to be aware of these priorities to ensure that some beneficiaries are not unintentionally excluded from the estate by virtue of their gifts being more susceptible to abatement to pay creditors.