Administration of estates - Handling secured and unsecured debts

Learning Outcomes

After reading this article, you will be able to distinguish between secured and unsecured debts in estate administration, explain the statutory order of payment, and identify the duties and potential liabilities of personal representatives (PRs) when settling debts. You will also be able to apply these rules to both solvent and insolvent estates, ensuring correct prioritisation and compliance with SQE1 requirements.

SQE1 Syllabus

For SQE1, you are required to understand the legal rules and practical procedures for handling debts during estate administration. In your revision, focus on:

• 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

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. This article explains the distinction between secured and unsecured debts, the statutory order of payment, and the treatment of insolvent estates.

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.

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.

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.

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.

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)

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.

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
• pay unsecured creditors from the general estate assets

If PRs pay beneficiaries before settling all debts, they may become personally liable to unpaid creditors.

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.

Worked Example 1.2

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.

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 to defeat creditors (e.g., gifts at undervalue)

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.

Insolvent Estates

An estate is insolvent if its liabilities exceed its assets. In such cases, special rules apply.

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

Insolvent estates must be administered in accordance with the Insolvency Act 1986 and the Administration of Insolvent Estates of Deceased Persons Order 1986. The order of payment is:

1. Secured creditors (from their security)
2. Preferential creditors (e.g., certain employee claims, some taxes)
3. Unsecured creditors (paid proportionally if insufficient assets)
4. Deferred debts

PRs should 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.

Worked Example 1.3

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.

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

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

Key Terms and Concepts

• secured debt
• unsecured debt
• statutory order of payment
• personal liability (of PRs)
• section 27 notice
• insolvent estate