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Bankrupt Beneficiaries

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In today's financial climate, and as a practitioner specialising in the administration of estates, I have observed with some alarm the increase in not only insolvent estates, but also the increase in the numbers of beneficiaries that have been made bankrupt and that are not discharged at the time of their inheritance, resulting in their shares of the estate having to be paid to their appointed Trustee in Bankruptcy.

It is important to note that in a role as a Personal Representative you may be held personally liable to creditors of a bankrupt beneficiary, if you pay out to a beneficiary direct and can not recover the sums from them.

There has been a recent case which has given rise to concern as to when a bankruptcy search should be made and how often. 

A bankruptcy search will show a bankruptcy in the previous five years, after which the entries are cancelled.

Re Hemming Dec'd - Raymond Saul & Co (a firm) -v- Holden 2008 EWCH 273 (Ch) this was a case whereby Bertha Hemming left the majority of her residuary estate to her son, Bernard Hemming, who was also appointed as her Executor.  Bernard instructed solicitors to act on his behalf in the administration.  Unfortunately Bernard was declared bankrupt two months after his mother's death and a Trustee in Bankruptcy was appointed.  Before the administration of his mother's estate was completed, Bernard was automatically discharged from bankruptcy.

The claimant firm of solicitors, Raymond Saul & Co applied to Court under CPR, Part 64, for a declaration as to whether the residue of Bertha's estate should be paid to Trustee in Bankruptcy or to Bernard.  Bernard died after issue of the claim form and the first defendant, the sole executor by appointment of his will was substituted as defendant. 

Under the Insolvency Act 1986, Section 306, the bankrupt's estate (as defined in Section 283) vests in the Trustee in Bankruptcy on appointment.  Under Section 307 the Trustee may by notice in writing claim from the bankrupt's estate any property acquired after the commencement of the bankruptcy and before his discharge.  Section 333 (2) requires a bankrupt to inform the Trustee of any after acquired property.

The solicitors argued that a residuary legatee has two separate rights: a chose action to compel due administration of the estate which arises on death and, which the Trustee in Bankruptcy was, therefore, entitled to claim from Bernard in a separate right to payment of residue.

This right to receive the residue comes into existence only upon completion of the administration and, as that was after the date Bernard had been discharged from bankruptcy, the residue should pass to his estate.

This argument was rejected and it was held that the residue must be paid to the Trustee in Bankruptcy.

It was held that a residuary beneficiary has a composite right made up of:  a right of action to compel the due administration of the estate, and the residue (if any) transferred to him on completion of the administration.

When a legatee became a bankrupt, the chose in action which vests in his Trustee in Bankruptcy is therefore the composite right that includes the right to have the assets comprised in the residuary estate paid to him at the end of the administration.

Further, the law had long recognised that a residuary legatee had an immediate ‘interest' of some kind in the assets that would in the future form part of the residuary estate of a testator. It was accepted that the precise nature of this interest was unclear, but at the very least it must give the holder of the interest the right to receive the residue (if any) as and when ascertained. Whatever the precise nature of the interest, it would be entirely consistent with the statutory purpose of the bankruptcy legislation to conclude that it vested in the Trustee in Bankruptcy by virtue of S.306 of the 1986 Act.

The case above has highlighted not only the need to make bankruptcy searches, but when such a search should be undertaken.

Typically a beneficiary receives automatic discharge after twelve months so it is perfectly possibly for a beneficiary to be declared bankrupt after the death and be discharged before distribution. 

Searching at death will show whether a beneficiary is bankrupt at that point or was bankrupt at any point in the last five years.  However, it will miss the beneficiary who was declared bankrupt after the death (as in Raymond Saul).

In light of the case above it must, therefore, be best practice to search immediately before distribution, particularly as Personal Representatives may be personally liable to creditors of a bankrupt beneficiary. This is somewhat contrary to the Law Society guidance to date suggesting that it was not necessary to carry out bankruptcy searches unless the Personal Representative had reason to suspect that the beneficiary might be bankrupt. The position is therefore unclear, and it is likely that the Law Society will produce a practice note on this very topic to try and clarify the position.

Our policy is to make bankruptcy searches against beneficiaries before making payment to them, and, at a simple cost of £2 per search, we feel it is in our clients best interests to conduct a search before distribution to protect their position in their role as Personal Representative.

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