Understanding and Managing the Rights of Lifetime Creditors Following Death
“Understanding and Managing the Rights of Lifetime Creditors Following Death,” that’s a subject of today’s ACTEC Trust and Estate Talk.
This is Travis Hayes, ACTEC Fellow from Naples, Florida. Most professionals are aware of and apply the laws pertaining to their client’s existing and potential creditors as part of their practices. But how do professionals address the changing landscape following the client’s death?
ACTEC Fellows Jack Terrill of Philadelphia, Pennsylvania, John Moran of West Palm Beach, Florida, and Paul Barulich of Burlingame, California, who all hail from different states, will discuss the significant differences in legal traditions and post-mortem rules dealing with creditors and probate and trust administrations in different jurisdictions. Welcome to Jack, John, and Paul.
Jack: Thanks, Travis. This is Jack Terrill. I will start with noting that there is a significant interest among our clients and fellow advisors on the topic of asset protection planning, which we would say is best described as planning for living clients in a way that minimizes the exposure of the various assets to the claims of creditors during their lifetimes. That’s the subject of the significant amount of research and study and practice throughout our practice area. Paul, John, and I are interested in the other side of the coin. That is, after the client dies, do the rights and remedies of pre-death creditors change?
Do those changes suggest planning opportunities for clients who do or may have creditors? We pose this as essentially the following question: there’s a body of law that governs the rights of creditors during lifetime, we’ll talk a little bit about that as a matter of introduction to understand, how that body changes after death. So, we’ll start with John Moran talking about the rights of creditors during their lifetime because to understand post-mortem claims, we really need to understand what those rights are. John?
Creditors’ Rights During the Debtor’s Lifetime
John: Thank you, Jack. Those listening, I think most of us are familiar with the basic rules. There are some obvious assets that are available to creditors during the lifetime of the debtor. That would be, of course, assets in the debtor’s name, cash securities, or anything in their personal name. That could include assets in a revocable trust, although caveat on that to the extent that there’s not a probate asset available. It could include assets in certain irrevocable trusts, depending on the terms of those trusts. You’d even include assets in certain self-settled trusts. It might even reach joint assets depending on how those are titled. That’s the body of assets that generally a creditor can attach, but of course, even during life, there’s a whole bunch of exceptions.
For example, retirement accounts, IRAs, both qualified and depending on state laws, and some estate plans. Those are generally exempt, although there’s special rules for those. Life insurance, that’s another exemption. Creditors in many circumstances can’t reach assets. Death benefits, primarily, and life insurance. And then, of course, there are some of the more specific types of assets depending on which state you’re in.
Entireties property, tenancy by the entirety. I know, Jack, that’s something that we talk about here in Florida and I know you’ve got that in Pennsylvania. Homestead’s a big one in Florida. That’s just a whole – you could spend all day talking about how homestead works and how it’s exempt from the claims of creditors. And again, Entireties is great, but Paul, I know you in California, you’ve got this whole concept of community property. What about that?
Creditors Rights in Community Property States: Marriage, Tenancy, and Entireties
Paul: Thanks, John. In California, we are subject to community property rules. We are different from you commoners, as Jack likes to refer to himself. We have community property estate where creditors are treated a bit differently. So, let’s first touch on the claims of creditors with regard to interests in co-owned properties. To put community property in a historical perspective, this is a system that by its very nature, was to provide historically the wife’s support and to curb the husband’s despotic powers. That is as true then as it is more so today.
The martial community property is an association between spouses and the community property is the property belonging to the association. So, to your point, John, during the marriage, in California under family code 910, that provides for a community property estate to be liable for the debts incurred by either spouse before or during the marriage regardless of which spouse has the management or control of the property. And regardless of whether one or both spouses are properties to the debt or to a judgment for that debt.
So, one may ask the question, is the non-debtor’s spouse’s interest in the community liable for the debts of the debtor spouse, even if it was incurred prior to the marriage? There are certain exceptions aside, but the answer is yes. The shared community estate will be held liable for the debts whether incurred prior to or during the marriage. The separate property of the non-debtor’s spouse, however, will not be held liable. Again, the reason for the result is based on the concept that the community is equally shared by both spouses therefore it makes sense, that it would be subject to the debts incurred by only one spouse because the community property is owned just as much by one as to the other. John, Jack, how’s this differ from joint tenancy, tenancy entireties, or tenancy in common?
Comparison of Community Property, Joint Tenancy, Tenancy Entireties, and Tenancy in Common
Jack: Well, joint tenancy probably is no different from what John just described as assets that are solely owned by an individual that is available to their creditors. It’s sort of a concept of a partnership in assets as opposed to a dual ownership. But with respect to entireties, and most entireties jurisdictions, creditors of one spouse cannot seize and cannot make available in the payment of debts assets held by the entireties. It’s probably an unusually valuable thing for our clients living in jurisdictions where tenancy by the entireties works. John, I think that’s the same in Florida.
John: It is, but we’re still talking while the debtors alive. Jack, how does this change? Let’s change the paradigm here. Now let’s have the debtor pass away and now you’ve got a creditor trying to get assets after the debtor dies. What changes?
Creditors Rights Upon the Debtors Death in Common Law States
Jack: Well, I think we way we think about it, John, is to consider the body of law during lifetime and you and Paul just talked about this – about the way assets are, or are not, available during lifetime. But during lifetime, there’s also a body of law in terms of bankruptcy, right? There’s a body of law that is sort of within the rubric of voidable or fraudulent transfers. There are ways that creditors’ rights, there are statutes of limitations, there are counterclaims, there are all sorts of things going on. But after death, while claims still exist, claims don’t die with you.
A claim – an outstanding liability or potential liability – doesn’t die with you. But what happens after death is mostly driven by the public policy towards rapid wrapping up of decedents affairs. That there’s a body of law that says you are going to deal with creditor claims in a certain kind of way after death getting them resolved and behind you, after the individual dies. And all of us learned in law school the basic concepts of opening an estate, qualifying a personal representative of some kind, and generally giving notice to the world of the qualification of that personal representative. But notably, within the estate administration realm that this public policy for a rapid conclusion, rapid wrapping up of a decedent’s affairs, and the concept there is no bankruptcy in estates.
There is no way that creditors just go through a process with getting a trustee in bankruptcy to kind of collect and wrap up the assets and the liabilities. Instead, you have this role of the court that is the court that has jurisdiction over the settlement of an estate, which is a different body of law and it’s different in important ways. I’m going to mention one important way that has to do with so-called probate estates and then we can get into the problem of non-probate assets, which is one that we’re interested in.
Most of the listeners will be aware of the 1988 Supreme Court decision in Tulsa v. Pope that’s a decision in which a majority of the Supreme Court of the United States held that once a will is probated and the public takes a role, whether it’s a registered will or a surrogate or a similar kind of administrative agency or court, that at that point, there’s a due process right of known or knowable creditors that requires them to be given notice.
So, in the body of law post-death, there’s this concept of collecting assets, but also giving notice to known or knowable creditors. That’s fine with respect to an estate where there is a probate and there is an administrator or an executor or personal representative. And you and I both, John, in our states, know kind of how that process works. It’s a bit different in California in the sense that while my executor, your personal representative, may have an obligation to creditors. Paul, I guess California’s a bit different when it comes to post-death.
Creditors’ Rights Upon the Debtors Death in Community Property States
Paul: Yeah, California suffers a duality of realities here for creditors. There are competing theories about whether the fiduciary or personal representative holds the decedent’s estate in trust for the benefit of creditors for their legitimate claims, or that the fiduciary’s role is really the guardian at the gate to maximize inheritance and deflect claims no matter how legitimate. In California, importantly, there are two time clocks for creditors because their rights are cut off absolutely.
In the formal probate process, there is a four, loud, ticking, four-month clock that expires after the issuance of letters. There is a silent clock ticking for one year if it’s a trust estate that does not avail itself of a formal probate process. So, the trustee can wait and not notify creditors, sort of the anti-Tulsa approach, and not advise them that there’s a clock ticking and simply wait the one year. And after one year, with some exceptions, the creditors are barred even if the statute of limitations is open on the claim had the decedent not died. So, in California, most estates are trust administrations, which avail themselves of the one-year statute.
A formal probate in California is a four-month statute. So, the fiduciary is at a choice whether to shorten that time down and actually notice to creditors and give them the opportunity to file their claims within four months or say nothing and let them sleep through the one-year process and bar their claims, ultimately.
What are Probate Protected Assets?
John: It kind of begs the question though. What assets are we talking about of being available through the creditor process and an estate? Because frankly, when you think about assets that most clients have right now, you’re thinking about things that might not actually be probate assets. Pay on death accounts, living trusts, and so, you wonder: how did we get here? Well, historically, folks listening to this may remember the 1966 book, How to Avoid Probate by Norman Dacey.
And Dacey, who passed away in 94, was not a lawyer. But, he criticized what he was calling the unnecessarily high fees that were deducted in the estate probate process and that book ultimately sold over two million copies and it was really the beginning of what, I think, folks would call the non-probate revolution. Because candidly, not a lot of the assets that folks have, especially when they’re doing sophisticated planning, are probate assets. Jack, what would you say to that?
Jack: Well, I think that most clients that we see clearly have assets that are beneficiary designated, that are jointly owned, that are in revocable or irrevocable trusts, and that description of how estates get settled, the Tulsa rule, the California rule where the choice exists with respect to what was a revocable trust largely doesn’t apply to those assets.
The law was not, Uniform Probate Code might address some of these non-probate asset issues, but the fact is that post-death this body of law that we all learned in law school is largely irrelevant to many estates that don’t have assets exposed to a probate process. Paul and John and I think – that’s an important gap in the laws of all of the states; and it’s something that needs to be considered to connect between the rights of beneficiaries and the rights of appropriate creditors.
Travis: Thank you Jack, John, and Paul for discussing differences among various states in dealing with creditors after a client’s death.
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