When there is a shortfall between what payments an estate is required to pay and the value of the estate, some problems can arise. Two such situations include: (i) when the estate assets are insufficient to satisfy the debts and (ii) when the estate assets are insufficient to distribute specific bequests.
Firstly, sometimes a deceased’s person’s debt is greater than the assets of their estate. It is the executor’s duty to pay all debts out of estate assets and often that means liquidating assets such as real properties and investment accounts. If an estate is insolvent, the executor retains control and is usually involved in negotiations with creditors for settlement of debt.
However, if the estate does end up falling into bankruptcy, the executor must surrender control to a Trustee in Bankruptcy who deals with the estate going forward. It is, however, of some comfort to know that beneficiaries of a bankrupt estate, are not personally responsible for the estate’s debt obligations.
Secondly, when a testamentary document (i.e. a will) gifts to beneficiaries without the adequate assets to support the gifts, an executor may have to proceed with the process of abatement. Abatement, when it comes to debts and legacies, refers to the reduction of gifts. The specific gift is partially satisfied from funds remaining in the estate after payment of debts and the legacies are reduced on a pro rata (proportionate) basis. For example, if an individual gifts each of their two children one million dollars but after liquidation of the estate, the estate only has net assets of one million dollars, both children cannot possibly receive the full gift and therefore each will receive a lesser amount.
Abatement is to be distinguished from ademption- the occurrence of a specific gift of personal or real property in a Will that no longer exists at the date of death. In the case of ademption, the gift fails. The distinction between the two is discussed by David M. Smith here.
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