Nevada probate law and bankruptcy (“BK”) law often interact, and, at the surface may seem contradictory. After all, state laws govern probate matters, while the U.S. constitution give the federal government authority to establish bankruptcy laws under Article 1, Section 8, Clause 4 of the United States Constitution (“The Congress shall have Power To…establish …uniform Laws on the subject of Bankruptcies throughout the United States.”) In contrast, states retain sovereignty over probate law because the Constitution does not explicitly reserve probate law to the federal government.
Nonetheless, from a 30,000 foot level, there are some interesting parallels. In both areas, a third party, either a personal representative or a trustee, has a duty to marshal assets of the estate. In both areas, creditors must file claims within a limited period of time. Additionally, in both regimes, the estate pay may some, none or all of a claim depending on the circumstances. So what happens when a probate estate becomes insolvent? Can a probate estate declare bankruptcy? And what happens when a bankruptcy debtor dies? Do the federal bankruptcy proceedings stop and transfer to state probate court?
When A Debtor Dies in Bankruptcy
“Death’s got an Invisibility Cloak?” Harry interrupted again.
“So he can sneak up on people,” said Ron. “Sometimes he gets bored of running at them, flapping his arms and shrieking…”
― J.K. Rowling,
Death sneaks up at inopportune times, sometimes while a person is in the middle of a bankruptcy. So what happens? At the outset, it’s important to understand that family, beneficiary and heirs are not personally responsible to pay the debts.
Bankruptcy Rule 1016:
Death or incompetency of the debtor shall not abate a liquidation case under chapter 7 of the Code. In such event the estate shall be administered and the case concluded in the same manner, so far as possible, as though the death or incompetency had not occurred. If a reorganization, family farmer’s debt adjustment, or individual’s debt adjustment case is pending under chapter 11, chapter 12, or chapter 13, the case may be dismissed; or if further administration is possible and in the best interest of the parties, the case may proceed and be concluded in the same manner, so far as possible, as though the death or incompetency had not occurred.
First, the BK doesn’t necessarily stop or terminate. A Chapter 7 BK involves liquidation of the debtors assets. In Chapter 7, bankruptcy law pays creditors are by liquidating assets. Some property, like pensions, the residence of the debtor and vehicles, are exempt from liquidation. Thus, under Bankruptcy Rule 1016, if the debtor is in Chapter 7, the BK must continue and complete. Of course, even after a Chapter 7 BK there may be exempt property remaining.
Exempt property may include:
- Home equity, up to a certain value.
- Vehicles, up to a certain value.
- Personal items (clothing, jewelry, household items)
- Personal Injury Claims
Probate After Bankruptcy
Probate administration may be necessary for remaining exempted property following the death of a debtor in Chapter 7 bankruptcy. I say may because often, exempted property won’t have much value. If the value of the property is greater than $25,000.00, or there is real property in the estate, probate proceedings will be necessary. If the value of the probate estate is less than $25,000.00, the estate may be administered by affidavit without court intervention.
While a Chapter 7 BK must continue after death of a debtor, a Chapter 13 BK may, but does not have to, continue. In Chapter 13, the debtor makes monthly payments for a period of approximately 3-5 years. If the debtor dies while in the middle of this plan, one of four things can happen. First, Bankruptcy Court can dismiss the matter. Dismissal of the bankruptcy estate my occur anytime a debtor stops making monthly payments. The personal representative could choose this option. However, because dismissal ends bankruptcy protection, creditors could come after the estate in probate proceedings. Second, the personal representative of the probate estate could ask the bankruptcy court for a hardship discharge. This would result in wiping out the creditors, which would prevent them from coming after assets in the probate estate. Third, the personal representative could ask the bankruptcy court to convert to a Chapter 7 (liquidation). Finally, the personal representative could continue making payments in Chapter 13.
Probate Estates May Not Seek Bankruptcy Protection
A probate estate can’t seek bankruptcy protection. A living person may seek bankruptcy protection. However, such protection is not available after death. It is too late to obtain such protection. That may seem counter intuitive given that a bankruptcy estate can proceed to probate.
Under 11 U.S.C, § 109(a), only a “person” can file for bankruptcy protection. A probate estate may not seek bankruptcy protection because bankruptcy law does not consider a probate estate to be a person. “A probate estate…is not an individual person within the meaning of Bankruptcy law and and such a probate estate, albeit an insolvent one, must be administered pursuant to the laws of the decedent’s local jurisdiction.” In re Estate of Brown, 16 B.R. 128 (Bankr. D.D.C. 1981).
Nevada Probate Law Resolves Insolvency
This, even though insolvency is extremely common in probate estates. People often die with more liabilities than assets. Nevada probate law has it’s own mechanisms to resolve insolvency.
Nevada probate law has a statutory scheme to resolve insolvent estates, much in the same way the federal bankruptcy code accomplishes the same result.
NRS 147.195 Debts and charges of estate: Priority of payment. The debts and charges of the estate must be paid in the following order:
1. Expenses of administration.
2. Funeral expenses.
3. The expenses of the last illness.
4. Family allowance.
5. Debts having preference by laws of the United States.
6. Money owed to the Department of Health and Human Services as a result of the payment of benefits for Medicaid.
7. Wages to the extent of $600, of each employee of the decedent, for work done or personal services rendered within 3 months before the death of the employer. If there is not sufficient money with which to pay all such labor claims in full, the money available must be distributed among the claimants in accordance with the amounts of their respective claims.
8. Judgments rendered against the decedent in his or her lifetime, and mortgages in order of their date. The preference given to a mortgage extends only to the proceeds of the property mortgaged. If the proceeds of that property are insufficient to pay the mortgage, the part remaining unsatisfied must be classed with other demands against the estate.
9. All other demands against the estate.
Most creditors will fall into NRS 147.195(9). The probate estate pays claims on a pro rata basis where the liabilities exceed the assets in any given class. This is most common for unsecured creditors in subsection (9). Thus, a probate estate doesn’t need bankruptcy protection because Nevada probate law already has a system in place to resolve insolvency.