When you accept the role of an executor or personal representative to someone close to you, you know the role will take time and patience. Yet perhaps the last thing you're considering is that the person you’ll represent might die in bankruptcy.
When Debtors Die, What Happens to Their Bankruptcy Cases?
State probate courts, such as those in Virginia and Maryland counties and in D.C., have jurisdiction over all wills and estates. This would seem to mean that a federal bankruptcy court cannot make any moves to convey the assets of anyone after death.
Yet this is not the case. Under the Federal Rules of Bankruptcy Procedure, a deceased debtor’s Chapter 7 liquidation continues, as though the person were still alive. What about a pending Chapter 11 reorganization? It may simply be discontinued unless further administration is possible and serves the parties’ best interests. If so, reorganization continues, too, as though the person were still alive.
Thus, when a debtor dies during a bankruptcy proceeding, the executor is only left to administer the assets that have been declared exempt from the bankruptcy. These exempt assets go into probate separate and free from the debt.
How Can Bankruptcy and Probate Coexist?
The legal mechanism of bankruptcy itself makes two coexisting estates possible. By filing a petition for bankruptcy, a person creates a bankruptcy estate.
The bankruptcy estate is a distinct taxable entity—separate, that is, from the debtor’s estate that may retain any property exempted from the bankruptcy proceedings.
Under the federal Bankruptcy Code, the debtor has no claim to this new creature of law, the bankruptcy estate. It is the bankruptcy trustee who has the responsibility to liquidate assets, pay off creditors, and otherwise administer the bankruptcy estate—not the debtor.
Under the bankruptcy trustee's oversight, the bankruptcy case can survive the debtor. A discharge, once ordered, relieves the debtor’s personal representative of liability for the discharged debts.
As Marc Cormier observes, “This is, of course, good news for the heirs, and a relief for them in their time of grieving and distress. The deceased’s debts are discharged, so creditors may not make claims against the property they stand to inherit.”
This is how both cases—bankruptcy and probate—coexist. From the date the debtor filed the petition, the federal bankruptcy court had jurisdiction to determine the exempt assets. But it never assumes jurisdiction over any element of the probate estate. Conversely, the probate estate may never encroach on a bankruptcy trustee’s control over the property in the separate taxable entity: the bankruptcy estate.
A Different Scenario: The Chapter 13 Bankruptcy
In a Chapter 13 filing, a debtor undertakes a repayment plan spanning three to five years. With the debtor’s disposable income, the bankruptcy trustee pays off debts—discounted or in full. The saving grace of Chapter 13 is its option for debtors to hold onto their homes and catch up on mortgage payments.
The debtor's income plays a starring role in Chapter 13. Such a role cannot continue when the debtor dies and monthly income stops. The bankruptcy court may dismiss the case—unless the heirs wish to step into the shoes of the deceased, keep the bankruptcy case alive, and make the plan's payments.
If a married couple filed for Chapter 13 jointly, and death means lost income, the surviving spouse could ask the court to reduce the payments.
Should the Heirs Keep a Chapter 13 Bankruptcy Case Alive?
When a person dies after filing for Chapter 13 bankruptcy, the heirs have some influence over whether the bankruptcy case proceeds or stops short.
Option A. Continue the Case
If they decide to hold onto the home, the heirs might opt to keep the bankruptcy case alive. The lender, by law, must work with the heirs to put their names on the mortgage.
It might seem like a burden on people in their time of grief to step in for the deceased and keep a bankruptcy case going. Yet the heirs may stand to benefit significantly by continuing, because a number of debts will be deeply discounted, leaving more in the estate for its beneficiaries.
Option B. Dismiss the Case
Alternatively, the heirs could ask to have the Chapter 13 case dismissed, then refinance the home. If the heirs are in the position to purchase other secured debts (which might be a computer, a car, home appliances, and so forth), they could work with the lenders when the case is dismissed.
Under Chapter 13, if there is a surviving spouse in a joint bankruptcy proceeding, the spouse may petition the court for a hardship discharge, and obtain a sped-up process.
Caution: If the deceased had heavy credit card debt or outstanding medical bills, the creditors could go after the decedent’s estate once the bankruptcy is dismissed.
This is not legal advice, simply written for discussion. I am not a lawyer nor an accountant. Marc Cormier ~ Realtor
