How should PRs protect themselves from contingent or unascertained liabilities?
Long Term Liabilities: A solution for Personal Representatives
In the administration of an estate, the Deceased’s creditors take priority over the beneficiaries. The personal representative must make full provision for liabilities before he makes any distribution to the beneficiaries, or face the risk of personal liability if the creditor makes a claim and the retained assets are insufficient to meet the debt. This priority rule applies not only to existing debts but also to contingent debts where the liability is unascertained and has not yet fallen due.
This has always been a problem as there is limited statutory protection available. The issue comes to the fore, particularly in the wake of financial crises or widespread investments which do not perform as expected. It was a particular problem in the 1990s following the losses sustained by Lloyd’s in the 1980s and 1990s. The problems faced by the estates of Lloyds’ Names led to the publication of a special practice direction for dealing with the potential liabilities resulting from a deceased’s position as a Lloyd’s Name. But what of the personal representatives of an estate which faces contingent or unascertained liabilities from a different source?
An old problem renewed?
This problem is likely to come to the fore again, given that there have recently been a large number of widely marketed tax avoidance schemes (particularly film partnership investments) which depend for their success in part on the investor taking out a long term full recourse loan. Although it is intended that the loan will be repaid in full from the income from the film partnership if the scheme runs its course, the loans will not be repaid for many years to come. If an investor dies part way through the life of the partnership, his personal representatives will need to make provision for the loan. Although the loan which ought to be repaid in due course, there is a possibility that it will not be. Given HMRC’s challenge to such schemes, the personal representative of an investor also faces the possibility (if HMRC are successful in their challenges) of having to pay historic and future income tax liabilities. Those liabilities may not be determined for many years to come.
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Ingrey v King (2015)
This was the difficulty faced by the executor in Ingrey v King LTL 12/02/2015. The Deceased had entered into 3 film partnerships which involved loans of over £5.5 million. At the date of the hearing, the estate had been in administration for 3 ½ years. If the executor waited until the loans were paid off before distributing the estate, another at least another 6 years would have elapsed before distribution could be made. The Court gave the executor directions to distribute the estate on taking of security and thereby allowed him to avoid personal liability. This is a welcome reminder of the principles that apply and that this is an option open to a personal representative in this situation.
Protection for Personal Representatives
Given the priority of creditors over beneficiaries, what are the options for personal representatives? The statutory protection under s 26 of the Trustee Act 1925 which relieves personal representatives from personal liability in respect of liabilities under leases or authorised guarantee agreements is limited in scope: it deals only with a particular type of liability. Section 27 of that Act which relieves a personal representative of personal liability in certain circumstances if he advertises for claims, only assists where the personal representative is not aware of the liability concerned. In the film scheme situation, as well as many others, the personal representative will be aware of the potential liability: what is not clear is whether the assets of the estate will be required to pay it.
What options are available for PRs?
The personal representative could of course retain the whole estate until all the liabilities are ascertained and paid off in full. That is not likely to be a popular option with the beneficiaries who will be kept out of their money for a considerable period. In a small estate, where the liabilities are relatively limited and the risks of a claim against the estate being made are small, insurance may be available. Where potential liabilities are significant, this is not likely to be an option.
A representative may make an application to the Court for directions allowing the distribution of the estate on a particular basis, for example, the taking of security or the retaining a particular sum of money in respect of contingent claims. If the personal representative obtains and acts on the Court’s directions, the personal representative will be absolved of personal liability even if the security or retention made turns out to be inadequate. Costs will usually be payable from the estate.
This was the approach taken in Ingrey. The Court gave the executor directions to distribute the estate on taking security. On doing so, he was absolved from personal liability even if the security proved to be inadequate if a creditor brought a claim. The Court applied the principles set out in Re Yorke  4 All ER 907. The overriding principle is the need to balance the interests of the creditors with the interests of the beneficiaries. Of particular significance was the level of security provided, the fact that there was another source of payment for the outstanding loans (namely the film partnership income) the illiquidity of the estate and lengthy period before the position could be known with certainty.
Applications for Directions: Points to Remember
Ingrey is a welcome reminder that the principles underlying an application for directions are of general application. Prior to Ingrey there had only been one reported case on applications for directions, Re K (Deceased)  EWHC 622 (Ch), where the principles were applied in an estate which faced a number of stale claims. Ingrey (where the claims were not stale) makes clear the principles are of general application.
There are three points to remember in relation to applications of this nature:
- First, the personal representative will not be protected unless he does actually obtain the directions of the court, even if the court would probably have given him directions had he applied for them.
- Second, any security or retention need not cover the creditors’ claim in its entirety.
- Third, if directions are given, the creditor will not be wholly without remedy. The creditor can still make a claim against the beneficiary if the liability is not met.
The Approach to Directions Applications
If a personal representative wants to make an application for directions, careful consideration should be given to the retention or security offered. Directions may be given even if no retention is to be made, but it is likely to be easier to persuade the court that an appropriate balance has been struck if some retention or security is given to protect the creditors’ position.
The evidence in support should deal with the following issues:
- The worst case scenario, so that the Court can see the full extent of the potential liability
- The likelihood that the worst case scenario will occur.
- Any protection available to the creditors in respect of the debts i.e. other potential sources of payment (in the film partnership situation this was the income from the film partnership and the letter of credit provided by the film studio to guarantee the annual ordinary distributions)
- The nature of the estate. The fact that the estate was illiquid and intertwined with the beneficiary’s own business interests and assets was a significant factor in That, however, is not a necessary condition of directions being given.
- The financial position of the beneficiary. If the beneficiary is wealthy, this of itself gives a creditor a further safety net.
- The extent of the security offered
- The likely timescale to finalise the administration if directions are not given.
The practical approach of the court signalled by Ingrey is to be welcomed. The ability to apply for directions is a useful exit strategy for personal representatives to ensure that they are not trapped indefinitely in an administration and removes the personal liability when distributing the estate.
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