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Tuesday, June 07, 2011

DEBT FORGIVENESS IN AN INSOLVENT ESTATE [FLORIDA, BUT RELEVANT ELSEWHERE]

A recent Florida case addresses an interesting question not previously decided in Florida. The facts are straightforward. A decedent’s son and daughter-in-law owed the decedent money under a promissory note. In the decedent’s last Will, he forgave the repayment of the note. However, if the decedent’s estate does not collect on the note, it will not have enough money to pay its administrative costs, debts and expenses. Thus, the question raised is whether the loan forgiveness is effective if the estate is rendered insolvent by it.

The probate court held the loan forgiveness was effective. On appeal, the probate court was reversed and the loan forgiveness was not given effect.

This makes sense. Florida law, as does the probate law of most states, gives a priority in payment to administrative costs, debts of the decedent, and expenses. Heirs of the probate estate are entitled to receive gifts and bequests only to the extent there are assets remaining after the payment of such items. One policy of such a system is to encourage the probate of insolvent estates to wind-up the affairs of the decedent, even though there may not be assets for the heirs. If costs and expenses of administration could not be paid from available assets first, it would be difficult to find persons willing to undertake such administration. Another policy served is that a decedent’s creditors should be paid before his heirs.

Thus, if a probate estate has $100,000 in cash which is left to the decedent’s son, but has $100,000 of administrative costs, debts and expenses, the son would get nothing. What if the estate did not have $100,000 in cash, but instead has $100,000 due to it from the son under a promissory note which is forgiven in the Will? If the forgiveness is effective, the son is effectively $100,000 richer as if he received $100,000 from his father’s estate, and the estate has no money to pay its costs, debts and expenses. That is, if the promissory note forgiveness is given effect, the son receives the benefit of the write off and thus gets more than if he was entitled only to a $100,000 cash gift, and essentially jumps ahead of the creditors in receiving payment. This was rejected by the appellate court – it noted:

“[t]he ruling by the lower court elevates the gift of forgiveness of an obligation to a superior status over the rights of legitimate creditors of the decedent, contrary to the priorities established in the Probate Code.”

The appeals court distinguished these facts from those in Estate of Whitley, 508 So.2d 455 (Fla. 4th DCA 1987). In that case, loan forgiveness was effectuated by the provisions of the promissory note itself, thus keeping the note out of the probate estate and giving effect to the write-off. This is important in context of the judicial recognition of the effectiveness of the cancellation provisions of self-cancelling installment notes, and provides an avenue for a decedent to be able to assure loan forgiveness at death in all events.

The appeals court rejected arguments that the forgiveness mechanism was the equivalent of forms of ownership that allow for the transfer of assets at death outside of the probate estate. Again, this appears to be a correct analysis since it is the Will that effectuates the loan forgiveness.

The appellate court also noted that while this was a case of first impression in Florida, its decision is in accord with all other jurisdictions that have addressed the issue.

Bernadette Lauritsen, as Personal Representative v. Brian Wallace, 5th DCA, April 1, 2011

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