Can a person in bankruptcy inherit from an estate?

Here at Scotia Trust, one of our main tasks is to administer the estates of deceased persons who named us as their executor. As you can imagine with all of the estates that cross our desks, we see pretty much every situation sooner or later. Right now my colleagues are working on an estate in which one of the beneficiaries has declared bankruptcy, and has not yet been discharged.

A discharge of bankruptcy is an order of the court that says that the bankrupt person has fulfilled his or her obligations under the bankruptcy proceedings. Either all debts have been paid, or more likely, the property that was available for paying debts was divided up among creditors so that they were paid in part. While a person is undergoing the process and the court has not yet discharged him or her, any surplus income not needed for essentials is paid to the trustee in bankruptcy to be divided among the creditors.

If the person who is in bankruptcy is the beneficiary of an estate of someone who passed away, the bankrupt person's entire share of the estate will go to the trustee in bankruptcy. The trustee will use as much of the inheritance as is needed to pay all of the debts, even if this means the whole inheritance. If the trustee doesn't need all of the inheritance to pay the debts, then the surplus amount will be paid to the bankrupt person.

The bankrupt person can't legally waive his inheritance (i.e. decide he doesn't want it), and he can't assign it to someone else (i.e. say that he wants his inheritance paid to his wife or children or friends etc). The trustee in bankruptcy has complete control over the bankrupt person's incoming money. The executor of the estate has no choice but to send the inheritance cheque to the trustee in bankruptcy.

If the bankrupt person has been discharged by the court and later inherits money, he is free to receive it just like anyone else.

What happens with a bankrupt estate?

First of all, it's important to realize that there is a difference between an insolvent estate and a bankrupt estate. An insolvent estate, which is much more likely, simply does not have enough assets to pay all of the debts. A bankrupt estate has actually declared bankruptcy.

When talking about either insolvent or bankrupt estates, I often hear people comment that nobody needs to do anything about it because obviously there are no assets. But that's not necessarily true. A deceased person could have a half-million dollar home and another half-million in investments, but if he or she has more than a million dollars in debts and liabilities, there isn't going to be enough money to pay all the creditors. So even though there are assets, the estate is still insolvent. And someone still has to sell that house and cash in those investments on behalf of the deceased person and pay out the proceeds.

That person is the executor named in the Will. If there is no Will, there should be an administrator appointed by the court in the usual way.

Usually in an insolvent estate, the executor will negotiate with the creditors to come to an agreement as to how much each will get. Often everyone agrees to a certain amount "on the dollar" so that they'll each recover at least part of the debt. It's to everyone's advantage not to turn it into a lawsuit, because fighting it out in court means the resources of the estate, which are already not enough, will end up being spent on legal fees and court fees.

If after an executor starts working on the insolvent estate, it is petitioned into bankruptcy by the creditors or the executor declares that the estate is bankrupt, the executor will have to step out of the picture. The control of the assets and debts will be handed over to the Trustee in Bankruptcy to deal with. The executor's claim for compensation can be added to the other claims against the estate.