8. Payment of debts

Introduction

8.1 The terms of reference direct the Commission to review and report on ‘how assets are designated to pay the debts of an estate and the effect that this has on the estate available for distribution to beneficiaries or to meet a successful family provision claim’.
8.2 Victoria’s current law in relation to the application of assets to estate debts is difficult both to locate and to understand.
8.3 It is difficult to locate as the substantive provisions are contained in a schedule to the Administration and Probate Act 1958 (Vic) and, by incorporation, in the Bankruptcy Act 1966 (Cth). It is difficult to understand largely because of inaccessible and complex drafting.

National Committee for Uniform Succession Laws

  1. 8.4 The National Committee for Uniform Succession Laws recognised the difficulties, common to most jurisdictions, in its four-volume report on the administration of estates of deceased persons. It made recommendations to overcome them and proposed model legislation.1 A number of the National Committee’s recommendations would simplify and update the law in Victoria.
  2. 8.5 In the consultation paper on debts, the Commission identified the major differences between Victorian law and the reforms proposed by the National Committee.2 Most of the submissions received in response to the questions raised in the paper supported the adoption of the National Committee’s recommendations in Victoria.

Areas in which the Commission recommends reform

  1. 8.6 This chapter sets out the aspects of Victoria’s estate debt payment scheme that, in the Commission’s view, should be reformed.
  2. 8.7 The Commission’s recommendations are intended to:
  • modernise Victoria’s laws in relation to debt payment and bring the law up to date with other jurisdictions
  • clarify Victoria’s debt payment laws and provide certainty to those administering solvent and insolvent estates, and simplify the administration of estates thereby increasing the ability of laypersons to administer.
  1. 8.8 The Commission is not recommending significant changes to the law and the basic principles of the scheme would be unchanged. In order to achieve a clearer, simpler scheme, the Commission considers that relevant sections of the Administration and Probate Act should be redrafted and that the provisions relating to debt payment in the schedule to the Act should be revised and incorporated into the body of the Act.

Overview of the application of assets for payment of debts of deceased estates in Victoria

  1. 8.9 It is a fundamental duty of the personal representative to pay out of the estate the deceased person’s debts and liabilities, including funeral, testamentary and administration expenses.3 The personal representative has the power to sell the estate’s assets for this purpose.4 Assets should not be distributed to the beneficiaries under a will or upon intestacy until all outstanding debts are settled.
  2. 8.10 In Victoria, the payment of debts out of an estate is governed by theAdministration and Probate Act. Part I, Division 5 of the Act sets out the personal representative’s powers to deal with the estate’s assets and specifies which assets are available to pay debts.
  3. 8.11 The Second Schedule to the Act deals with the payment of estate debts, and is divided into two parts:
  • Part I applies to insolvent estates. It deals with the priority of debts—the order in which debts will be paid—and imports the rules of the Commonwealth Bankruptcy Act.
  • Part II applies to solvent estates. It deals with the order of application of the available assets—to what extent particular assets will actually bear the burden of a debt.
  1. 8.12 The existing scheme for solvent estates is discussed first below. Insolvent estates are discussed at [8.65]–[8.85].

Solvent estates

Order of application of assets

Current law

  1. 8.13 A solvent estate has sufficient assets to pay all debts and administrative expenses in full.5 After debts are paid, the balance of the estate is distributed to beneficiaries under the will or in accordance with the rules of intestacy, subject, in each case, to modification by any applicable family provision order.6
  2. 8.14 When paying debts, the personal representative may use any of the available assets in the estate.7 To ensure that creditors are paid expeditiously, the most easily sold assets may be used first.
  3. 8.15 This may result in some beneficiaries’ entitlements being disproportionately depleted, compared to the entitlements of other beneficiaries, simply because the assets left to them were easier to sell. To arrive at a fairer outcome for all, the value of assets remaining after the debts are paid is adjusted before they are distributed to the beneficiaries.8 
  4. 8.16 The extent to which each beneficiary’s share is adjusted after the payment of debts is determined by:
  • the order of application set out in Part II of the Second Schedule to the Act
  • any provision of the will showing a ‘contrary intention’, meaning an intention by the will-maker that the assets of the estate should be applied to the payment of estate debts in another way.9
  1. 8.17 The order of application sets out categories of asset in the order upon which they are to be drawn. The personal representative applies the assets in the first category to pay the debts, and will move to the second and subsequent categories only if the prior category is exhausted.
  2. 8.18 Under this system, a gift to a beneficiary that was initially used to pay debts can be reinstated in full or in part, and other beneficiaries’ gifts may be reduced accordingly.
  3. 8.19 If all categories of asset are exhausted before the estate’s debts are paid in full, the estate is insolvent, and the beneficiaries will not receive any benefits under the will.
  4. 8.20 The Victorian order of application10 contains a hierarchy of seven categories of property:

1. Property of the deceased undisposed of by will, subject to the retention thereout of a fund sufficient to meet any pecuniary legacies.

2. Property of the deceased specifically appropriated or devised or bequeathed or directed to be sold (either by a specific or general description), for the payment of debts.

3. Property of the deceased charged with, or devised or bequeathed (either by a specific or general description) subject to a charge for the payment of debts.

4. Property of the deceased not specifically devised or bequeathed but included (either by a specific or general description) in a residuary gift, subject to the retention out of such property of a fund sufficient to meet any pecuniary legacies, so far as not provided for as aforesaid.

5. The fund, if any, retained to meet pecuniary legacies.

6. Property specifically devised or bequeathed, rateably accordingly to value.11

7. Property appointed by will under a general power, including the statutory power to dispose of entailed interests, rateably according to value.

Contrary intention of the will-maker

  1. 8.21 The order of application applies subject to the terms of the will, and can be displaced by contrary intention shown by the will-maker. Part II of the Second Schedule to the Act provides that:

The order of application may be varied by the will of the deceased.12

  1. 8.22 Contrary intention is determined by reference to the wording of the purported contrary intention and the circumstances of each case.13
  2. 8.23 However, a will-maker may not necessarily displace the order by simply setting aside certain property to pay debts. As noted above, the order of application includes a specific category of ‘property set aside by the will-maker for the purpose of paying debts’. This category is listed second, after property undisposed of by will. Third order of priority is given to property that is subject to a charge for the payment of debts.
  3. 8.24 A tension therefore arises between interpreting the setting aside of assets to pay debts as a manifestation of the will-maker’s intention to oust the statutory order, or seeing it simply as the creation of a category of property that falls within the Victorian order at category 2 or 3.14

Reducing the number of categories of asset

  1. 8.25 The National Committee’s recommendations, if adopted in Victoria, would change the order of application. Model legislation proposed by the National Committee and based on Queensland legislation contains only three categories of asset, four fewer than in Victorian law:15

1. Property specifically appropriated or given by will (either by a specific or general description) for the payment of debts; and property charged by will with, or given
by will (either by a specific or general description) subject to a charge for, the payment of debts.

2. Property comprising the residuary estate16 of the deceased person and property in relation to which a disposition in the deceased’s will operates as the exercise of a general power of appointment.

3. Property specifically given by will, including property specifically appointed under a general power of appointment, and any legacy charged on property given or appointed.17

  1. 8.26 The National Committee noted that a shorter, simpler list of categories of asset would make it easier to understand the effect of any direction in the will and that the resulting improvement in certainty may ‘reduce opportunities for litigation’.18
  2. 8.27 A reduction in the number of categories in the Victorian order received universal support in submissions to the Commission and during consultations. Legal practitioners with expertise in administering deceased estates said that the change would make the law clearer and easier for personal representatives to apply.19
  3. 8.28 Reform would be particularly helpful for personal representatives who administer small estates. A small estate is more likely than a large estate to be administered by a non-professional executor and to present difficulty with the payment of debts.20

Reordering the categories of asset

  1. 8.29 Adopting the model provision would not only reduce the number of Victorian categories from seven to three, it would reorder them to give the highest priority to property that the will-maker specifically set aside to pay debts. Property that is specifically set aside to pay debts (currently categories 2 and 3) would be applied to debts before, rather than after, property that has not effectively been disposed of by will (currently category 1).
  2. 8.30 Category 1 property under the model is specifically created by the will when the will-maker sets aside assets for the payment of debts. It encompasses property that is currently allocated in Victoria to categories 2 and 3. As noted above, these categories include property specifically appropriated, devised or bequeathed for payment of debts, and property charged with payment of debts. The National Committee saw ‘no cogent reason’ to assume that the will-maker intended either of these two categories to have priority over the other.21
  3. 8.31 Category 2 of the model aligns with categories 1 and 4 of the Victorian order. It combines property which is the subject of a residuary disposition, and property undisposed of (or not effectively disposed of) by will. The amalgamation is achieved by broadening the definition of ‘residuary estate’ that applies to the model to include both types of property:

residuary estate, of a deceased person, means—

(a) if the deceased left a will, either or both of the following—

(i) property in the deceased’s estate that is not effectively disposed of by the deceased’s will;

(ii) property in the deceased’s estate that is not specifically given by the deceased’s will but is included in a residuary disposition, by either a specific or general description; or

(b) if the deceased did not leave a will, the whole of the deceased’s estate.22

  1. 8.32 Category 3 of the model retains the protected position of property specifically given. As currently applies in Victoria, gifts made under the will remain the last to be drawn upon for the payment of debts.
  2. 8.33 There are a number of advantages in reordering the categories of asset in the manner recommended by the National Committee. Placing the primary burden for payment of debts upon assets that have been set aside for this purpose better recognises the will-maker’s overriding intention to pay debts from those assets. The National Committee supported its recommendation for change by citing a body of case law where it was held that funds specifically set aside by the will-maker’s directions should be the primary fund for debt payment.23
  3. 8.34 Adopting this change would also resolve the difficulty in determining whether the setting aside of assets for the payment of debts should be taken as manifesting an intention to oust the statutory order, or as property which falls within the Victorian order at category 2 or 3.24
  4. 8.35 In Re Williams,25 the Supreme Courtof Victoria explained that, as the schedule is subject to the provisions of the will,26 there is no need to resort to it at all where a will-maker has turned their mind to the payment of debts. Justice Dean observed that:

it is not necessary to attempt to solve the conundrum which has hitherto remained unsolved of what words can answer the description of our present para (2) and (3)27
and not override or vary the Schedule order.28

  1. 8.36 The proposed reordering of the categories of asset enshrines the view expressed in Re Williams in legislation, and gives primacy to the will-maker’s intent: where there is no property set aside for payment of debts, property not specifically given is exhausted first. This revision would resolve difficulties of judicial interpretation affecting the Victorian provisions.
  2. 8.37 Almost all submissions strongly supported revising the Victorian provisions in accordance with the National Committee’s model order of application.29 The Commission was not presented with a persuasive reason why it would be preferable to retain the current law rather than adopt the National Committee’s model order.
  3. 8.38 The Commission accepts that the arguments in support of the proposed change to the order of application of assets for payment of debts in solvent estates are well-founded and that the Victorian order should be amended to reflect the National Committee’s model.30

 

Recommendation

63 The Administration and Probate Act 1958 (Vic) should be amended to:

Payment of pecuniary legacies

  1. 8.39 Part II of the Second Schedule to the Administration and Probate Act directs that funds be retained for the payment of pecuniary legacies from categories 1 (property undisposed of by will) and 4 (property not specifically given, but included as a residuary gift). The fund retained becomes category 5 of the current order of application, to be drawn upon fifth, before property specifically given.
  2. 8.40 The model order proposed by the National Committee does not provide for the payment of pecuniary legacies. Rather, it is provided for in a separate provision of the model legislation:

504 Payment

(1) Pecuniary legacies must be paid out of available class 2 property.

(2) However, to the extent that available class 2 property is insufficient to pay the pecuniary legacies, the legacies must abate proportionately.

(3 Subsections (1) and (2) are subject to a contrary intention appearing in the deceased person’s will.

(4) In this section—

available class 2 property means class 2 property or, if debts are to be discharged from the property, class 2 property after the discharge of the debts.31

8.41 This model provision stipulates that pecuniary legacies are to be paid from class 2 of the model order. As class 2 of the model order aligns with categories 1 and 4 of the Victorian order, the effect of adopting this model provision would be to retain the Victorian status quo in relation to the payment of pecuniary legacies.

8.42 It should also be noted that the definition of ‘pecuniary legacy’ in the Administration and Probate Act32 aligns with the National Committee’s recommended definition.33

Recommendation

64 A provision should be inserted into the Administration and Probate Act 1958 (Vic) that stipulates that the payment of pecuniary legacies is to be made from the residuary estate.

 

Exception to the statutory order for charged or mortgaged property

Current law

  1. 8.43 Although most debts of solvent estates will be paid according to the order of application discussed above, section 40 of the Administration and Probate Act sets out an exception in relation to assets charged with the payment of a debt.
  2. 8.44 An asset that is charged with the payment of a debt—typically real estate subject to a mortgage, or to a lien for unpaid purchase money—will bear that debt, and entitled beneficiaries will take the asset subject to the debt. If more than one beneficiary is entitled to the asset, they will bear the debt in proportion to their share.34
  3. 8.45 When the asset is given by will, the debt remains attached to the asset, providing clear and simple recourse for secured creditors. The practical effect for beneficiaries is that the secured debt will not be pooled with other debts and paid out of assets in accordance with the order of application in the second schedule of the Act.
  4. 8.46 The will-maker can prevent the operation of this rule by expressing a contrary intention and explaining that they intend that debts be paid out of other property.35
  5. 8.47 In Victoria, a contrary intention may be shown by ‘will, deed or other document’.36 This is the case in other Australian jurisdictions, except the Australian Capital Territory and Queensland, where the legislation specifies that contrary intention may be shown by will only.37

Retaining the exception to the statutory order

  1. 8.48 The Commission’s consultation paper on debts asked whether there were any significant difficulties with the operation of section 40 of the Administration and Probate Act and, if so, whether it should be repealed, as it has been in the Northern Territory.
  2. 8.49 Most submissions, and comments made during consultations, supported the retention of section 40. One submission advocated the abolition of the section, but did not provide reasons for this view.38
  3. 8.50 All jurisdictions except the Northern Territory retain a rule to the effect of section 40.39 Given the multi-jurisdictional nature of estate assets, including real property subject to mortgages and other charges, national consistency in this area is desirable.
  4. 8.51 The Commission considers that section 40 should be retained, agreeing with the National Committee’s view that it provides a settled rule for payment of debts charged on specific property.40

Connection between the debt and the charged property

  1. 8.52 The consultation paper also asked whether section 40 of the Administration and Probate Act should be modified to require a sufficient connection between the purpose of the debt and the property over which it is charged, before the exception comes into operation.41 Requiring the asset to bear the debt in all cases can lead to an unfair outcome, for example when a family home is mortgaged to finance a business. Under the current operation of the rule, the beneficiary who is given the family home will bear the mortgage debt, and the beneficiary given the business will not.
  2. 8.53 Three submissions discussed the idea of requiring a connection between the purpose for which the debt was raised and the property to bear the debt.42 Although the potential for section 40 to operate unfairly was raised, State Trustees noted that a requirement for a connection between the debt and the property could produce equally arbitrary results.43
    It was also noted that problems here may be resolved by careful will drafting.44
  3. 8.54 The Commission does not believe that there is good reason to require a connection between the purpose for which the debt was raised and the property to bear the debt.

Proposed change to location of contrary intention

  1. 8.55 The Commission is of the view that contrary intention in this context should only be manifested by will. This aligns with the National Committee’s recommendation on this topic.45
  2. 8.56 Allowing contrary intention to be found outside a will may present problems of proof, and potentially of fraud. The National Committee report cited the reasoning of the Law Reform Commission of Western Australia:

There seems to be no good reason why such an expression of what is essentially a testamentary intention should remain outside the normal rules relating to the form in which testamentary wishes must be expressed.46

  1. 8.57 This recommendation, theoretically limiting sources of evidence for contrary intention, was made having regard to the earlier recommendation of the National Committee for a general dispensing power and a broader interpretation provision for wills.47
  2. 8.58 Adoption of this proposal would bring Victoria into line with the position in the Australian Capital Territory and Queensland, the two jurisdictions to have most recently amended their legislation in this area.48
  3. 8.59 Similarly, the majority of submissions and consultations on this point agreed that any expression of contrary intention should be by will only.49 State Trustees pointed out that a representative seeking to administer an estate has no way of knowing whether other documents containing contrary intention exist, potentially delaying finalisation of administration indefinitely.50
  4. 8.60 Two submissions expressed the opinion that the current position—manifestation of contrary intention by will, deed or other document—should be retained. The reasons given were that wills are often poorly drafted,51and that the will reflects the will-maker’s intent only at a fixed point in time.52
  5. 8.61 The Commission does not find either of these reasons persuasive, as any document may be poorly drafted; any expression of intention will reflect intent at a particular point in time. The practical concerns relating to effective administration made above by State Trustees and the Law Reform Commission of Western Australia are compelling. For these reasons, the Commission recommends that an expression of contrary intention should be by will only.

Recommendation

65 Section 40(1) of the Administration and Probate Act 1958 (Vic) should be amended to provide that an expression of contrary intention may only be shown by will.

Effect on successful family provision claims

  1. 8.62 The terms of reference direct the Commission to consider the effect of the application of assets to the payment of debts on the estate that is available for distribution to beneficiaries or to meet a successful family provision claim.
  2. 8.63 Paying the debts of an estate, and thereby determining its net value, will naturally reduce what is left in the estate for beneficiaries and, it follows, for family provision claimants. Applicants for family provision seek provision out of the net estate, as a family provision order will operate as either a codicil to the will,53 or a variation of the statutory distribution on intestacy.54
  3. 8.64 The order of application of assets to pay the debts of an estate is designed to adjust the burden of debts between the beneficiaries of that estate. As the size of the net estate is not affected by this exercise, the manner in which assets are applied to debt payment will have no impact on the estate available to meet a successful family provision claim.

Insolvent estates

Application of the Bankruptcy Act to payment of debts

  1. 8.65 Insolvent estates are administered either under the Administration and Probate Act, importing specified rules and priorities of the Commonwealth Bankruptcy Act, or directly under the Bankruptcy Act. All Australian jurisdictions have equivalent statutory provisions that apply the rules of bankruptcy to the administration of insolvent estates.55

Indirect application under the Administration and Probate Act

  1. 8.66 Section 39 of the Administration and Probate Act directs that insolvent estates must be administered according to the rules set out in Part I of the Second Schedule to the Act.
  2. 8.67 Part I of the schedule provides that, subject to funeral, testamentary and administration expenses having priority, the rules of Commonwealth bankruptcy law will apply:

Subject as aforesaid, the same rules shall prevail and be observed as to the respective rights of secured and unsecured creditors and as to debts and liabilities provable and as to the valuation of annuities and future and contingent liabilities respectively, and as to the priorities of debts and liabilities as may be in force for the time being under any law of the Commonwealth relating to bankruptcy with respect to the assets of persons adjudged bankrupt.56

  1. 8.68 While insolvent deceased estates are not automatically bankrupt, the practical effect of the above section is to apply the scheme designed for bankruptcy in cases of insolvent deceased estates. These estates are effectively administered under the Administration and Probate Act, by reference to the rules contained in the Bankruptcy Act. 

Direct application

  1. 8.69 A parallel option for the administration of insolvent estates is available when the estate is bankrupt.57 In these cases, a petition for bankruptcy may be filed by a creditor or the personal representative of the estate.58 Where a bankruptcy order has been obtained, the estate will be administered in bankruptcy—that is, administered under the provisions of the Bankruptcy Act.

Clarification of the interaction between the two systems

  1. 8.70 Retaining two systems, under which bankruptcy rules may apply indirectly through the Administration and Probate Act or directly where an estate is bankrupt, would maintain national consistency and the Commission does not consider that the dual systems should be replaced. However, some difficulties arise under the dual systems.
  2. 8.71 The Commission asked in the consultation paper on debts how the two systems can operate more efficiently and effectively together.59 In its report on administration of estates, the National Committee for Uniform Succession Laws put forward a number of proposals for minor reform, discussed below.60
  3. 8.72 Although consultation on these topics was limited, submissions broadly supported the changes proposed by the National Committee. No submissions identified any major difficulties with the operation of the dual systems as a whole,61 however those that dealt with this topic made some suggestions for general reform:
  • The Administration and Probate Act should be amended to better refer to the applicable sections of the Bankruptcy Act.62
  • The two systems should, as far as possible, ‘mirror each other’.63
  • Terminology used in the Bankruptcy Act should be applicable to deceased estates.64
  • The applicable bankruptcy law should be that in force at the time of death.65
  1. 8.73 State Trustees supported a general uptake of the National Committee’s recommendations in this area.66
  2. 8.74 While none of the recommended reforms below represents a substantial change in the law, the Commission considers that the interaction between the two systems of administration could be significantly improved by simpler drafting and clearer acknowledgment of the application of the provisions of the Bankruptcy Act. Clear reference to the applicability of specific legislation, to relevant provisions and to identifiable dates promotes clarity and comprehension of the law.
  3. 8.75 The Commission is of the view that the structure and format of the National Committee’s model legislation should be taken into account if the changes set out below in recommendation 66 are implemented. Ancillary and procedural aspects of this model legislation should also be considered.
  4. 8.76 In accordance with its general focus on clarity and accessibility, the Commission recommends that the provisions governing debt payment contained in the second schedule of the Act should be moved into the body of the Act. This applies to payment of debts in both solvent and insolvent estates.

Clarifying when the Administration and Probate Act rules67 apply

  1. 8.77 Where an insolvent estate is being administered under the Bankruptcy Act, the provisions of the Administration and Probate Act, to the extent that they are inconsistent, do not apply.68
  2. 8.78 However, Part I of the Second Schedule of the Administration and Probate Act does not make clear that an alternative method of administration is available. Further, Part I of the Second Schedule to the Act refers to the applicable rules as those ‘in force for the time being under any law of the Commonwealth relating to bankruptcy…’.69 It does not make express reference to the Bankruptcy Act.
  3. 8.79 The National Committee recommended that the model provision make a clear distinction between the two methods of administration of insolvent estates. The model provision achieves this by providing that the part relating to insolvent estates will only apply where a deceased person’s estate is not being administered under the Bankruptcy Act.

Specifying that the applicable provisions of the Bankruptcy Act are those in force at the time of the deceased person’s death

  1. 8.80 The Administration and Probate Act refers to the relevant rules of bankruptcy as those in force ‘for the time being’.70
  2. 8.81 The National Committee recommended that the model legislation refer to the applicable rules as those in force at the time of death of the deceased person.71
  3. 8.82 Submissions on this question were largely supportive of this change, with one group noting that this would be a practical way to ensure that the rules to be applied are clear.72 The Commercial Bar Association agreed that substantive laws should be those applicable at the time of death, but that ‘procedural rules should not be limited in this way’.73

Clearly listing the matters which the Administration and Probate Act imports from the Bankruptcy Act

  1. 8.83 Clause 2 of Part I of the Second Schedule to the Administration and Probate Act specifies the general application of Commonwealth bankruptcy law when an insolvent estate
    is administered under the Administration and Probate Act.
  2. 8.84 The Commission is of the view that the provision should be redrafted to clearly list the relevant areas covered by the bankruptcy legislation.
  3. 8.85 The National Committee proffered the following list:74

Application of bankruptcy rules

(1) The bankruptcy rules as in force at the date of the deceased person’s death apply to the following—

(a) the rights of secured and unsecured creditors against the deceased’s estate;

(b) the debts and liabilities provable against the deceased’s estate;

(c) the valuation of annuities and future and contingent liabilities of the deceased’s estate;

(d) the priorities of debts and liabilities of the deceased’s estate.

Recommendation

66 The Administration and Probate Act 1958 (Vic) should be amended to:

 

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