Suing on a Decedent’s Promise to Pay Versus Enforcement of a Gift Under a Trust.

People may borrow money from family members to purchase real property. They often promise or agree to repay the loan over years and to repay the balance when the real property is sold. What happens if the debtor dies with an unpaid balance? The answer depends whether the debtor did to protect the lender’s interest in being repaid. Let us discuss.

Did the borrower signs a promissory (installment) note saying that any unpaid balance is fully due and payable at the borrower’s death? The debtor’s signing a promissory note with the terms of repayment ensures that debt is legally enforceable against the debtor and the debtor’s estate. The lender would file a timely creditor’s claim as an unsecured (general) creditor against the decedent’s estate and/or file a creditor’s claim with the trustee administering the decedent’s trust estate.

The lender/creditor has several disadvantages: The creditor must establish whether a probate is open or else open a probate; once opened, the creditor must file a timely creditor’s claim within the 1 year date of death statute of limitation (Code of Civil Procedure section 366.2); and as an unsecured general creditor, repayment of the debt depends on the decedent’s estate having enough assets remaining after the secured creditors, the expenses of administration, and taxes are paid. Sometimes, the decedent’s remaining estate is insufficient to fully pay the all general unsecured debts of equal priority. The foregoing make being an unsecured creditor unsuitable in many situations.

To improve the lender’s situation, the promissory / installment note should be secured by a deed of trust recorded with the county as a lien. A lien is not an absolute guarantee of repayment. Preexisting liens (such as a mortgage) must be paid first from the sale of real property proceeds. Also, if the real estate market is down then more may be owed than the property’s value. Secured creditor may then be partially or wholly unsecured. Again, the creditor would need to file a timely creditor’s claim for the unpaid balance within a probate or trust administration, as relevant.

Alternatively, the borrower in a family situation may promise to include a gift to the lender (family member) in the debtor’s estate planning inside a will, a trust or other instrument (e.g., as a death beneficiary to pay on death bank account). If the promise is yet unfulfilled at the borrower’s death, then the lender must file a timely creditor’s claim within the 1 year date of death statute of limitations.

But, if the borrower while alive actually included a gift to cover the unpaid balance owed to the lender within the debtor’s own will, trust, or death beneficiary form (e.g., a non probate asset such as a Pay on Death bank account, or a retirement account) then that is a totally different situation. Now, the lender is a beneficiary under the decedent’s estate plan with a right to enforce distribution of the gift.

In Kathleen Smith vs. Emma Myers, Trustee (Super. Ct. No. 20PR01166), the Third Appellate District (Glenn County), decided whether the 1 year statute of limitations to file a claim to enforce a promise to make a gift under a will, trust or other instrument (Code of Civil Procedure Section 366.3) applies to enforcement distribute a gift to a beneficiary under a trust. The 3rd Appellate District held that the 1 year statute of limitations does not apply because the beneficiary was seeking distribution under the terms of a trust and not enforcement of a promise to be included as a beneficiary under a trust.

Being a beneficiary has limitations too. The decedent’s trust estate may provide for payment of the settlor’s unsecured debts — even without a probate court’s approval of a timely and enforceable creditor’s claim. Paying debts may leave insufficient assets to distribute stated gifts to the beneficiaries.

The foregoing discussion is not legal advice. Consult a qualified attorney for guidance. Dennis A. Fordham, attorney, is a State Bar-Certified Specialist in estate planning, probate and trust law. His office is at 870 S. Main St., Lakeport, Calif. He can be reached at Dennis@DennisFordhamLaw.com and 707-263-3235.