When a person dies, his or her estate is liable for any valid debts incurred before death. But what if there is no estate as such? In California, an estate need not be opened—or administered—if the deceased person's property passes to a spouse. Can the deceased person's creditors then demand the spouse pay off the debt?
Yes, actually. California law treats such situations as if the deceased person never died. As with any other debt incurred by a married individual, the creditors may claim (1) the community property belonging to both spouses and (2) any separate property of the deceased spouse, even though such property has now passed to the surviving spouse.
The California Court of Appeals recently addressed a case involving this principle. The case is discussed here for informational purposes only and should not be treated as a binding statement of law. As with any question of probate law, you should speak with an experienced California estate planning attorney.
Massoyan v. Otto
John Otto ran an illegal Ponzi scheme through a number of corporate alter egos. After the scheme finally collapsed in 2009, Otto committee suicide. Two weeks later, the investors Otto defrauded filed a class action complaint. The named defendants included the corporate alter egos and “the Estate of John Otto,” even though Otto's widow, Kathleen Otto, never opened an estate.
A civil jury ultimately found John Otto liable for over $114 million in damages to the class plaintiffs. The trial court entered the judgment against Kathleen Otto. While the jury found she was not a part of her husband's Ponzi scheme, under California probate law, she was personally liable for her husband's debt since there was no estate.
Kathleen Otto appealed the judgment, but the court of appeals found nothing wrong with the trial court's decision. As explained above, when a person dies and no estate is opened, the surviving spouse can be held personally liable up the amount of any community property or individual property inherited from the deceased spouse. In this case, the class plaintiffs established John Otto owed them a debt incurred by his fraud. Therefore, the trial court was correct in demanding Kathleen Otto pay the debt.
The appeals court further pointed out that, contrary to Kathleen Otto's claim, the creditors were not required to open an estate for John Otto and pursue their claims against it first. It is true that creditors may petition a court to open a probate estate to seek repayment of debts. However, the law applicable in this case is the exception to the general rule that a person's property must pass through probate. The whole point of California law is that property may pass from one spouse to another without the need for probate—and when that occurs, the creditors can then pursue their claims against the surviving spouse directly.
Again, it should be clear that creditors may not go after the individual assets of a surviving spouse, only community property and individual assets inherited from the deceased spouse. And this law applies regardless of whether the deceased spouse had a will. But even if you don't anticipate leaving your estate to anyone other than a spouse, you should still work with a qualified attorney who can advise you on the best way to protect your assets after you're gone. Contact the Law Office of Scott. C. Soady in San Diego if you have any questions.