It is not uncommon for a disgruntled spouse to render him or herself bankrupt in order to avoid a claim by their spouse for a property settlement.
The Bankruptcy and Family Law Legislation Amendment Act 2005 gave the Family Court and Federal Circuit Court jurisdiction to deal with the bankruptcy of a party to a marriage or de facto relationship. Prior to the amendments the Family Court had a limited role once a party became bankrupt. The non-bankrupt spouse had to take action through the Federal Court to recover any surplus after creditors were paid. Now when bankruptcy and family law issues co-exist they are dealt with at the same time by the Family Court and the competing rights and interests of the creditors and the non-bankrupt spouse are determined by the Court.
What are the options for the non-bankrupt spouse?
The 2005 amendments allow the non-bankrupt spouse to make an application for a property settlement under the Family Law Act even if their spouse is bankrupt at the time the application is made.
Trustees can be joined to the family law proceedings to enable a non-bankrupt spouse to make a claim for property which has vested in the trustee in bankruptcy. The non-bankrupt spouse may also apply to the Court for an injunction to restrain the trustee from distributing the bankrupt’s estate to creditors prior to their property settlement being determined.
It is often viewed that these amendments favour the spouse as a trustee cannot commence proceedings against a non-bankrupt spouse to increase the assets in the bankrupt estate available for creditors.
If a trustee is joined to family law proceedings it has serious consequences for the bankrupt as they lose the right to make submissions with respect to property which has vested with the trustee. The bankrupt will only have the right to make submissions about property which is protected from the trustee in Bankruptcy pursuant to the Bankruptcy Act such as superannuation up to a certain limit.
What does the Court consider when dividing the property between trustee, creditor and non-bankrupt spouse?
The factors the Court will consider in each case vary. However, the Court must always consider whether it is just and equitable to make an order. There are a number of relevant factors that the Court will consider including:
- Whether a party had attempted to reduce or minimise the matrimonial assets or has acted recklessly or negligently in respect of matrimonial assets;
- The non-bankrupt spouse’s knowledge of the bankruptcy, benefit from or contribution to the bankruptcy;
- If any of the parties failed to make full and frank disclosure of their financial position;
- The financial circumstances and family situation of the non-bankrupt party including the care of any children under the age of 18;
- Whether the debt was incurred before or after separation;
- Whether property proceedings appear to be a tactic to reduce the assets available to the trustee or creditor;
- The extent to which the creditor pursued the payment of the debt; and
- The impact of the proposed orders upon a creditor’s rights.
Are all creditors treated equally?
In the Commissioner of Taxation and Worsnop [2009], the husband transferred to the wife his interest in the former matrimonial home for $1 prior to separation. At the time of separation, the husband had debts totalling $13 million to the ATO, with the former matrimonial home being the only substantial asset, then worth $4.75 million.
There was conflicting evidence as to whether the wife was aware of the husband’s tax avoidance; however the Trial Judge accepted that she had no knowledge of the $13 million debt. The Judge ordered that the former matrimonial home be sold and that the wife receive 50% of the net proceeds and the Commissioner of Taxation receive the remaining 50%.
In balancing the competing claims of the wife against the Commissioner, it was stated that the Commissioner of Taxation is in a position distinguishable from that of a commercial creditor. Commercial creditors have a choice about who they extend credit to. On the other hand, the position of the Commissioner as a creditor of taxpayers is of a completely different origin. The onus is on taxpayers to make full and proper disclosure to the Commissioner of Taxation. The Commissioner does not extend credit at all, but becomes a creditor by virtue of the conduct of the affairs of the taxpayer.
Does it have to go to Court?
Parties can finalise their property settlement by way of consent orders or a Binding Financial Agreement (“BFA”).
If parties seek to finalise a property settlement without the knowledge of the creditor or trustee, without making full and frank disclosure or to defeat creditors an application can be brought under s 79A of the Family Law Act to set aside or vary those orders.
The way consent orders are drafted will also affect whether orders are varied or set aside in the event of a future bankruptcy. In Oliver v Malanos [2011], consent orders were entered into before bankruptcy which set up a trust fund for the education of the children of the marriage. The trust fund was in the names of both the bankrupt and the non-bankrupt spouse. On appeal the Federal Court decided that the non-bankrupt spouse was protected by s 59A of the Bankruptcy Act. Therefore her share of the trust fund established for the benefit of the children of the marriage was not available to creditors.
A BFA is a private agreement that is intended to exclude the jurisdiction of the Family Court. A trustee can set aside a BFA pursuant to sections 120 or 121 of the Bankruptcy Act in circumstances where the transfer may have been for less than market value consideration or if the main purpose of the agreement was an intention to defeat creditors or delay providing property to creditors.
The main purpose will be determined by the surrounding circumstances of each case and may simply be to make provision for spouse and children.
In Sutherland v Byrne – Smith [2011], a de facto couple entered into a BFA and then subsequently purchased a property together. Approximately two years later the couple separated and sought to rely on the agreement to transfer property to the de facto wife. After a few months, the de facto husband filed for bankruptcy. The issue was whether the couple had used the financial agreement to defeat the creditors’ claims.
The Court examined the contributions to the acquisition of the property and found that the main purpose was not to defeat creditors, but the transfer was void as it was transferred to the wife for no consideration.
Provided that consent orders or a BFA are entered into in good faith, for market value consideration and with the main purpose of dividing property between spouses in the event of a breakdown of a relationship the non-bankrupt spouse should be protected in the event of a future bankruptcy.
Conclusion
If one of the parties to a property settlement has become or is likely to become bankrupt, the impact on parties is complex. Specific legal advice should be obtained by an accredited family law specialist who is also conversant in insolvency law, prior to initiating a property settlement or negotiations to ensure that any orders or Binding Financial Agreement is not subsequently set aside. This will ensure that parties can bring finality to their financial relationship without fear of a trustee or creditor setting aside their agreement.
Disclaimer
This information is provided as a guide only and is not intended to constitute advice whether legal or professional. You should obtain appropriate advice concerning your particular circumstances.
