Family Law and Bankruptcy – what it looks like when they collide

Family Law 16 December 2020

Many consequences arise and impact on an outcome in a family law property settlement and/or family law property proceeding if a person in a marriage or de facto relationship is declared bankrupt.

What is bankruptcy?

Bankruptcy is the inability of a person to pay their debts as and when they fall due.  Pursuant to the Bankruptcy Act 1966 (Cth), a person can be declared bankrupt in the following circumstances:

  1. The creditor commencing Court proceedings to bankrupt the debtor through the presentation to the Court of a Creditor’s Petition with the view to obtaining a Sequestration Order. This is also referred to as an involuntary bankruptcy;
  2. Through the debtor filing with a Debtor’s Petition to the Official Receiver, also referred to as a voluntary bankruptcy.

When a person is declared bankrupt, so after the making of the Sequestration Order or the Official Receiver accepts the Debtor’s Petition, ‘vested’ bankrupt property vests in the Trustee in Bankruptcy pursuant to Section 58(1) of the Bankruptcy Act 1966.  ‘Non-vested’ bankrupt property is property excluded from the hands of the trustee and is defined under s 116 of the Bankruptcy Act 1966.  Examples of non-vested bankrupt property include but not limited to:

  1. Pursuant to Section 116 (2)(a) – Property held on trust by the Bankrupt for another;
  2. Pursuant to Section 116(2)(b) – Household property of the Bankrupt; and
  3. Pursuant to Section 116(2)(d) – Superannuation. However, it is important to note that payments into a superannuation fund for the purposes of defeating creditors may be subject to the claw back provisions contained in Sections 128(b) and 128(c) of the Bankruptcy Act.

Family law and Bankruptcy – what it looks like when they collide

Section 58A of the Bankruptcy Act 1966 provides that in a family law matter pursuant to Section 79 and Section 90SM of the Family Law Act 1975, the Family Court is empowered to remove property otherwise vesting in the Trustee in Bankruptcy from the hands of the Trustee and into the hands of the non-bankrupt spouse.

Further, property that is transferred to a bankrupt under an Order under s 79 or s 90SM of the Family Law Act 1975 vests in the Trustee as ‘after acquired’ property for the purposes of s 58(1)(b) of the Bankruptcy Act 1966.

The Rights of a bankrupt in a family law dispute

Section 58 of the Bankruptcy Act 1975 prevents a bankrupt party from making submissions in relation to vested bankrupt property unless there are exceptional circumstances.  As such, the ability of the bankrupt to participate in the proceedings is limited to matters concerning ‘non-vested’ bankrupt property such as superannuation.

A bankrupt should be mindful of the operation of s 60 of the Bankruptcy Act 1966 should bankruptcy occur during the course of family law proceedings presently on foot, regardless of whether the application relates to parenting or property.  The consequence of s 60 is that a bankrupt is precluded from further participating in the proceedings where:

  1. A person who commences family law proceedings (so is the applicant) becomes bankrupt during the course of the family law proceedings; and
  2. Receives notice from the trustee that the trustee does not wish to join in and participate in the proceedings, and therefore the proceedings are abandoned.

Rights of the non-bankrupt party

The rights of the non-bankrupt party depend on the nature of the vested bankrupt property.  For example, if the non bankrupt spouse does not have a legal interest in real property (i.e. is not a registered proprietor of joint real property) the rights of the non bankrupt spouse will be severely impacted.  Accordingly, the non bankrupt spouse may need to explore ways to protect their interest in vested bankrupt property, such as seeking a court order for injunctive relief restraining the Trustee in Bankruptcy from being able to deal with the vested property, or by lodging a Caveat so as to notify the Trustee in Bankruptcy of their equitable interest.

The non-bankrupt party should also be mindful of the powers of the trustee to ‘claw-back’ transfer of property pursuant to s 120, s121 and s 122 of the Bankruptcy Act 1966.  The consequence of the claw-back provisions is that the pool of property available for division among creditors is widened and may impact on the non-bankrupt spouses entitlement under a property order.

How does the Family Court determine property matters?

Following the decision in Stanford v Stanford, the Court is required to follow a five step process to determine what outcome is ‘just and equitable’ in the circumstances of the case.   This process does not change, even in circumstances where there is a bankrupt party.   Accordingly, the Court will make orders in relation to what both the no- bankrupt spouse and the bankrupt spouse will receive by way of a division of property.  As noted, the bankrupt spouse’s entitlement pursuant to Final Property Orders will vest in the Trustee in Bankruptcy to the extent that they are not otherwise excluded under Section 116.

The five step process is as follows:

  1. The court to assess whether it is ‘just and equitable’ for the court to make a property settlement order under s 79 or s 90SM of the Family Law Act 1975;
  2. The court to assess the legal and equitable interests of the parties;
  3. The court to assess the financial and non-financial, and direct and in-direct contributions of the parties during the course of the relationship and post-separation;
  4. The court to assess the further consideration and future needs factors under s 75(2) and s 90SF(3) of the Family Law Act 1975;
  5. The court to assess whether the orders providing for the outcome of the property settlement are just and equitable in the circumstances of the case.

The rights of unsecured creditors are assessed under Section 75(2)(ha).  As such, the interests of unsecured creditors are considered among other factors under Section 75(2) of the Family Law Act 1975 including but not limited to:

  1. The age and state of the parties;
  2. The income, property and financial resources of the parties;
  3. Whether a party has care or control of a child under 18 years; and
  4. Any fact or circumstances which, in the opinion of the court, the justice of the case requires to be taken into account.

Can the Trustee in Bankruptcy apply to set aside Orders made under a Consent prior to bankruptcy?

Yes.  Pursuant to s 79A or s 90SN of the Family Law Act 1975the trustee in bankruptcy is able to apply to set aside the Orders made under s 79 or s 90SM of the Family Law Act 1975 should a ground for setting aside or varying the property order be met.

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