Overview — Bankruptcy in the family law context

Prior to the introduction of the Bankruptcy and Family Law Legislation Amendment Act 2005 (Cth) (BFLAA), the position of the Family Court in respect of a bankrupt party was very uncertain. That has changed and matters related to the property of a bankrupt and a non-bankrupt spouse (including those in de facto relationships) may now be relatively confidently dealt with under the Family Law Act 1975 (Cth) (FLA).

Under s 35 of the Bankruptcy Act 1966 (Cth) (BA) the Family Court is given specific jurisdiction in bankruptcy where the trustee is a party to property settlement or spousal maintenance proceedings. By enabling the trustee in bankruptcy to be joined to family law proceedings, the BFLAA gave the Family Court jurisdiction to deal with a non-bankrupt spouse’s claim once the bankrupt’s property had vested in the trustee. Nevertheless, the BA and the FLA have quite different approaches to measuring contribution by a party which can make it difficult for the trustee to succeed in securing the interests of the creditors against the interests of the spouse.

s 35, Bankruptcy Act 1966 (Cth)

In particular, the FLA recognises the non-financial contribution of the spouse which is not a factor considered under the BA and gives a more uncertain outcome to any proposed action. Another factor that should be considered in the equation is the action of the Australian Taxation Office in recovering unpaid tax or superannuation.

Who is a bankrupt?

Both the FLA and BA refer to a bankrupt as being a person:

• • against whose estate a sequestration order has been made; or
• • who has become a bankrupt because of a debtor’s petition.

Once a person has been declared a bankrupt, they are required to advise their spouse (married or de facto) and the court within seven days of their change in status. Once declared bankrupt, their property vests in the appointed trustee in bankruptcy and the bankrupt is no longer able to make separate submissions to the court except in relation to their superannuation assets which are exempted from the vesting.

Usually a bankruptcy lasts for three years and the bankrupt is limited as to how he/she may use any income earned or property that may be obtained during that period.

The role of the trustee

Parties should be aware that very little property is exempted from being vested in the trustee including the family home. In fact, the family home may be “clawed back” by the trustee if there has been a transfer of property by the bankrupt to the spouse within the 6 months prior to the act of bankruptcy occurring. Any transfer of property which gives a preference to another person over the interests of other creditors can be voided by the trustee. The only exempted assets are: household goods, superannuation, tools of trade up to $3,400 and a motor vehicle up to $6,850 in value: s 116, BA.

s 116, Bankruptcy Act 1966 (Cth)

The trustee represents the interests of creditors and often there is a conflict between the role of the trustee on behalf of the creditors and the proposed claim of the spouse which is likely to reduce the entitlements of the creditors.

Joining a trustee in bankruptcy to proceedings

In most cases, the non-bankrupt spouse will join the trustee in bankruptcy by way of an Application in a Case once proceedings have commenced. Although the FLA tends to use the term “creditors” and “trustee” interchangeably, once a party is bankrupt, it is necessary to join the trustee rather than a creditor.

A debtor in a personal insolvency agreement who becomes a party to proceedings, is also required to notify the court, their spouse and the court within 7 days of the event:s 79G, FLA.

s 79G, Family Law Act 1975 (Cth)

The trustee can also apply to be joined to proceedings in their own right.

Powers of the court when dealing with a bankrupt party

The FLA makes specific provision to protect the interests of trustees and creditors in both the making of orders and agreements and in the setting aside of orders and agreements in Part VIII of the Act.

Part VIII, Family Law Act 1975 (Cth)

Alteration of property interests

The process followed by the court in making any alteration to the property interests of the parties under s 75(2) of the FLA retains the same just and equitable requirement as is usually followed (see Just and equitable principle) but the additional requirement is that the court must consider the interests of the trustee or creditor. It is not that the interests of creditors will always prevail over the interests of the spouse, but rather that the court will attempt to balance their competing claims.

s 75(2), Family Law Act 1975 (Cth)

Financial agreements

While financial agreements are often made with the intention to oust the jurisdiction of the Family Law Act, s 79A permits the court to set aside any orders which have been made in certain circumstances. These include that;

• • the court or a party was not notified that a trustee had been appointed;
• • there was not proper disclosure by a party; or
• • the interests of a trustee have been affected by an order.

Where the court has made an order, and at the time of making the order a party was a bankrupt or subsequently became bankrupt, s 79A(5) of the FLA enables the court to set aside the order on the basis that the bankruptcy trustee’s interests have been affected. See Setting aside orders.

s 79A(5), Family Law Act 1975 (Cth)

Bankruptcy and superannuation

In general terms, the bankrupt’s assets held in a regulated superannuation fund either at the time of entering into bankruptcy or during the course of the bankruptcy, are exempted from vesting in the trustee. There are exceptions however, if it is found that a bankrupt has transferred their assets into their super fund prior to the bankruptcy with the intention of defeating the claims of creditors, or if the bankrupt has taken funds out of their super fund. In such cases those transfers will be voided and the funds will vest in the trustee: s 128B, BA.

s 128B, Bankruptcy Act 1966 (Cth)

Bankruptcy and maintenance obligations

The obligations of a bankrupt to support any children of the relationship is unaffected by entering bankruptcy and will be enforced by the Child Support Agency. See s 50 Child Support (Registration and Collection) Act 1988 (Cth).

s 50, Child Support (Registration and Collection) Act 1988 (Cth)

Similarly a non-bankrupt spouse may seek spousal maintenance from a bankrupt spouse however their claim is more likely to be satisfied by a transfer of property in either partial or total satisfaction of their claim rather than periodic or lump sum payments, as is more usual.