Bankruptcy and family law: alteration of property interests between bankrupt and non-bankrupt spouse

29 September 2015

In this issue:

Reviewing provisions of Family Law Act relating to alteration of property interests between a bankrupt and non-bankrupt spouse (including dependents).
Rights of the non-bankrupt spouse in bankrupt spouse’s property that has vested in a trustee in bankruptcy
Consequences of family law entitlements for creditors in the bankruptcy
The legal effect of pre-bankruptcy spousal property settlements obtained by means of consent-based court orders

Introduction

In 2005 the Family Law Act 1975 (FLA) was substantially amended to clarify the interaction between bankruptcy and family law. Significantly, under the 2005 provisions the Family Court was granted comprehensive powers to deal with proceedings for property settlement and spousal maintenance in circumstances where a bankruptcy trustee has been appointed, and property of the bankrupt spouse has vested in the trustee under the Bankruptcy Act 1966.

The Family Law Act amendments have provided the non-bankrupt spouse with the opportunity to obtain a share in the vested assets of the bankrupt for the benefit of the non-bankrupt spouse and dependents. Moreover, unlike the position prior to the introduction of the amendments, it is not a prerequisite of the proceedings that the parties to the marriage have separated, with the amendments applying whether the marriage is intact or not: see Stanford v Stanford (2012) HCA, 15/11/2012.

It is important to recognize the nature and scope of these enhanced powers and responsibilities of the Family Court with a view to determining their effect on bankruptcy trustees, their administrations and the interests of creditors in the bankruptcy.

Post-bankruptcy alteration of property interests

Under section 79 FLA a party to a marriage may apply for property settlement in the Family Court even though the party’s spouse (or former spouse) is bankrupt. In that event the trustee in bankruptcy may apply to the court to be joined as a party to the proceedings. Thereafter, except with leave of the court, the bankrupt party to the marriage is not entitled to make a submission to the court in connection with any vested bankruptcy property (see section 79(12) FLA).

Significantly, under section 79(1)(b) FLA with respect to vested bankruptcy property the court may make such order as it considers appropriate altering the interests of the bankruptcy trustee in the vested property. In providing for this outcome the provision does not seek to give the trustee or the non-bankrupt spouse any priority over the vested property. The basis of the court’s decision is contained in section 79(2) FLA which states:

“The court shall not make an order under this section unless it is satisfied that, in all the circumstances, it is just and equitable to make the order.”

In section 79(1)(b) proceedings there are three types of property of the marriage that the Family Court is likely to be dealing with:

The bankrupt’s property vested in the trustee.
The bankrupt’s property which does not vest in the trustee being exempt assets under the Bankruptcy Act e.g. interest of bankrupt in a superannuation fund.
The non-bankrupt spouse’s assets.

Once the relevant property has been identified, the court, in determining what is “just and equitable,” is required by section 79(4) to take into account the matters listed in that provision. Most significantly, the court is required to take into account:

The non-bankrupt spouse’s direct and indirect financial and non-financial contributions, such as contributions as home-maker and parent, to any of the property of the marriage.
The effect of any proposed order upon the earning capacity of either party to the marriage.
The effect of any proposed order on the creditors in the bankruptcy.

It is the task of the Family Court to make comprehensive findings on each of the above criteria with a view to making an order that achieves a “just and equitable” outcome. Such order may well result in the non-bankrupt spouse and dependents obtaining a share of the vested assets of the bankrupt to the disadvantage of creditors in the bankruptcy.

Right of trustee in bankruptcy to apply to set aside post-bankruptcy property settlement order

If a court makes a property settlement order under section 79(1)(b) in favour of the non-bankrupt spouse, it is available to the trustee in bankruptcy to apply to the Family Court to set aside the order (see section 79A, FLA). The grounds on which section 79A applications may be made are, however, limited. Perhaps the most relevant for the trustee in bankruptcy is the ground contained in section 79A(1)(a), being concerned with “a miscarriage of justice by reason of fraud, duress, suppression of evidence (including failure to disclose relevant information), the giving of false evidence or any other circumstance.” Under this ground the trustee may seek to set aside an order where subsequent to the making of the order matters have come to light which in the opinion of the trustee have a bearing on the court’s original findings.

Alteration of property interests by means of consent-based orders obtained under section 79 FLA before bankruptcy arises

Under section 79(1)(a), FLA a husband and wife may obtain property settlement orders from the Family Court on a consent basis made before bankruptcy arises. In these circumstances when the Family Court makes an order by consent any alteration of the interests of the parties takes effect by reason of the court order and not by reason of the consent of the parties.

With respect to such pre-bankruptcy, consent-based court orders the bankruptcy trustee on appointment has the right to challenge the order under section 79A. Such challenge will, however, be confined to the grounds allowed by the section (as discussed above). Again such an appeal would usually be based on the ground that the order was obtained without full disclosure of relevant information, such as the imminent bankruptcy of one of the parties to the marriage.

Note that with respect to dispositions of property under pre-bankruptcy, consent-based orders the trustee will not be in a position to invoke sections of the Bankruptcy Act, such as sections 120 and 121, which are usually employed by trustees in bankruptcy to challenge pre-bankruptcy dispositions of property between spouses. The reason for this restraint is that a transfer of property by a person pursuant to a court order, including a consent-based court order, is not a transfer of property under either section 120 or 121 which only apply to a transfer by a person (who later becomes a bankrupt) outside the operation of a court order: see Official Trustee in Bankruptcy v Mateo (2003) FCAFC 26, 28/2/2003.

Finally, consent-based court orders will not be an option available to the parties to the marriage in cases where bankruptcy has already arisen. In those circumstances the bankrupt’s interest in property will have vested in the trustee (other than exempt property), thereby depriving the parties of any opportunity to alter vested property interests on a consent basis: see Debrossard & Official Trustee in Bankruptcy (2011) FamCA 648, 19/8/2011. The only option available to the non-bankrupt spouse will be to apply for a post-bankruptcy property settlement order under section 79(1)(b) FLA as discussed above.

Concluding comments

The Family Law Act has provided the Family Court with jurisdiction to deal with proceedings for property settlement in circumstances where property of a bankrupt spouse has vested in a bankruptcy trustee. In allowing the Family Court to make orders that alter the interest of a bankruptcy trustee in vested property, the Family Law Act has sought to do justice and equity between the non-bankrupt spouse and the trustee representing the interests of creditors in the bankruptcy.

Trustees may argue that the pendulum has swung too far in favour of the bankrupt’s family and against the interests of creditors in the bankruptcy. Ultimately the Family Court has been given the task of balancing the competing claims of the bankrupt’s creditors and the non-bankrupt spouse on a “just and equitable” basis premised on specified criteria without any pre-conceived idea that one interest should prevail over the other.