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Bankruptcy Law Meets Family Law
The Bankruptcy and Family Law Legislation Amendment Act 2005 received royal assent on 18 March 2005, with commencement dates for the various provisions up to September 2005.

Is this the end of asset protection?

Introduction

The Act, which in our view could place valid asset protection arrangements at risk, contains provisions originally included in the Bankruptcy Legislation Amendment (Anti-Avoidance and other Measures) Bill 2004, introduced by the current government last year and now abandoned.

It seems to us that the original Anti-Avoidance bill, hotly disputed as being largely unworkable and now rejected, was intended to be balanced, with some amendments in favour of the trustee in an attempt to stop high-income professionals from rorting the system, and with other amendments in favour of non-bankrupt spouses so that bankrupt spouses would effectively be forced to comply with their maintenance obligations. While the Act has been introduced as a long overdue solution to many of the disparities between bankruptcy and family law, the removal of the anti-avoidance amendments has left the scales of justice leaning clearly towards to the interests of non bankrupt spouses, with the bankruptcy trustee (and creditors) wondering what rights they may have left. Certainly, the amendments have raised a number of questions in our mind as to how they will work in the best interests of all parties.

Past experience with the law

Some of the differences that have caused problems in the past between bankruptcy and family law proceedings are:
  • Non-monetary claims are specifically excluded in the Bankruptcy Act 
  • Marital agreements are excluded from vested property 
  • Non-bankrupt spouse couldn’t start maintenance proceedings once a bankruptcy had commenced 

Effects of the new changes

The proposed amendments will be quite a departure from the current position. They will allow non-bankrupt spouses to make an application for property settlement under the Family Law Act 1975 in the Family Court even though their spouse was bankrupt or subject to a personal insolvency agreement at the time the application is made.

There are 3 important changes here:

  • the jurisdiction of the Family Court rather than the Federal Court; 
  • the ability to make an application even though the spouse is bankrupt; and 
  • the fact that even though the non-bankrupt spouse did not make a financial contribution to those assets subject to the application, they are able to make such an application under the Family Law Act. 

The impact on the non-bankrupt spouse

Some of the amendments are clearly long overdue. Previously, a non-bankrupt spouse had to take action through the Federal Court if they wished to claim part of the bankrupt spouse’s property. They could not commence Family Law proceedings where the spouse was bankrupt. Clearly they were able to retain those assets which were held in joint names or their own names, but if they wished to, as is usual, obtain a higher share for the benefit of dependents, they were unable to do so unless they could prove financial contribution. de Vries Tayeh have long believed, from their experiences in this area, that this is in conflict with established family law principles and clearly needs to be rectified to provide for dependents.

Removal of Binding Financial Agreements. (BFA’s)

In December 2000 the Family Law Act 1975 ('FLA') was amended to allow parties to enter into a binding financial agreement, either before or during the marriage or after dissolution of the marriage.

It was possibly not envisaged that such agreements would be used by people such as Jodee and Maxine Rich [Asic v Rich & Anor (2003) FamCA1114] to ensure that assets would not available to creditors in the event of bankruptcy. However it was certainly recognised that BFA’s could legitimately include matters that were ancillary and incidental to property and maintenance matters, such as partnership or business arrangements.

The BFA amendments

The FLA has since been amended to allow third party proceedings to apply to the Family Court to set aside BFA’s, but as a further step BFA’s are now specifically excluded from the definition of maintenance agreements in the Bankruptcy Act.

The exclusion results in the property subject to those BFA’s being possibly recoverable by the trustee under Sections 120 or 121 of the Bankruptcy Act. In order to do so, however, the trustee will need to consider the following:

Section 120 – the transfer will be void if done within 5 years before the commencement of the bankruptcy and for a consideration less than market value. A major exemption from this is when the transfer took place more than 2 years before bankruptcy commenced and the transferee is able to prove that the transferor was solvent at the time.

Section 121 – the transfer will be void if the trustee can show that it was done for the purpose of defrauding or defeating creditors, unless the transferee participated in the transaction in good faith and paid consideration at least equal to market value.

If family law proceedings are underway or likely to be made, then these decisions will be made by the Family Court. We query whether the Family Court’s definitions of undervalued transactions and market value will vary materially from those traditionally adopted by the Federal Court, particularly where they will include non-financial contributions. The Bankruptcy Act specifically excludes such non-monetary factors as 'love and affection' from the definition of consideration, but the Family Court has always taken non-monetary factors into account.

Consideration vs. Statutory Exclusion in Bankruptcy

The Family Court’s determination of 'consideration' may well override statutory exclusions, particularly where it is consistent with the principles of equity within family law. 'Consideration' could well be the giving up by one spouse of the right to bring a claim for property settlement or other indirect monetary matters such as the deferral of a career in favour of homemaker activities.

This is one area where clearly family law and bankruptcy law intentions can be at odds. It would be quite reasonable to enter into a BFA in the event of future separation – after all one of the objectives of the changes to the Family Law Act is to enable these agreements to be made and so avoid the problems of starting proceedings through the Family Court. At the time of making the BFA each spouse recognises the financial and non-financial contributions each has made to the marriage as well as the future needs of dependents. There is obviously therefore no need for further consideration (especially market value) to be paid by one party to the other as the distribution already reflects this.

If bankruptcy is not foreseen but happens anyway within a 2 year period, such a BFA could be automatically void. What happens to the non-bankrupt spouse and dependents? If the non-bankrupt spouse commences proceedings in the Family Court, we have a fight on our hands. The bankruptcy trustee will no doubt try and set aside the BFA, but the non-bankrupt spouse may well argue the concept of undervalued in the Court and try and retain those assets.

If the Family Court makes an order under Section 79, this may also override the consideration parameters of Sections 120 and 121. This is a conflict even for the Family Court itself – BFA’s are encouraged on the one hand to provide certainly of income, but on the other hand the Court is obliged to consider the interests of creditors in the event of bankruptcy.

Spousal maintenance proceedings and bankruptcy

The Act provides that a non-bankrupt spouse may make an application for spouse maintenance, notwithstanding that at the time the application is made, a party was bankrupt or became bankrupt during the proceedings. The fact that a non-bankrupt spouse can commence spouse maintenance proceedings after a spouse becomes bankrupt is a significant departure from the current law.

The Family Court has traditionally decided maintenance on the grounds of need as well as the capacity to pay. The Bankruptcy Act presently includes a section that spouse maintenance agreements (i.e. those already in place) are not disturbed by the bankruptcy. Certainly there was no provision for such agreements to be funded out of the property available to the trustee. However, the Act now provides that the maintenance liability may be satisfied in whole or in part by way of transfer of vested bankruptcy property, if the Court makes such an order.

This reduces even further the asset pool available to creditors of the bankrupt. We would also argue that such applications will be made as a matter of course where a bankrupt’s earning capacity is diminished by his position.

An example of the Act in action

In our opinion this could lead to abuse of the system. Say the bankruptcy is commenced and the non-bankrupt spouse starts proceedings in the Family Court. The non-bankrupt spouse is entitled to make an application for any or all of the following:
  • Their own property (which would of course be exempt property) 
  • Exempt property of the bankrupt (or a share thereof) 
  • Vested property of the bankrupt (or a share thereof) 
  • Additional share in the vested property to meet maintenance claims 
It is not necessary for the parties to be actually separated prior to commencing family law proceedings – what is there to prevent collusion between the bankrupt and the non-bankrupt spouse to ensure that as many assets as possible are removed from the reach of creditors?

On the other hand, spousal maintenance orders are often worth less than the court-issued paper they are written on, if the spouse is determined not to earn sufficient income to satisfy his obligations. At least this way, the non-bankrupt spouse may have a chance to obtain at least some of the financial support the Court has obviously decided is appropriate. This is clearly some progress towards resolving some of the societal problems resulting from relationship difficulties and that have in themselves caused increased workloads and delays in Family Court hearings.

Vested property and the non-bankrupt spouse

The non-bankrupt spouse can now apply for orders that they be entitled to part of the property vested in the bankruptcy trustee, which at present is not accessible by the non-bankrupt spouse.

Sections 58 and 59 of the Bankruptcy Act provide the general rules for the vesting of property in the trustee. However, they are now subject to a new Section 59A, which states that any such vesting of property, is subject to an order under Part VIII of the Family Law Act.

Although superannuation is generally exempt from being vested property under the Bankruptcy Act, the Family Court’s treatment of it as an asset divisible among the parties to the marriage will have an effect on the property that is divisible amongst creditors. Even if the Court gave a higher percentage of the superannuation entitlement to the non-bankrupt spouse rather than disturb the asset pool for creditors, this would have to be offset by the need for a non-bankrupt spouse to obtain readily available cash to support themselves and dependents in the meantime.

Not only will vested property become subject to claims of the non-bankrupt spouse, but exempt property will now include an additional definition – 'any property that under an order under Part VIII FLA, the trustee is required to transfer to the spouse of the bankrupt'.

Family court jurisdiction over bankruptcy legislation - more questions than answers

The amendments include specific jurisdiction of the Family Court where both family law and bankruptcy proceedings are on foot. We see this as a challenge for members of the law profession from both bankruptcy and family law backgrounds.

Most bankruptcy trustees have had relatively little involvement with the Family Court and may not be familiar with the methods and rationale behind those judgements. Most Family Court judges may not have had the extensive commercial and practical experience of their counterparts in the Federal Courts in the application of the bankruptcy laws. By their very nature, Family Courts are more subjective, taking into account much more than financial contribution or contractual obligations. Indeed, for example, the Family Court is obliged to do so by virtue of Section 75(2) of the FLA, which provides for the 'future needs factors'.

If the legal representatives of the parties are working in unfamiliar territory, will this mean more costs involved in retaining senior counsel, reducing even further the asset pool for distribution?

Those scales of justice may be tipping, if only one party has access to the necessary funds to cover legal action. Non-bankrupt spouses may not have access to similar funds, certainly in ready cash form, whereas bankruptcy trustees may be funded, perhaps by major creditors. Should Government funding be made available in these circumstances, and does this open up other claims for government funding to fight legal action against liquidators, receivers etc.?

Will the decisions be biased towards the non-bankrupt spouse? We believe there are challenges ahead for Family Court judges who in making their decisions now need to consider a number of other parties who have joined the action. The decisions have to be just and equitable, but if we’re talking about division of a finite pool of assets, then someone surely has to lose out! The amendments provide for the Court to 'take into account' the interests of other parties, but there are no guidelines as yet on how and to what degree these interests will be taken into account.

There may well be a general throwing of hands in the air by trustees, unable to justify the costs of defending any action in the Family Court with the small pool of assets available to him or her. At any rate, the trustee may regard his or her role as secondary to the social issue.

We might even end up with a situation where anything less than, say, $100,000 is effectively given to the non-bankrupt spouse because it’s not worth fighting for. This then puts doubts into the mind of the trustee of whether he has properly discharged his obligations to creditors.

Figures released by ITSA show that in the 2002-2003 year there were 23,925 non-business bankruptcies, personal debt agreements or Part X arrangements carried out under the Bankruptcy Act, of which 3,680 or 15.38% were attributable to 'domestic discord'. The non-bankrupt spouses in these cases have not been able to take proceedings in the Family Court to date, but under these amendments they are now able to do so.

If we assume that property and maintenance orders made through the Family Courts of Australia and Western Australia remain relatively stable, then based on 2000 figures of 14,170 such applications, and even if only half of the bankruptcy related matters went to court (i.e. 1,840) we would expect to see an increase in applications of just under 13%. The workload of the Family Courts, already stretched, may suffer as a result.

Negotiation rather than litigation

The solution is obviously to keep the matters out of Court if at all possible. We should aim to come to an agreement whereby the property is distributed with the interests of all parties in mind. The difficulty with this of course is that the parties often have different objectives. The non-bankrupt spouse would likely have more emotional motives, which may have to be tempered by reason and logic. The trustee is charged with looking after the interests of the creditors, not the spouse, and may overlook the impacts of his commercial decisions on others. Both parties need to look at the costs and benefits of their actions.

All parties need to keep a cool head - however, some parties are possibly better at keeping a cool head than others.

Conclusion of all arguments

The legislation amendments include two very important changes to the law. Firstly the Family Law Act has been amended to include claims against the bankruptcy trustee and to specifically allow the interest of 'third parties' to be taken into account. Secondly, the definition of property for family law purposes has now been expanded to include vested bankruptcy property that has been to date totally out of reach of the non-bankrupt spouse except where they were able to make a contributions-based claim.

What is there to stop the problems that seem to have generated these amendments in the first place?

We would argue that the changes brought about by these amendments may go some way to improving the inequalities of property distribution to non-bankrupt spouses. However, it seems that the legislation has been introduced, at least in part, by the behaviour of various parties over the years in hiding behind bankruptcy law and family law agreements so as to thwart creditors. The Government abandoned many of the proposed changes in favour of creditors as a result of unfavourable reaction, including doubts as to their feasibility and unforeseen consequences.

None of the amendments retained seem to resolve these issues or generate any benefits for creditors, other than the removal of binding financial agreements from the definition of maintenance agreements. The onus is still on the trustee in this regard, so his or her position has not improved greatly.

We foresee that the timing of administrations and proceedings will suffer. As the time required to have matters heard in the Family Court lengthens, so will the bankruptcy administrations. Dividends won’t be able to be distributed if an injunction is made under S. 114 of the FLA. And if the bankruptcy drags out, so will the family law proceedings. If a bankruptcy is commenced and the trustee has already distributed assets prior to the separation of the parties, it is as yet unclear what happens to that property. If there is any likelihood of the Family Court overturning distributions that have already been made, this will, in our opinion, be unworkable.

The interests of creditors are just that – they will rank prima facie equally with the interests of other parties such as spouses and children, but what will be the weight given by the Court to each class?

What value is placed then on personal guarantees? Creditors will be making sure that both husband and wife give personal guarantees on their debts, to safeguard their position, but these may not be able to withstand orders from the Family Court. The costs of borrowing may well increase to offset the increased risk that the pool of assets may shrink.

The bankruptcy trustee’s access to available property has not really increased other than the possibility of overturning BFA’s. The trustee’s role as a party to family law proceedings is limited to his access to vested bankruptcy property – he is not able to extend his claim beyond those definitions of property already established in the Act. He can defend a claim from the non-bankrupt spouse for a share of vested bankruptcy property but cannot make claims to any other property, at least under the FLA. The trustee has a shield, but not a sword.

The proposed amendments seem to give the Family Court far greater powers and responsibilities, but we will need to wait for a clearer interpretation of the amendments through the judicial system before we can finally determine what effects this will have on bankruptcy trustees and their administrations as well as other parties.

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