It has been law to protect certain types of divisible property of a bankrupt. The Act has meticulously set out those assets that will not be divisible amongst creditors as evidenced by Sub-Sections 116 (2)-(9). 

One of these assets is Superannuation. In an effort to allow individuals to fund their own retirement and be less of a burden on the Social Security System, it became prudent for the Government to place any superannuation contributions and funds up to the Pension RBL limit out of the reach of the bankruptcy trustee.

However a key feature of the bankruptcy law that has acted as an appropriate safeguard to protect the interests of creditors was Sections 120 and 121 of the Bankruptcy Act 1966. Sections 120 and 121 of the Act allowed a trustee in certain circumstances to recover property transferred prior to bankruptcy.

In the case of superannuation contributions, it was argued that in order for these transactions to be valid the Superannuation Trustee should give valuable consideration for the contributions made by a debtor. If as is the case in many superannuation deeds the trustee’s only obligation under the Deed is to receive additional contributions such obligations would probably not constitute valuable consideration under Section 120 or 121. However in Cook v Benson (June 2003) the High Court disagreed with this proposition.

In Cook v Benson the Trustee made application under Section 120 and 121 of the Act for orders in respect of payments made to three superannuation funds by the bankrupt prior to the date of commission of bankruptcy.

The court also considered whether the disposition of property was in favour of a purchaser (the superannuation trustee) for valuable consideration and whether s116(2)(d) of the Act applied so that the payments made to the superannuation funds were excluded from the operation of ss120 and 121.

The factual background was as follows:

1. On 21 July 1992 a sequestration Order was made against the estate of the bankrupt and the date of commission of the bankruptcy as set at 18 September 1991.
2. From 1972 to 1990 the bankrupt was employed and during his employment was a member of the Industrial Sales and Service (ISAS) superannuation fund.
3. In January 1990 proceedings were commenced against the debtor for monies owed by him in the amount of $222,588.
4. ISAS was wound up on 4 June 1990 and on the account of the termination of his employment the bankrupt obtained a vested interest in a benefit in the company superannuation fund in the sum of $96,192.36

1. The second respondent [Legal & General] in the sum of $20,000.00.
2. The third respondent [Prudential] in the sum of $40,000.00.
3. The fourth respondent [Mercantile] in the sum of $20,000.00.

The High Court in a 4 to1 majority decision, Kirby J dissenting, held at 33 ‘that the payments in question were made pursuant to arm’s-length, commercial transactions. The payments, at the direction of the bankrupt, out of the funds due to him under the ISAS superannuation schemes, were made in return for the obligations, undertaken by the trustees of those schemes, to provide him with the rights and benefits to which he would in due course become entitled under the rules of each scheme. Those rights and benefits constituted substantial and valuable consideration for the contributions of the bankrupt’.

Consequently in an effort to preclude bankrupts from placing excessive amounts into their superannuation plans just prior to bankruptcy, new legislation was proposed.

The new legislation will now be introduced to allow the courts to take into account the person’s history of contributions and whether the contributions in question are ‘out of character’. However genuine contributions to superannuation funds for retirement purposes will still be protected from recovery.

This concept is different to the earlier proposed legislation that would have allowed trustee’s to claw back ‘excessive’ superannuation contributions. Meaning any contributions an excess of the statutory 9%.

The amendments will:

1. allow a trustee in bankruptcy to recover the value of contributions made by the bankrupt to defeat creditors, where the contributions were made to the bankrupt’s own superannuation plan and that of a third party.
2. allow the trustee to recover contributions made by a person other than the bankrupt for the benefit of the bankrupt where the bankrupt’s main purpose in participating in the arrangement was to defeat creditors,
3. provide that consideration given by the superannuation trustee for the contribution will be ignored in determining whether the contribution is recoverable by the trustee, thus overcoming the effect of the High Court decision of Cook v Benson,
4. allow the Court to consider the bankrupt’s historical contributions pattern and whether any contributions were ‘out of character’ in determining whether they were made with the intention to defeat creditors.
5. provide that the superannuation fund will not have to repay any fees and charges associated with the contributions or any taxes it has paid in relation to the contributions, and
6. give the Official Receiver the power to issue a notice to the superannuation fund or funds that are holding the contributions that will put a freeze on the funds in order to prevent the bankrupt from rolling them over into another fund or otherwise dealing with them in circumstances where the trustee is entitled to recover them.

The new legislation may cause further confusion when taken together with the amendments to the Bankruptcy and Family Law Legislation Act 2005 as the Family Law Act provides that superannuation can be split between separating spouses. What interest will the non-bankrupt spouse have in a bankrupt’s superannuation fund? The trustee may be arguing that the ‘out of character’ amounts should be void against the trustee but the spouse may be arguing that he/she is entitled to a portion of the superannuation monies irrespective of it being ‘out of character’.

It remains for the Courts to determine the definition of ‘out of character’ but one would presume that this may be a somewhat cumbersome exercise. It is not possible in every instance for the Court to understand how the individual debtor would have contemplated how he/she would fund their retirement. It would be perfectly normal for a debtor who is approaching retirement to place as much of his income into a superannuation fund. This would mean that large amounts of contributions will be made in the years leading up to a debtor’s retirement. It may be difficult for a trustee in bankruptcy to determine whether or not these superannuation contributions where out of character.

A further complication may be those funds that are self-managed by the individual investor. DIY superannuation funds allow investors the ability to directly control their retirement savings. The difficulty facing bankruptcy trustees is the mechanism used by investors that employ undeducted contribution strategies.

Undeducted contributions are contributions made to superannuation from after-tax earnings for which no tax deduction has been claimed. Accordingly if a debtor has excess after tax earnings he can place it into a DIY superfund and these amounts could vary from year to year which will make it difficult for the courts to determine whether or not these contributions were out of character and were made to defeat creditors.

Some of the new superannuation rules beginning 1 July 2007 include:

• The ability to make deductible contributions up to $50,000 per annum to be taxed at the concessionial rate of 15% within the fund 
• Additional contributions of up to $150,000 can be made from income on which tax has already been paid.

The changes to the Bankruptcy Act regarding superannuation contributions although well intentioned may be yet another minefield for practitioners.