Bankruptcy in family law proceedings

23 April 2021

Personal bankruptcy can significantly impact a family law matter and it is important that parties are aware of the potential consequences.

By way of general summary only:

What are the implications of bankruptcy?

If you or your former spouse / former de facto partner become bankrupt:

  1. A Trustee in Bankruptcy (the Trustee) is appointed and the bankrupt spouse’s assets ‘vest’ in the Trustee.
  2. The Trustee manages the liquidation (i.e. sale) of the bankrupt spouse’s assets so that creditors may be paid (if possible).
  3. Certain assets do not vest in the Trustee. Examples of such assets include, household items, tools used to earn an income, superannuation and / or motor vehicles. These exceptions are, however, subject to:
    • value limitations on household items and motor vehicles;
    • the Trustee’s ability to ‘claw back’ superannuation contributions which were designed to ‘hide’ funds so that creditors could not be paid.

What happens if a family law court proceeding is underway?

If a family law court proceeding is already underway the non-bankrupt spouse, or the Trustee, may apply to the Court for the Trustee to be joined as a party to the proceeding.

Further, if the bankrupt spouse is:

  1. The ‘applicant’ to the proceeding:
    • The proceeding will be ‘stayed’ (i.e. suspended) for 28 days to enable the Trustee to consider whether it wishes to continue the proceeding.
    • If the Trustee does not elect to continue the proceeding within the 28 days, the Trustee is considered to have abandoned it. The respondent may, however, elect to continue the proceeding and rely upon her / his own court application.
  2. The ‘respondent’ to the proceeding:
    • the Trustee will be given the opportunity to join the proceeding; or
    • the respondent may elect to join the Trustee to the proceeding.

If the Trustee is not joined or does not seek to participate in the proceeding, the proceeding will continue without the Trustee. If, however, the Trustee elects to continue, or is joined to, the proceeding:

  1. The bankrupt spouse loses the right to:
    • make submissions to the Court in relation to the assets that have vested in the Trustee; and
    • consent to any court order made in relation to the assets that have vested in the Trustee .
  2. The Trustee and the non-bankrupt spouse may make submissions to the Court and / or consent to orders in relation to the assets that have vested in the Trustee.
  3. The Trustee is almost entirely reliant upon the bankrupt spouse’s co-operation to provide evidence to the Court in support of any argument that may be made by the Trustee to ‘maximise’ the vested assets received in the property settlement.

This can pose a significant issue for the Trustee (and thus creditors of the bankrupt spouse) as the bankrupt spouse’s evidence will be required to, among other things:

  • inform the Court of the bankrupt’s contributions to the ‘asset pool’; and
  • challenge any evidence lead by the non-bankrupt spouse regarding their ‘future needs.’
  1. The bankrupt spouse retains the right to make submissions to the Court in relation to assets that have not vested in the Trustee.

When making a final court order, family law courts are required to take into account the effect of any order on the ability of creditors to recover their debts. However, the interests of creditors do not take priority over the interest of a non-bankrupt spouse. Accordingly, a court can make an order to transfer property to a non-bankrupt spouse even if such an order would result in the Trustee being unable to pay any or all of the bankrupt’s creditors.

That being said, the Courts have historically found that it would not be just and equitable (that is, ‘fair or reasonable’) for a non-bankrupt spouse to receive a direct or indirect financial benefit from the wrongdoing of the bankrupt spouse. It is therefore frequently a difficult exercise for Courts to balance the legal entitlements of the non-bankrupt spouse and the impact to children on the one hand, and third party creditors on the other.

What happens if there is no family law proceeding on foot?

If a family law court proceeding is not on foot and an individual becomes bankrupt:

  1. The Trustee cannot initiate a family law proceeding on behalf of the bankrupt estate, even if:
    • the bankrupt and non-bankrupt spouse have separated; and
    • the bankrupt has an entitlement to a property settlement pursuant to the Family Law Act 1975 (Cth), which may be sufficient to pay some or all of the bankrupt’s creditors.
  2. The bankrupt spouse can initiate a family law proceeding during the course of bankruptcy. However, any vested property received by the bankrupt spouse as a result of the proceeding will vest in the Trustee.
  1. The non-bankrupt spouse may initiate a family law proceeding after their spouse is declared bankrupt.

Despite a Trustee in Bankruptcy being unable to initiate a family law proceeding, a Trustee can apply to ‘set aside’ any court order made by consent or financial agreement. Such an application may be successful if the court order of the financial agreement is found by a Court to either have been made:

  1. for the purpose of (or a purpose that included) defeating the rights of a bankrupt’s creditor(s); or
  2. in reckless disregard to the interests of a bankrupt’s creditor(s).

So what should I do?

If your former spouse / former de facto partner has been declared bankrupt, you should seek specialist family law advice. It may be that an urgent family law application is needed to, for example, restrain the Trustee from distributing assets amongst the bankrupt’s creditors.

Accordingly, if you or your former spouse / de facto partner has recently become bankrupt, or if you are a creditor of a person who is involved in a family law proceeding, we invite you to contact our Family Law team to discuss your options.

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