Bankruptcy and Family Law

Bankruptcy can have a significant effect on a family law matter. A bankrupt is defined under section 5 of the Bankruptcy Act 1966 as a person against whose estate a sequestration order has been made and who has become a bankrupt because of a debtor’s petition.

Bankruptcy can occur involuntarily when a creditor makes an application to the court which has the effect of making the debtor bankrupt; or voluntary when a person files a debtor’s petition to the court which has the effect of making them bankrupt.

A party must notify the court at the start of family law proceedings if they are bankrupt or if they become bankrupt during the proceedings.

Legislation

The Federal Circuit and Family Court of Australia (FCFCA) has jurisdiction under the Family Law Act 1975 to deal with the bankruptcy of party in a marriage or de facto relationship in court proceedings for:

• property settlement (section 79 or 90SM), and/or
• declaration on interest in property (section 78 or 90SL), and/or
• setting aside property orders (section 79A or 90SN), and/or
• spouse maintenance (section 72),
• de facto partner maintenance (section 90SE), and/or
• enforcement of any of the above orders.

The effect of bankruptcy

When a party to a family law matter becomes bankrupt, control of their property and income automatically transfers to the trustee. Some property is excluded, including most household goods, motor vehicles and trade tools up to a certain value, and superannuation. A trustee can apply to become a party to family law proceedings. If the trustee becomes a party, the bankrupt party cannot make any submissions to the court about property vested in the trustee, unless the court grants permission. The bankrupt party also loses the right to consent to any order made for assets that have vested in the trustee.

The non-bankrupt party does not have priority over other creditors; the court must examine the competing rights and determine priority. That party can, however, apply to the court for an injunction to restrain the trustee from declaring or distributing dividends among creditors before the property settlement is completed.

In some cases, a party likely to go bankrupt will transfer property to a non-bankrupt party in a bid to defeat creditors. However, a trustee in bankruptcy can claw back any transactions made up to six months prior to bankruptcy.

Any person affected by a property settlement order can apply to have the order set aside or varied. A creditor can apply to have set aside or varied an order that prevents them from recovering a debt owed.

A bankrupt spouse can begin family law proceedings during bankruptcy, and a non-bankrupt spouse can begin family law proceedings after their spouse is declared bankrupt. A trustee in bankruptcy cannot initiate family law proceedings but can apply to have a financial order set aside or varied. This may be successful if the court finds the order was made with the purpose of defeating the rights of the bankrupt’s creditors, or in reckless disregard of those creditors.

If a person becomes bankrupt after beginning any legal proceedings, the Bankruptcy Act provides that the proceedings are stayed for up to 28 days, during which time the trustee can advise whether or not the action will continue.

Process

The five-step property settlement process still applies when a party is or becomes bankrupt in family law proceedings:

1. identifying property, its value and associated debts and liabilities;
2. assessing whether it is just and equitable to make an order;
3. determining how each spouse contributed during the relationship, financially and otherwise;
4. determining any special circumstances that require adjustment of the settlement; and
5. assessing whether the order is just and equitable for the parties.

Spousal maintenance and child support may also be relevant, with the potential for the transfer of vested property to satisfy such liabilities.

Considerations

There are many factors the court can consider when deciding whether to alter existing interests in property as a result of bankruptcy, such as:

• the likely impact of proposed orders on a creditor’s rights;
• whether a party has acted to deliberately reduce the value or worth of assets, and whether the party has acted recklessly or negligently with assets;
• the non-bankrupt party’s knowledge leading up to the other party’s bankruptcy, or the nature of their involvement in those events;
• whether either of the parties failed to make full and frank disclosure of their financial position;
• the financial circumstances of the non-bankrupt party and any children at the time of the proceedings, and the effect of proposed orders;
• whether the debts related to bankruptcy were incurred before or after separation;
• whether any party derived a benefit for the debt, and the nature and extent of the benefit.

For advice or representation in any legal matter, please contact Armstrong Legal.