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Family Law and Bankruptcy: What if my former spouse is declared bankrupt?

Family Law: 27 May 2020

Bankruptcy and family law can collide when spouses separate, often as a reason for the separation or as an outcome of the separation. Recently, COVID-19 has caused economic uncertainty with falling house prices and stagnant incomes. As such, families may be experiencing higher levels of financial stress and bankruptcies are likely to increase in number and frequency over the coming months.

Complications in family law matters can arise quickly when one party becomes bankrupt. The most common issue becomes how the non-bankrupt spouse's entitlements are considered against those of the Trustee in Bankruptcy or creditor(s) and who has priority over certain property.

What is bankruptcy?

Bankruptcy occurs when a person is unable to pay their debts as and when they fall due. Under the Bankruptcy Act 1966 (Cth) a person can be declared bankrupt in one of two ways:

  1. Someone a person owes money to, known a creditor, makes an application to the Court; or
  2. The person owing money files a debtor's petition (voluntary bankruptcy).

What is the effect of bankruptcy?

When a person is declared bankrupt their assets vest or go into the control of the Trustee in Bankruptcy. Simply, this means the bankrupt party will not have control or possession of the assets. Some categories of assets are excluded, such as most household goods, some tools of trade, superannuation, and a motor vehicle up to a certain value.

What if my former spouse becomes bankrupt?

The good news is, bankruptcy does not prevent a non-bankrupt spouse from pursuing a property settlement under the Family Law Act. The 2005 amendments to the Family Law Act mean a non-bankrupt spouse is now afforded with protection of their interests in matrimonial or jointly owned property. Non-bankrupt spouses' have further been afforded the opportunity to share in the bankrupt spouse's vested assets for the benefit of the non-bankrupt and their dependents.

Under s 79 of the Family Law Act the Court has the power to adjust property interests between spouses, regardless of whether the asset/liability is held jointly or in a sole name. The most common example is when the Court deals with the former matrimonial home. In circumstances where the registered title to the property is listed in the bankrupt's sole name, the Court may conclude that it is in fact a joint matrimonial property and that the non-bankrupt's interest in the property must be protected from the bankruptcy. In such circumstances, the Court may order the property to be sold and the distribution of proceeds to one or the other spouse.

The Court will always apply the following five step process when determining property settlements, regardless of whether a party is bankrupt:

  1. Determining and valuing the parties' property;
  2. Determining if it is just and equitable to make an order altering the parties existing interests;
  3. Any financial and non-financial contributions to property and the welfare of the family;
  4. Consideration of the specific needs and characteristics of the parties set out in section 75(2) of the Family Law Act; and
  5. Determining that the order to be made is just and equitable.

The Court must consider the effect of any proposed order on the ability of the creditor to recover debts from the bankrupt party. As such, the Court will need to consider whether the benefit of making an order in favour of the non-bankrupt party can actually be obtained.

What are the rights and restrictions of the Bankrupt Party?

The bankrupt party is not permitted to make submissions to the Court in relation to vested property unless the Court provides permission. The bankrupt party does, however, have the right to make submissions in relation to property owned by the non-bankrupt spouse which has not been vested in the Trustee.

What are clawback powers and how do they impact my Family Law proceedings?

People who believe they are likely to go bankrupt sometimes pre-emptively transfer property that is in their name to their spouse. They do so under the belief it will avoid the Trustee in Bankruptcy having a claim to the property. Unfortunately, any transfer of property made in such circumstances can be clawed back by the trustee in bankruptcy for the period of 6 months prior to bankruptcy. It is important to note any property clawed back is declared to be property of the bankrupt (and is part of the bankrupt estate) under s 58(1) of the Bankruptcy Act.

If your former spouse has declared bankruptcy, it is important that you seek appropriate family law advice.

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