It is not uncommon for property settlement proceedings between two parties to involve the bankruptcy trustee.
Wondering what happens if you are bankrupt and have not yet done a property settlement with your former partner? This article explores the consequences of declaring bankruptcy prior to formalising your property settlement.
What is bankruptcy?
Bankruptcy is a legal process that takes effect when a person cannot pay their debts as and when they fall due. Upon a person reaching bankruptcy, a trustee is appointed by the Australian Financial Security Authority to manage the bankrupt person’s estate including all their assets and payments due to creditors.
Bankruptcy trustee’s property and Bankrupt’s right to litigate
s58 of the Bankruptcy Act 1968 provides that the bankrupt’s property (assets owned by him/her) held at the time he/she is bankrupt and during the period of bankruptcy, vests with the trustee.
The ability to litigate when you are bankrupt is quite limited. You can still be a party to the proceedings, but arguably, the bankrupt spouse cannot have an order for the alteration of property interests in their favour.
The reasoning behind the limited rights of the bankrupt in property settlement proceedings are explained further below.
What is the power of the Family Law Courts to deal with Bankruptcy matters?
s35(1) and s35(1A) of the Bankruptcy Act 1966 provide that if at the particular time a party to the marriage/relationship is bankrupt and the trustee of the bankrupt estate is a party to the property settlement proceedings, spousal maintenance proceedings, an application under s79A (to alter property settlement orders) or an applicant under s90K to set aside a binding financial agreement, the Federal Circuit & Family Court of Australia has jurisdiction for the matter and all matters connected with the bankruptcy being bankrupt.
Why can’t orders be made in favour of the Bankrupt or the Bankruptcy trustee?
Section 79 and section 90SM of the Family Law Act 1975, provides:
(1) In property settlement proceedings the court can make such orders as it considers appropriate upon the breakdown of a marriage of de facto relationship.
(a) altering the interests of the parties to the marriage in their property;
(b) in the case of bankrupt property where the bankrupt is a party to the proceedings, altering the interests of the bankruptcy trustee in the vested bankruptcy property;
(c) an order for a settlement of property in substitution for any interest in the property;
(d) an order requiring either/both of the parties to the marriage/de facto relationship or the bankruptcy trustee, to make for the benefit of either/both the parties to the marriage/de facto relationship or a child of the relationship, such settlement/transfer of property as the court determines.
Notably, s79/s90SM (1)(d) does not provide the Court with power to make orders for the benefit of the trustee of bankruptcy.
Furthermore, matrimonial cause is also defined in s4 of the Family Law Act as proceedings between a party to a marriage and the bankruptcy trustee of a bankrupt party to the marriage.
Because of s79(1)(b) and (d), s90SM(1)(b) and (d) and s4 of the Family Law Act, it is arguable that the Court only has power to make an order altering interests in vested bankruptcy property in favour of the non-bankrupt spouse but not in favour of the trustee.
If any orders were made altering the interests in vested bankruptcy property in favour of the bankrupt, that property would then vest in the trustee. As such, it appears to be the case that the Court does not have power to make orders that property be transferred to the bankrupt as that would in effect result in the property being vested in the trustee and not for the benefit of the bankrupt party: Redmond v Stolz (No3] .
Finally, it should be noted that s75(2)(ha) and s90SF(3)(i) of the Family Law Act states that of the range of factors that the court can take into account when making property settlement orders, one of them is the effect of any proposed orders on the ability of a creditor of a party to recover the creditor’s debt. This would include the trustee.
Notice of bankruptcy / personal insolvency agreement to the parties and to the Court
If a party in financial proceedings becomes bankrupt or a debtor subject to a personal insolvency agreement (a legally binding agreement between the debtor and creditors to enable the settlement of debts), that party must notify all parties to the proceeding, the bankruptcy trustee / trustee of the personal insolvency agreement, and the court about the bankruptcy or personal insolvency agreement: r3.21 FLR.
Notice must occur in writing and within 7 days or as soon as practicable after the party becomes a bankrupt or a debtor: r3.22 and r3.23 FLR.
Where there is no bankruptcy, there are also obligations for parties to notify their creditors who may be entitled to become a party to the proceedings where the proposed court order may affect the ability of the creditor to recover their debt: s79(10) & s90SM(10).
How does the Bankruptcy Trustee become a party to the proceedings?
The bankruptcy trustee must be joined to property settlement proceedings where:
- an application is made for property settlement involving a bankrupt party;
- The bankruptcy trustee makes an application to be joined as a party; and
- The court is satisfied that the interests of the bankrupt’s creditors may be affected by the making of an order: s79(11) / s90SM(14) Family Law Act.
What happens when a party becomes bankrupt during proceedings? – Stay of legal proceedings
In Sloan & Sloan  FamCA 610, the husband became bankrupt during proceedings for parenting and property orders. The issue was whether or not the husband could continue with his application, which he brought before becoming bankrupt.
Justice Gill stated that the right to litigate family law property proceedings does not vest in the trustee because such a right is personal to the bankrupt, except where the proceedings affect the quantum of the bankrupt estate, meaning a bankrupt spouse may commence proceedings but any property settlement obtained by the bankrupt party will become the property of the bankruptcy trustee and be applied to meet their debts.
Consequently, whilst a bankrupt spouse may commence property settlement proceedings, any property settlement obtained by the bankrupt party will become the property of the bankruptcy trustee and be applied to meet their debts. As stated above, it is questionable whether the Court has the power to make such orders altering property interests to the bankrupt party for this reason.
S60 of the Bankruptcy Act 1968 allows civil proceedings to be stayed where a person who commenced proceedings becomes bankrupt, enabling the trustee to become party to proceedings and to secure property to satisfy debts.
The Court in Sloan held that proceedings can be continued if a person becomes bankrupt but if the trustee is joined to proceedings, any settlement obtained by bankrupt party will become property of the bankruptcy trustee and be applied to meet their debts.
Ultimately, the proceedings (including parenting and property settlement proceedings) were stayed so that the trustee could be joined as a party.
My former partner has been declared bankrupt – what do I do?
If you become aware that your former partner has been declared bankrupt, this may have a significant impact on your property proceedings/ability to negotiate a settlement.
You should obtain urgent legal advice on the impact of this on your ability to negotiate a settlement of assets.
Contact one of our experienced Brisbane Family & Divorce Lawyers to have a confidential discussion about your individual circumstances.