November 17, 2015

Protected and exempt monies – more than meets the eye!

‘Damages’ or ‘Compensation’ referred to in Section 116(2)(g) of the Bankruptcy Act 1966 (‘the Act’) are termed ‘Exempt Money’ or ‘Protected Money’. Common examples include compensation, damages (or rights to recover same) arising from personal injury; wrong done to and/or the death of, the Bankrupt, the Spouse or De Facto partner of the Bankrupt or a member of the family of the Bankrupt.  Sections 116(3) and (4) respectively go on to state…

“Where, the whole, or substantially the whole, of the money paid for the purchase, or used in the acquisition, of particular property is protected money, that property is not divisible amongst creditors.”
“Where…the outlay in relation to the property is in part protected money and in part other money, the Trustee is required to pay to the Bankrupt so much of the proceeds of realising the property as can fairly be attributed to that protected money.”

These terms pose some thought provoking questions, which include:

  1. What is the definition of ‘substantially the whole’?;
  2. Can post-acquisition contributions (i.e. mortgage repayments, costs of improvements, etc.) be considered ‘Exempt Money’ or ‘Protected Money’; and
  3. How do Trustees determine a fair attribution to the Bankrupt of the protected portion where the purchase price consists of co-mingled (protected and non-protected) money?

Not surprisingly, the Courts have played a fairly active role in providing guidance on and/or determining the answers to these questions. In the matter of James George Turner v Official Trustee In Bankruptcy payment of $10,300 from protected money towards the $21,000 purchase price of land (i.e. just under half the purchase price) was held not to represent “the whole, or substantially the whole, of the money paid”. Interpreting the phrase “substantially the whole”, the Court followed the approach taken in Re Iskenderian; Ex parte Iskenderian Bros Pty Ltd and Others (1989), and held:

“the sub-section (s116(3)) does not contemplate that property will be withheld from creditors wherever the protected monies can account for a significant part of the purchase price, or the means by which it is acquired… Whilst “substantial”, when it appears alone, might refer to a contribution of significance, here it derives its meaning from “the whole”, the expression which it qualifies. In our view, s116(3)  provides that a bankrupt may retain property that can be seen to represent the protected monies, subject to only a minor qualification of input from other sources.”

In Re Manivilovski , the Court held that “used in the acquisition” is wide enough, when associated with the words “paid for the purchase”, to encompass moneys used to pay off a capital sum borrowed to enable a property to be acquired and secured by mortgage or charge on that property.”

But what we really need, is a practical application!  The recent case of Vrsecky v Reaper & Anor (No.2) , is a timely case in point. Here, the Court was presented with the following scenario:

Mr Reaper and his non-bankrupt co-owner purchased, without encumbrance, a parcel of land for $120,000 in 2002. In 2004, the Bankrupt and non-bankrupt co-owner took out a mortgage over the parcel of land for the purposes of building, which was drawn down progressively;

  • Between 2004 and May 2007, Mr Reaper paid his share of the mortgage payments from his ordinary wages. His co-owner paid her share from her salary;
  • Mr Reaper was the subject of a significant workplace injury in 2007 and from May 2007, had been in receipt of accident compensation payments and/or a disability pension;
  • In May 2007, the property was valued at $510,000 and the mortgage was $317,649;
  • Mr Reaper was made Bankrupt in 2012;
  • From May 2007 until 2013, all payments made in respect of the mortgage were made from the compensation monies and thereafter from Mr Reaper’s disability support pension. The co-owner received a carer’s allowance in respect of the Bankrupt and did not make contributions to the mortgage during this period; and
  • In 2015, the property was valued at $775,000 and the mortgage at that time was $275,000.

The Trustee ultimately sought Orders for the partion sale of the property. The bankrupt and non-bankrupt co-owner asserted the property was wholly or substantially wholly bought with protected funds.

The Court rejected the Trustee’s submission that the only relevant circumstance was the actual reduction in the principal owing on the loan (between May 2007 and 2015 i.e. $43,000), as being “too narrow a construction” of Section 116(3) and the authorities.
“it is immediately apparent, that albeit that the mortgage itself decreased by only a relatively small amount, the fact that the mortgage was paid has enabled the property to accrue very significantly in value.”

The Court, in assessing the extent to which the equity in the property ought to be paid to the Bankrupt as “Protected Money”, determined the Trustee’s share as follows:

Net Equity in 2015 $500,000
50% allocation to co-owner ($250,000)
Trustee’s Gross Share $250,000
Protected Monies (Contribution and Increase in Equity from May 2007 to 2015) ($308,000)
Add: 50% allocation to co-owner $154,000
Trustee’s (Net) Equitable Share $96,000

Advisors and Lawyers will regularly encounter and need to consider, the concepts of ‘Exempt Monies’ or ‘Protected Monies’ in planning their client’s financial affairs and/or when considering a bankruptcy event. Commonly, the issue will present in respect to contributions to the purchase and outgoings on the Family home, which is ordinarily a divisible asset available to a Trustee.  A concise understanding of the legal authorities will ensure that an expanded definition of qualifying contributions (beyond those to the initial purchase) as well as an accounting for the increase in value stemming from same, are vital inclusions in a protected property claim.

SV Partners have extensive experience and knowledge in all aspects of personal insolvency administration. If you or your clients require personal insolvency advice, please contact one of our advisors on 1800 246 801.

Article written by Fabian Micheletto, Associate Director, Victoria.

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