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What Happens to the Family Home in Bankruptcy?

What Happens to the Family Home in Bankruptcy?

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Upon an individual’s bankruptcy, a Bankrupt’s interest in ‘divisible’ property/assets vests in the Bankruptcy Trustee to recover and sell for the benefit of the bankrupt estate and creditors. Divisible property includes a wide range of assets, such as real estate and the family home. There are some exemptions, which allow a Bankrupt to retain certain assets (which we will traverse in a separate newsletter article).

Sounds simple! In theory yes, but there are a number of factors to consider when dealing with a Bankrupt’s interest in a property, especially the family home.

We often get faced with questions regarding:

    1. What happens to a Bankrupt’s interest in a family home, especially when they have a spouse and / or joint ownership?
    2. What if a Bankrupt is not a registered owner of the family home?
    3. Can a Bankruptcy Trustee recover a property that has been transferred prior to the bankruptcy?

The answer to these questions is…it depends on the circumstances.

We have covered some common issues below.

1. Property registered in a Bankrupt’s name

(a) Property registered solely to a Bankrupt

When an individual is declared bankrupt and they are registered as an owner of a property, the Bankrupt’s interest vests in the Bankruptcy Trustee to recover and sell for the benefit of Creditors.

In practice, the Bankruptcy Trustee will generally:

      • secure the property by lodging a caveat and/or transferring title in the property to the Trustee;
      • assess whether there is any equity available, that is, consider the value and any security/mortgages;
      • on the basis there is some equity available, sell the property, with any surplus proceeds being applied to the costs of the bankruptcy and payment of a dividend to creditors (if sufficient funds are recovered); and
      • pay any surplus, after the payment of all debts and costs of the bankruptcy, to the Bankrupt.

This is relatively simple (putting aside any difficulties with possible claims by the Bankrupt or other stakeholders), if the property is solely owned by the Bankrupt.

The unfortunate consequence of this is that if a Bankrupt has a Spouse or Family, they are inadvertently impacted by the bankruptcy and the sale of the family home.

The Bankrupt’s Spouse may have some options available, including:

      • claiming an interest in the property (if they have contributed to the property in some manner);
      • purchasing the property from the Bankruptcy Trustee (or the equity in the property, if suitable arrangements are made with the Trustee and any mortgagee); or
      • in the event of a separation, commence Family Law proceedings seeking an interest in the property.

(b) Property registered jointly – Bankrupt and Non-Bankrupt Person

We are often faced with situations where a person is declared bankrupt and he/she is the co-owner of a property with his/her Spouse or a Family Member (who are not bankrupt), typically as joint owners (not tenants in common).

In this instance, the Trustee does not have the unilateral right to deal with the property, rather the Trustee stands in the Bankrupt’s position.

Similar to the above, the Trustee will take steps to protect/secure his/her interest in the property and assess the equity position. If there is equity available in the property (a surplus in value over the debts secured against the property), the Trustee has the following options for dealing with the Bankrupt’s interest in the property:

      • Liaise with the Bankrupt to pay sufficient funds to payout the debts and the costs of the bankruptcy in full (which would annul the bankruptcy). This may be arranged through friends, family, borrowings, exempt assets (such as superannuation), etc. If the bankruptcy is annulled, the Bankrupt is no longer bankrupt and he/she retains his/her interest in the property.

An example of when this may occur is when someone is declared bankrupt with a small amount of debt.

      • The Bankrupt can offer a compromise with Creditors pursuant to Section 73 of the Bankruptcy Act 1966 to annul the bankruptcy. Similar to above, this may be facilitated through external funds or ongoing payments over time. If Creditors accept the proposed compromise, the outcome is the same as above.
      • The co-owner/s (or someone else) may purchase the Bankrupt’s share or equity in the property from the Trustee.
      • The co-owner and Trustee can sell the property, with the net sale proceeds being distributed in accordance with the respective interests in the property.
      • If none of the above occur and an agreement cannot be reached with the co-owner, the Trustee (or co-owner) can apply to the Court seeking an order for the sale of the property. This option is the least desirable, considering the costs involved, which invariably reduce the amount recovered by the respective parties.

(c) Property Held by the Bankrupt on Trust for Another Person

Ordinarily, property held by a Bankrupt on trust is not available to be recovered by a Bankruptcy Trustee (section 116(2)(a) of the Bankruptcy Act).

This is not always the case, as there may be other factors that provide for a Bankrupt to have an interest in the property, and each case requires a review and analysis of the individual issues and circumstances.

 

2. Property not registered in the Bankrupt’s name

When we are appointed Trustee of a bankrupt estate, we conduct searches for properties registered in the name of the Bankrupt. In addition, it is prudent to search and investigate any properties where the Bankrupt resides or that may be registered in the names of close family, friends or companies.

Registration is not always proof of ownership of a property. There are a number of other factors to consider.

A Trustee can look behind the registered ownership of the property to determine whether the Bankrupt has an interest in the property, such as a beneficial or equitable interest. The most common instance where a Trustee may have a claim to a property in these situations is if a Bankrupt contributes, financially or non-financially, to the property. For example:

      • The Bankrupt previously owned a property and a share of the sale proceeds were used to purchase the property not registered in his/her name;
      • The Bankrupt is a co-borrower for loans secured against the property;
      • The Bankrupt pays some or all of the mortgage payments or outgoings for the property;
      • The Bankrupt has contributed to improvements to the property.

In addition to the above, it may be the case the property (or a share of the property) is held by a non-Bankrupt person on trust for a Bankrupt. Some common examples of this are:

      • Constructive Trust – this occurs when, taking into account the relevant circumstances, it would be considered unconscionable for one party to rely, as against the other party, on legal title to property as representing the actual interest of the parties. This can be the case irrespective of the intentions of the parties.
      • Resulting Trust – this may occur where two (2) or more parties contribute to the purchase of property, the equitable presumption is the legal title of the property is held on trust for each party in shares proportionate to their contributions to the purchase. Funds borrowed from a financier jointly and severally can be considered to be a joint contribution to the purchase of a property.

Importantly, the Bankruptcy Trustee does not have an automatic right to take steps to recover a property if the Bankrupt is not registered on the title. The Trustee has to prove a case and in the absence of an agreement with the registered owner, take legal steps to enforce a claim.

 

3. Bankrupt’s interest in property transferred prior to Bankruptcy

Part of the role of a Trustee is to investigate a Bankrupt’s financial affairs, which includes any assets or property sold, disposed or transferred prior to the bankruptcy.

A Trustee will pay particular attention to the timing and consideration paid for assets and property transferred prior to the bankruptcy. The Bankruptcy Act (and some other affiliated State based legislation) contain provisions that allow a Trustee to overturn certain sales or transfers that:

      • Occur after the commencement of the bankruptcy;
      • Afford a particular creditor a preference or priority over other creditors;
      • Are transferred at under fair value; or
      • Are transferred with the intention to defeat the interests of creditors.

The above provisions are designed to allow a Trustee to recover property transferred prior to the bankruptcy that otherwise could have been utilised to pay creditors.

If following the Trustee’s investigations he/she believes the transfer of the property meets the above criteria, the Trustee may seek to resolve the matter with the relevant parties or apply to the Official Receiver (Government Authority) or the Court seeking to recover the property transferred.

There are different timeframes applicable to the above transactions, outlined in section 5 below.

 

4. Some Other Factors to Consider

In addition to the above comments, there are also a number of other factors to take into account when dealing with property in bankruptcy. Below are some of the more common issues:

(a) Property with No Equity

Where a Bankrupt’s property (either solely or jointly owned) has no equity available, the Trustee may elect not to sell the Bankrupt’s interest for commercial reasons. A Bankrupt may therefore be able to retain the family home, if suitable arrangements can be agreed with the mortgagee. The Trustee may however seek to recover the interest at a later date if the position changes, for example, the mortgage is discharged or the value of the property increases.

(b) Defence Force Home Loans

Property subject to a Defence Force loan cannot be sold by a Trustee in a bankruptcy without the permission of the Secretary of the relevant Department. In our experience, such permission is not usually provided, allowing a Bankrupt to retain the property.

(c) Exoneration claims

The doctrine of exoneration provides that a party can be exonerated (released) from certain debts. A previous article discussed this in more detail – https://svpartners.com.au/the-doctrine-of-exoneration-and-how-it-can-salvage-more-than-a-draw/.

(d) Property Purchased using Exempt Property

The Bankruptcy Act allows a Bankrupt to retain some assets/property, known as exempt property. Property acquired by a Bankrupt using some forms of exempt property (for example proceeds from a personal injuries claim) can retain their exempt status in a bankruptcy, resulting in the (house) property not being available to be recovered by the Trustee.

(f) Family Law Matters

A non-bankrupt spouse or partner can apply to Court for an adjustment to the parties’ property interests under the Family Law Act. This can override a Trustee’s claim to a Bankrupt’s property.

 

5. Timeframes

There are a number of timeframes applicable to dealing with property in bankruptcy. Below is a table providing a guide to the relevant Bankruptcy Act sections and applicable timeframes involved.

 

SectionType of ClaimPeriod you can go back
115Property available at the commencement of bankruptcy• Sequestration Order (Court bankruptcy) – earliest ‘’act of bankruptcy’ within 6 months of the bankruptcy
• Debtor’s Petition (voluntary bankruptcy) - date of the bankruptcy if no prior Creditor’s Petition
118Execution by a Creditor against Property pre-bankruptcy • Within 6 months’ before the presentation of a Petition
127Limitation of time for Trustee making claims• Divisible property - 20 years from the date of bankruptcy
• Sections 118, 120, 122 – 6 years from the date of bankruptcy
• Section 122 – no time limit
129AATime limit for realising property• Normally 6 years from the date of discharge from bankruptcy
- There are some variances
- The Trustee may continue to extend this period by intervals of 3 years (having regarding to section 127)
139D/EAssets/income from other entities the bankrupt has contributed to• 4-5 years before the commencement of the bankruptcy
139DA/DEContributed financially or non-financially to assets held by another person/entity• 4-5 years before the commencement of the bankruptcy
120Undervalued transfers• Transactions within 5 years before the commencement of the bankruptcy
- no need to prove insolvency if within 2 years to a non-related entity
- no need to prove insolvency if within 4 years to a related entity
121Transfers to defeat creditors• no time limit (just need to prove insolvency)
122Preferences to Creditors • Transaction within 6 months (depends though on the type of bankruptcy) before the bankruptcy
128B/CTransfers to superannuation (out of ordinary)• no time limit (just need to prove insolvency) - but after 28/7/2006
N/ATrust Claims• no time limit

Conclusion

There are a number of factors to consider if you have clients facing financial difficulty. There are often options available that may assist mitigate your client’s risk or exposure. It is imperative that your client obtain specialist advice to understand their rights and obligations, otherwise, they may be exposed to losing their castle.

At SV Partners, we have a team of specialists that can assist you and your clients through this process and help manage these often stressful situations.

 

Article written by Jason Cronan (Director) – Sunshine Coast

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