Penniless partner: bankruptcy and family law property disputes

Date: Jun 08, 2015
Document Type: Article

In certain circumstances in the past, a situation could arise where a spouse facing family law property proceedings would file for bankruptcy or be declared bankrupt (the Bankrupt), with the result of becoming a “penniless partner” of a non-bankrupt spouse (the Spouse), whose claim might  then be defeated in the Family Court property settlement proceedings. The only salvation for the Spouse was to apply to the Federal Court for annulment of bankruptcy on the grounds of some abuse of process. If the bankruptcy was annulled in the Federal Court, the Spouse could then proceed in the Family Court with their property settlement or maintenance claim.

Since 2005, family law and bankruptcy have become more intertwined. The Family Court now has a decisive say in what assets are available to a bankrupt’s creditors in a situation where the bankrupt is also a party to a family law dispute. As a result, the Family Court now also has significant powers to adjust the property available to the trustee of the Bankrupt which in turn may affect the dividend available to creditors..

According to the Bankruptcy Act 1966, a bankrupt is a person against whose estate a sequestration order has been made or who has become a bankrupt because of a debtor’s petition.

All the bankrupt’s property, except some exempt property, vests in the trustee - a private registered trustee or the Official trustee, who takes control of the estate of the bankrupt and who has the right and obligation to possess and sell it for the benefit of the bankrupt’s creditors.

The exempt property includes some household property, some personal property, property (to a certain value) used in earning income, a vehicle (to a certain value) used by the bankrupt, life assurance policies, some superannuation interests, rights to recover compensation for injury and any compensation recovered.

What happens if the parties separate in a situation where one of the parties is bankrupt?

Family law provisions now ensure that the competing claims that may arise between the Spouse and the creditors of the Bankrupt  are to be weighed against each other, if the Bankrupt and the Spouse seek property settlement orders through the Court.

Under the Family Law Act, the Court has power to make orders altering the interests of the parties to the marriage or de-facto relationship. If one of the parties to the property proceedings is bankrupt and his/her property has been vested in a trustee in bankruptcy, then the Court can make Orders with respect to that property as well. The property against which an order might be made includes the exempt property of the Bankrupt and the vested bankruptcy property. Such orders may require the trustee of the Bankrupt to transfer property to the Spouse.

As a result, in some circumstances, a trustee in bankruptcy now stands in the position of the Bankrupt for the purpose of property settlement proceedings in family law disputes.

A court may also grant an injunction, albeit to be in operation for a limited period of time, restraining the trustee of the Bankrupt from declaring or distributing dividends among the Bankrupt’s creditors. This can be done on an application by the Spouse.

This raises the question of how the Court is to balance the interests of the Bankrupt’s unsecured creditors against the interests of the Spouse.

In making a property settlement order involving property held by the Bankrupt’s trustee, the Court is guided by the following considerations:

1.    The Court shall not make such an order unless it is just and equitable to do so in the circumstances of each particular matter; and

2.    The Court should also have a particular regard to the effect of any proposed order on the ability of a creditor of a party to recover the creditor's debt.

As a consequence, no priority is afforded either to the Spouse or to the Bankrupt’s unsecured creditors and either might be disadvantaged by the final order made in the property settlement proceedings.

Separation can have a significant impact on the legal rights available to a non-bankrupt spouse or partner. If you are facing property settlement in a situation where one of the parties has become or is likely to become bankrupt, you may benefit from legal advice from one of CMN’s family lawyers.

Please, note that since the June 2015, when the article was prepared, the law might have changed, so please talk to a lawyer before you take any steps.

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