BANKRUPTCY AND FAMILY LAW Denis Farrar Treasurer, Family Law Section, Law Council of Australia; President ACT Legal Aid Commission; Director of Farrar Gesini & Dunn, Family Lawyers, Canberra Family Law Act 1. Following the amendments to the Bankruptcy Act and the Family Law Act which were put into effect by the Bankruptcy and Family Law Legislation Amendment Act 2005 it is useful to remind ourselves of where we are in the current state of the law especially in the light of cases since. 2. The following were the significant changes made in an attempt to dovetail the amendments to the two Acts. Family Law Act 3. a) Section 4 of the Family Law Act was amended to add to the definition of matrimonial cause (definition caa). b) It says that property proceedings between: i) A party to a marriage; and ii) The Bankruptcy Trustee of a bankrupt party to the marriage with respect to the maintenance of the first mentioned party are a matrimonial cause. c) Definition cb was added which says that proceedings between: i) A party to a marriage; and ii) The Bankruptcy Trustee of a bankrupt party to the marriage with respect to any vested bankruptcy property are a matrimonial cause. 4. Under Section 8 of the Family Law Act proceedings by way of a matrimonial cause shall not be instituted except under this Act. 5. Section 31 lays down the original jurisdiction of the Family Law Act and says: a) Jurisdiction is conferred on the Family Court with respect to:
2 i) Matters arising under this Act in respect of which matrimonial causes are instituted under this Act. 6. Section 39 of the Family Law Act says a matrimonial cause may be instituted under this Act in the Family Court... 7. Section 39(5AA ) of the Family Law Act says that the Federal Magistrates Court has, and is taken always to have had, jurisdiction with respect to matters arising under this Act in respect of which matrimonial causes are instituted under this Act. 8. In a nutshell the effect of the above sections is that proceedings by a non bankrupt spouse to recover vested bankruptcy property from a Bankruptcy trustee are a matrimonial cause, and therefore must be brought under the Family Law Act, which usually means the proceedings are brought in either the Family Court or the Federal Magistrates Court. 9. Section 79 is the Section which empowers a Court to make Orders for property settlement. Section 79(1)(d) says that a Court may make an Order requiring the relevant Bankruptcy Trustee to make, for the benefit of either or both of the parties to the marriage or a child of the marriage, such settlement or transfer of property as the Court determines. 10. Section 79(11) says If: (a) (b) an application is made for an order under this section in proceedings between the parties to a marriage with respect to the property of the parties to the marriage or either of them; and either of the following subparagraphs apply to a party to the marriage: (i) (ii) when the application was made, the party was a bankrupt; after the application was made but before it is finally determined, the party became a bankrupt; and (c) (d) the bankruptcy trustee applies to the court to be joined as a party to the proceedings; and the court is satisfied that the interests of the bankrupt's creditors may be affected by the making of an order under this section in the proceedings the court must join the bankruptcy trustee as a party to the proceedings. 11. Section 79(12) says If a bankruptcy trustee is a party to property settlement proceedings, then, except with the leave of the court, the bankrupt party to the
3 marriage is not entitled to make a submission to the court in connection with any vested bankruptcy property in relation to the bankrupt party. 12. Section 79(13) says The court must not grant leave under subsection (12) unless the court is satisfied that there are exceptional circumstances. 13. It should be noted these sections do not prevent the bankrupt from being a witness in the proceedings, nor do they prevent the bankrupt from bringing proceedings, and making submissions, in relation to non-vested property. (That is, the property owned by the non-bankrupt spouse). 14. The second reading speech of the Attorney General (quoted in Lemnos (2009 FAM CA) at para 51 said of the above sections: The effect of these amendments will be to offer procedures and protections to the non-bankrupt spouse that were not previously available. At the same time the Court can be on notice about the interests of creditors of a bankrupt spouse and can take those interests into account in determining family property or spousal maintenance Orders. 15. Rule 6.17 of the Family Law Rules requires that if a party to proceedings is or becomes a bankrupt they must notify all other parties and the Court of that fact, and must notify the Bankruptcy Trustee of the case. 16. Rule 6.02 a person whose rights may be directly affected by an issue in a case and whose participation as a party is necessary for the Court to determine all issues in dispute must be included as a party to the case. 17. The Bankruptcy Trustee can become a party by making an application for leave to intervene (Rule 6.05), or by being named as a Respondent in the application filed by another party (Rule 6.03). 18. A Bankruptcy Trustee, having been given notice that the Bankrupt is a party to proceedings, may choose not to participate in those proceedings unless the nonbankrupt spouse is seeking Orders in respect of vested bankruptcy property. Bankruptcy Act 19. Section 35 of the Bankruptcy Act now gives the Family Court jurisdiction in relation to any matter connected with a bankruptcy if there are pending property settlement or spouse maintenance proceedings. 20. Section 58 of the Bankruptcy Act says: (1) Subject to this Act, where a debtor becomes a bankrupt:
4 (a) (b) the property of the bankrupt, not being after-acquired property, vests forthwith in the Official Trustee, or, if, at the time when the debtor becomes a bankrupt, a registered trustee becomes the trustee of the estate of the bankrupt by virtue of section 156A, in that registered trustee; and after acquired property of the bankrupt vests, as soon as it is acquired by, or devolves on, the bankrupt, in the Official Trustee or, if a registered trustee is the trustee of the estate of the bankrupt, in that registered trustee. 21. Section 58(6) says: In this section, after-acquired property, in relation to a bankrupt, means property that is acquired by, or devolves on, the bankrupt, on or after the date of the bankruptcy, being property that is divisible amongst the creditors of the bankrupt. 22. Section 59A of the Bankruptcy Act says: Sections 58 and 59 have effect subject to an Order under Part VIII or VIIIAB of the Family Law Act 1975. I think the precise impact of that section has yet to be considered see paragraphs 56 and 57 of this paper. 23. Section 116 (1)(a) says: (1) Subject to this Act: (a) all property that belonged to, or was vested in, a bankrupt at the commencement of the bankruptcy, or has been acquired or is acquired by him or her, or has devolved or devolves on him or her, after the commencement of the bankruptcy and before his or her discharge ; is property divisible amongst the creditors of the bankrupt. Section 116(2)(q) says that Subsection 1 does not extend to the following property: (q) any property that, under an order under Part VIII of the Family Law Act 1975, the trustee is required to transfer to the spouse, or a former spouse, of the bankrupt; 24. If the non bankrupt spouse brings proceedings against the Bankruptcy Trustee to claim back property which has vested in the Trustee under Section 58(1) those proceedings will be determined on the same principles as all property cases, that is the principles in Section 79(2) and (4), (incorporating Section 75(2). 25. Section 75(2)(ha) says that the Court shall take into account the effect of any proposed Order on the ability of a creditor of a party to recover the creditor s debt, so far as that effect is relevant. The conundrum for Family Lawyers has
5 been whether that factor means that creditors take priority over the claims of the non bankrupt spouse and the other Section 75(2) factors. 26. Historically the Family Court has adopted the approach that it deals with the net assets of the parties, not the gross. See Biltoft (1995) FLC 92-614 and Hickey (2003) FLC 93-143 (other cases are set out in Lemnos 2009 FamCAFC20 at paragraph 92). 27. Lemnos is the first decision of the Full Court which has considered the amendments, and it is worthy of study. The husband was a solicitor who during the marriage bought a property in his own name. There were borrowings and renovations. After renovating the parties moved in and occupied it and rented out their previous home. Over an 11 year period the husband wrongfully claimed tax deductions of $3.4m with respect to the renovated property in which the family resided. When those deductions were ultimately disallowed he owed $5.7m tax. He went bankrupt in November 2006 with debt of about $6m. The parties separated in July 2007. 28. The trial judge found that the husband had acted without the knowledge of the wife in falsely claiming deductions to which he was not entitled. The trial judge considered this to constitute waste. He found that the contributions of the parties should be considered to be equal. 29. Under Section 75(2) the trial judge found: The wife had limited income earning capacity, certainly inferior to the husband. The children were adults but still somewhat dependent on the wife. The wife contributed substantially to the success of the husband in that her care of the family freed him to pursue his career and study. 30. The trial judge concluded that the husband should satisfy his debt to the ATO from his own resources. He acknowledged that there is likely to be a very substantial deficit which would leave the creditors out of pocket. After having reached that conclusion His Honour then looked at Section 75(2)(ha). He characterised the case for the Bankruptcy Trustee as being that there should be an adjustment of 100% in favour of the Trustee. In other words he took the view that having decided the wife should get all the property on normal principles, it was then a question of whether Section 75(2)(ha) justified him taking away that property by ruling that the tax debt was paid in priority to the wife s claim for property settlement. 31. In Lemnos Coleman J said (para 57): In my view, by the express wording of the amendments to the FLA and the BA, the legislature revealed an intention that the rights of unsecured creditors of a
6 bankrupt spouse to a share of the bankrupt s Estate were no longer to be automatically preferred to the property settlement rights of the non-bankrupt spouse The more vexing question is how such rights are to be regarded 32. In paragraph 59 he said: In my view it is clear that Parliament intended by the 2005 amendments to change bankruptcy and Family Laws so as to avoid the situation where a nonbankrupt spouse could only make a Section 79 claim against non-vested property and whatever other property might remain after the completion of the bankruptcy The preferred position of unsecured creditors of the bankrupt spouse was removed by the 2005 amendments Consistent with that intention, property to which the non-bankrupt spouse was determined to be entitled pursuant to the provisions of the FLA no longer vested in the Trustee in Bankruptcy for the benefit of creditors of the bankrupt s Estate. 33. Paragraph 60: Whilst the 2005 legislative amendments removed the priority previously enjoyed by unsecured creditors of the bankrupt spouse over the non-bankrupt spouse s claim for Section 79 relief, I do not accept that the legislation established an effective priority in favour of the non-bankrupt spouse. 34. Paragraph 61: On a proper construction of the legislation I conclude that the reconciliation of the conflicting rights of unsecured creditors of the bankrupt and the rights of the bankrupt s spouse involves the exercise of discretion. That discretion is clearly exercised by reference to the facts as found, and the relevant provisions of the FLA. 35. In paragraph 93 Coleman J accepted that the general practice of dividing nett rather than gross assets as established by cases like Biltoft and Hickey were not embodied in statutory provisions, and as there are now express statutory provisions those principles must yield. He said (at para 94) I do not accept that the reference to property in Section 4 of the definition of matrimonial cause is confined to net property. 36. At paragraph 96 he observed that there will be many cases in which alterations to parties interests in property will be appropriate or necessary notwithstanding that the parties have unsecured liabilities which may exceed the parties total equity in such property. In other words the Court is not confined to only making Orders where there are net assets. 37. The other judges of the Full Court Thackray and Ryan JJ made the same observation at paragraph 202 when they said in particular we agree that the Court may make Orders in favour of a non-bankrupt spouse, even though the
7 combined liabilities exceed the total value of the property (including any property vested in the Trustee). 38. Coleman J found (para 176) that the trial judge erred in concluding that the husband should satisfy the debt to the ATO from his resources by relying solely upon the matters to which he had previously referred, before having regard to Section 75(2)(ha) he said, Whilst His Honour then considered Section 75(2)(ha) I conclude that his approach was erroneous in that he had already decided the issue which that section directed him to consider. In my view His Honour was required to consider Section 75(2)(ha) before determining what Order should be made. 39. Para 179 His Honour said an outcome whereby creditors of the husband with an entitlement of approximately $6m should only receive an amount of approximately $1.05m and $1.3m whilst the wife should receive the entirety, or close to the entirety of her contribution based entitlement was not an outcome which in my view would have necessarily resulted had the trial judge exercised his discretion in accordance with the statutory provisions to which I have referred. 40. All three judges agreed that Thackray and Ryan J differed in some matters. However Their Honours said (para 243) having had the benefit of the funds flowing from the husband s conduct, it would seem to us to be neither just nor equitable for the wife to escape all responsibility for the payment of the primary tax that would otherwise have been paid. 41. At para 245 they said although in the instant case it is accepted the husband was on a frolic of his own we do not accept that the wife s lack of knowledge or complicity in the husband s wrongful deductions is determinative of whether she should ultimately share responsibility for the payment of primary taxation on his income earned during the marriage. In our view, to adopt Their Honour s description (in Johnson (1990) FAM CA) the proposition that spouses should generally take the good with the bad has even more force when applied to allocation of responsibility for primary taxation. 42. The majority considered that the trial judge had erred in treating the husband s incurring of the tax liability as waste which should be laid at his feet alone. The husband may have been reckless and negligent in the preparation of his tax returns but the consequence of his actions was to increase the asset pool, not decrease it, because, as the trial judge found, all of the husband s income, including moneys which should have paid in tax, were devoted to the family and the acquisition of assets. 43. Each case will be decided on its own facts. In Lemnos the Full Court invited submissions as to the re-exercise of discretion, and at this time it is not known whether that has occurred. The matter is likely to be re-heard if not settled. Clearly any re-adjudication is likely balance the rights of creditors and the
8 rights of the non-bankrupt spouse in a more even way. The case is, however, authority for the proposition that there is no longer any general principle that the Court divides the net rather than the gross assets. However I would suggest that : If the liabilities are incurred with the knowledge of both parties then they will be deducted from the asset pool and the net assets divided between the parties; If the liabilities are incurred without the knowledge of one party, but that party derived a benefit from the incurring of those liabilities, then those liabilities will be deducted; If the liabilities were incurred without the knowledge of a party and that party derived no benefit from them, then the situation may well be different. This would be particularly relevant to liabilities incurred after separation. 44. In Worsnop (40 FAM LR at 552) the assets were $4.75m and the husband s tax debt was over $12m. His company (which was his alter ego) owed $420,000 in tax. 45. The trial judge ordered that the home be sold and the proceeds divided 50/50 between the wife and the Commissioner for Taxation. 46. This is not a bankruptcy case but S.75(2)(ha) is not restricted to bankruptcies. Given the size of the tax debt it may be surprising that the Commissioner has not bankrupted the husband, however bankruptcies trigger a statutory charge payable to ITSA of a percentage of the bankruptcy estate, and the Commissioner of Taxation may have thought it was not worthwhile to proceed to bankruptcy. 47. The trial judge had found that: The wife was unaware of the husband s failure to disclose income for tax purposes and unaware of the tax liability. The contributions of the parties were equal. There would be no adjustment under S.75(2). The wife had inferior income and earning capacity and the primary carer of the four children, but the indebtedness to the ATO was a factor under Section 75(2)(ha) which counter-balanced those factors. 48. Senior Counsel for the ATO argued that the established line of authority, including Biltoft, meant that the Court should make Orders for property settlement out of the net property of the parties. The trial judge had said There is no requirement that the rights of an unsecured creditor or a claim by a third
9 party must be considered and dealt with prior to the Court making an Order under Section 79, nor is there a rule of priority as between a creditor claimant and a spouse. Those rights, however, cannot be ignored. They must be recognised, taken into account and balanced against the rights of a spouse. 49. The Full Court avoided determining whether Section 75(2)(ha) represents a shift from the non-established approach, and said that in Biltoft and other cases there were sufficient assets to satisfy the alleged or actual debts. The interests competing were those of husband and wife (para 58). Their Honours also said we further observe that the proposition is expressed in relation to cases in which there is net property. The instant case immediately falls outside that category. In the instant case the critical tension arises precisely because such legitimate claims as the wife has to a share of property cannot be met out of net assets (para 51). 50. Overall the Court, somewhat in contrast with the later decision in a different Full Court in Lemonos, said that the trial judge had not demonstrably erred. In relation to the non-debtor spouse s ignorance of the other spouse s tax avoidance. Their Honours said that that issue may carry more weight in respect of penalties, but we see no reason why that question might not also be relevant to the issue of unpaid prime tax, even if the innocent spouse has received benefit from the failure to pay tax. (Para 70). 51. Worsnop was heard by a differently constituted full court from that which presided in Lemnos. The decision in Worsnop was handed down after the Full Court heard Lemnos. The Full Court in Lemnos referred to that decision and said that they did not consider it necessary to seek further submissions in light of the Worsnop decision.. 52. In Reua &Reua (2008) (FamCA 1038) (PAF 950 of 2006) the non bankrupt wife sought a transfer of vested bankruptcy property belonging to the Trustee. The total assets were about $640,000. The unsecured creditors in the bankruptcy were about $233,000. 53. The bankrupt participated in the proceedings and was given leave under Section 79(12) to make submissions. You will recall that sections 79(12) and (13) say: s79(12) - If a bankruptcy trustee is a party to property settlement proceedings, then, except with the leave of the court, the bankrupt party to the marriage is not entitled to make a submission to the court in connection with any vested bankruptcy property in relation to the bankrupt party. s79(13) - The court must not grant leave under subsection (12) unless the court is satisfied that there are exceptional circumstances 54. In Reua the trial judge held that the exceptional circumstances were: There was no opposition to leave.
10 The Bankrupt pursued relief in respect of the non-vested property so he was a participant in the proceedings in any event. He had knowledge of the circumstances in which a large number of the unsecured debts were incurred. 55. The Judge found that the liabilities which were owed by the husband in bankruptcy were pre separation debts or amounts spent on the construction of various properties which properties were now in the joint names of the wife and the husband s Trustee in Bankruptcy. Her Honour found the contributions to be 55% wife and 45% husband. 56. Her Honour considered the Section 75(2) factors seriatim. In relation to Section 75(2)(ha) she said the Orders sought by the wife would mean that no unsecured creditor could recover its debt.. the Orders sought by the bankrupt would mean that the unsecured creditors would be paid. The Orders sought by the Trustee would permit him to discharge the debts to the unsecured creditors from the property presently vested in him. Her Honour held it seems to me there should be no adjustment, pursuant to Section 75(2) which would prevent payment of the unsecured creditors. 57. Overall Her Honour : Dismissed the wife s application for the transfer to her of vested bankruptcy property from the Trustee; Concluded that there should be a 10% adjustment of the balance of the net non-superannuation, non-vested bankruptcy property, in favour of the wife. Therefore she ordered that the Application against the Trustee be dismissed, and that the non-bankrupt spouse pay the bankrupt 35% of the property vested in her. 58. You will remember that Section 58(1)(b) of the Bankruptcy Act says that afteracquired property of the bankrupt vests in the Trustee. Section 59A says that that Section has effect subject to an order under Part VIII of the Family Law Act 1975. 59. What is the effect of Section 59A in these circumstances? Is an Order that the wife pay the husband money an Order of the Family Court which overrides the vesting of after-acquired property provisions in Section 58(1)(b)? Or does section 59A require a specific mention in the Family Court order to the effect that it overrides the provisions of the vest in provisions of the Bankruptcy Act? 60. In Reua the wife appealed and in the course of negotiations the Trustee attached the money that the wife was going to pay to the husband and the husband (probably due to impecuniosity), did not assert Section 59A. Arguably he would have been entitled to keep that money. Equally that would have been somewhat of a travesty as far as his creditors were concerned.
11 61. Trustees in bankruptcy have been agitated about the High Court decision in Cummins (2006 HCA6). In that matter the husband and the wife were registered as joint tenant owners of their home in Sydney. Upon the husband s bankruptcy the wife asserted that she was entitled to a beneficial interest greater than 50%, by reason of monetary contributions made by her to the purchase price, which contributions totalled 75.8% of the purchase price. She argued that, on the basis of the High Court s decision in Calverley v Green, she should be entitled to 75.8% of the value of the property. She succeeded before the lower courts but the High Court rejected her argument and said: Where a husband and wife purchase a matrimonial home, each contributing to the purchase price, and title is taken in the name of one of them, it may be inferred that it was intended that each of the spouses should have a one-half interest in the property, regardless of the amounts contributed by them. 62. The ramifications of this decision have not yet been fully felt. Arguably it entitles a Trustee to claim a one-half interest in the matrimonial home notwithstanding that it is registered in the sole name of the non-bankrupt spouse. 63. Further it can be argued that Cummins case creates a rebuttable presumption in relation to the matrimonial home for example, evidence of the actual intention of the parties at the time that they bought the home and placed it in the sole ownership of the non-bankrupt spouse. I suggest that few people have any specific intention and certainly do not record it at that time. 64. Presuming that there is a presumption that the bankrupt owns 50% of the matrimonial home which is in the sole registered ownership of his or her spouse, how does the Trustee in Bankruptcy claw back that interest for the benefit of creditors? 65. The Trustee in Bankruptcy has no right to bring proceedings for property settlement under the Family Law Act. The Family Court can only deal with such claims if they are a matrimonial cause. The definition of matrimonial cause quoted earlier makes no reference to proceedings by a Trustee against a non-bankrupt spouse. 66. The Trustee could not claw back the interest in the matrimonial home under the Bankruptcy Act unless there had been a transfer for less than market value within the relevant periods set out in sections 120 and 121. If the parties bought the home some years ago then those sections would not apply.
12 67. The bankrupt still has a right to bring proceedings for property settlement but in such proceedings the bankrupt could only seek orders with respect to property which has not vested in the trustee upon the bankruptcy. (See the High Court s decision in Cummings v Claremont Petroleum ML (1996) 185 CLR 124). Of course a bankrupt would have little incentive to bring property proceedings if section 58 of the Bankruptcy Act meant that any property that the bankrupt was ordered to receive in those proceedings would be after-acquired property and vest in the trustee. 68. Perhaps there will be no testing of the Cummins principle because of the impracticability of trustees bringing proceedings and the uncertainty of a bankrupt being allowed to keep anything they succeeded in obtaining if they brought the proceedings themselves.