Family Law And Bankruptcy: Does One Affect The Other?
More often than not financial stress, such as a party claiming bankruptcy, can be a major factor in a relationship breakdown. Other times, and inevitably following separation, the parties’ property or nest egg which they otherwise had is due to decrease significantly, which again will often cause significant financial stress on a party or parties.
Complications can arise with property settlement matters when one party becomes bankrupt. The issue arises as to who has priority over certain property and how the non-bankrupt party’s entitlements are considered against those of a creditor or trustee.
In 2005 substantial amendments were made to the Family Law Act 1975 (the Family Law Act) and the Bankruptcy Act 1966 (the Bankruptcy Act) to improve the process when this occurs.
Prior to the amendments and following the case of Prince it was clear that by operation of sections 58 and 59 of the Bankruptcy Act , once a petition is granted the property of the bankrupt party vests in the trustee is to be distributed amongst the creditors. Without the non-bankrupt party having benefit of a maintenance order or agreement under section 79 of the Family Law Act, that party would only in the rarest of cases have a provable debt to stand as a Creditor to the bankrupt estate.
It was often submitted that this position was highly unjust for the non-bankrupt party to endure the same financial fate as the bankrupt party, especially when considering for example when you have a husband, who has made the majority of the financial contributions to the relationship, has declared Bankruptcy and the wife, who stayed home with the children and made the majority of the non-financial contributions and will continue to be primary carer of the children, suffer the same fate.
This is because the concepts underlying the Family Law Act and the Bankruptcy Act are somewhat different as the Bankruptcy Act does not consider non-financial contributions or future needs of the parties. However it is often argued that in many cases the non-bankrupt party, during the financially secure times, enjoyed the benefits and therefore should also carry the burden of the bankruptcy which would otherwise be borne by the creditors themselves, often referred to as the “roller-coaster principle”.
Whilst there is a long standing principle that courts will not interfere with other courts’ decisions, the vesting of the bankrupt party’s interest in an asset, can take precedence over an order made by the Family Court to otherwise transfer the bankrupt party’s interest to the non-bankrupt party.
Amongst other things the legislation amendments in 2005 vested both the Family Court of Western Australia and the Family Court of Australia with jurisdiction in bankruptcy matters for married couples.
Section 79 of the Family Law Act, which allows for the alteration of the parties interests was extended to allow for the joining of the trustee at the time which proceedings are commenced or prior to the making of a final order.
Further, section 75(2) which outlines the factors which are to be taken into account when considering a spousal maintenance application, was extended by a new factor (ha) which now requires the Court to have regard to the effect of any proposed spousal maintenance order on the ability of a Creditor to recover their debt.
The preferred approach in ascertaining a party’s entitlements under section 79 of the Family Law Act, including those of a third party such as a trustee or creditor, was amended following the High Court’s decision in Stanford. The steps undertaken by the court in ascertaining the parties, including third party’s interests, can now be summarised in the following 5 steps:
- Ascertaining the parties’ property by considering their legal and equitable interests in property and their liabilities.
- Determining whether it is just and equitable to make an order altering the parties’ “existing interests” both legal and equitable.
- If it is found just and equitable to alter the parties interest, assessing the parties’ financial and non-financial contributions.
- Ascertain if, after considering the above, it is necessary to make an adjustment for the future needs of the parties, taking into account matters set out in section 75(2).
- Finally, determining what orders it should make which will be just and equitable.
The first issue which now arises following the introduction of legislation amendments and the High Court decision of Stanford occurs when a party to a relationship is bankrupt, is the reference to their “existing interests” and the classification or effect of any property that, by virtue of the bankruptcy proceedings, are now vested in the trustee.
A further issue which also arises is the manner in which assets used by the parties or liabilities created are to be dealt with.
Following Stanford it was initially thought by some to benefit the trustees due to the focus on the determination of “existing interest” however on reflection of decisions pre-Stanford, it appears that the position of the trustee has in fact not altered.
Whilst the Family Law Act now allows creditors to intervene in property disputes in the Family Court, it has been read down to relate only to those debts which are uncontentious. His Honours Warnick and Boland JJ in the matter of Puddy and Grossward held that:
“…the terms of sections 79(10) and 75(2)(ha) of the Act are directed to the questions of the right to, and the prospect of, recovery by Creditors of their debts and not to the proof of the debts, against one or both of the parties… where liability is an issue”
The Court is now required to consider “the effect of any proposed order and the ability of a Creditor of a party to recover the Creditor’s debt, so far as that effect is relevant”. The question then remains whether the amendment favours the creditor or the non-bankrupt party.
Protection of the non-bankrupt party against the financial burden
Parties often think that entering into a financial agreement with the intention to protect the non-bankrupt party against the financial burden as a result of the bankruptcy, will protect the non-bankrupt party. This is incorrect, the parties’ intentions are defeated as Financial Agreements cannot substitute the provisions of the Family Law Act and override the trustee or creditor’s right to the vested interest in the bankrupt party’s property.
Accordingly, once a trustee is a party to Family Court proceedings with a vested interest in property, any financial agreement and the attempted allocation of property pursuant to that agreement can be disregarded completely.
Further, if a trustee makes an application under section 79(11) to substitute the bankrupt party, the Family Court must, subject to conditions, join the trustee to the proceedings. Once this has occurred, the bankrupt party can continue to participate with respect to exempt property such as superannuation however may only make submissions to the court with respect to any property vested in the trustee, if leave has been obtained by the trustee for the same.
Other parties may seek to finalise property settlement matters in the Family Court promptly and without the inclusion or knowledge of the creditor or trustee however, in the event that Orders have already been made allocating the bankrupt party’s existing interest in property to the non-bankrupt party, both a trustee or a creditor whose interest have been affected can bring an application under section 79A(4)and(5) to set aside or vary those orders.
De facto couples
Initially the amendments made only effected the affairs of married parties however on 1 March 2009 further amendments were made to mirror the amendments relating to jurisdiction of married couples and to also apply to de facto couples in all states and territories in the Commonwealth, which are all except Western Australia.
So what does the court consider when balancing the respective interests of the parties and the trustee or creditor and whether or not it should make orders altering the parties existing interests? The following are a number of relevant considerations of the court before pronouncing orders to alter existing interests in property:
- The court to be mindful of the likely impact of proposed orders upon a creditor’s rights, taking into account their legitimate interests, and ensure that they are reasonably necessary, or reasonably appropriate and adapt, to effect a just and equitable division of property between the parties.
- Whether a party’s conduct has been designed to reduce, minimise the value or worth of the matrimonial assets or whether a party has acted recklessly, negligently or wantonly with matrimonial assets, the overall effect which has reduced or minimised their value.
- The non-bankrupt party’s knowledge of events leading up to the other party’s bankruptcy including considerations such as the nature of degree of the non-bankrupt party’s involvement and their benefit from or contribution to the bankruptcy.
- When and how the relevant debt was incurred.
- The factual circumstances surrounding the commencement or continuation of property settlement proceedings such as whether:
- the relationship has broken down and the parties have separated;
- property settlement proceedings appear to be strategic or tactical to reduce the assets available to the trustee or creditor.
- Whether the creditor knew or ought to have known of a potential claim by the non-bankrupt party.
- If and in what manner the creditor pressed or pursued their rights regarding payment of the debt.
- Whether by words or conduct, the creditor or trustee led or permitted the non-bankrupt party to for a reasonable view that the debt would not be pursued or enforced.
- Whether by words of conduct, the non-bankrupt party led or permitted the creditor or trustee to form a reasonable view that their actual or potential entitlements under the Family Law Act would not be pursued or enforced.
- If either of the parties failed to make full and frank disclosure of their financial position at all relevant times.
- Whether the trustee has failed to make full and frank disclosure of all relevant information that relates to the identification and valuation of the property comprising of the vested interests and provided information relating to the debts.
- The overall financial circumstances of the non-bankrupt party and the children, if any, of the relationship during the period since incurring the debt, at the time of proceedings and the effect of the proposed orders.
- Whether the debts were incurred before or after separation; and
- Whether any party derived any benefit from the debts and the nature and extent of that benefit.
It appears that legislation amendments and their application to recent matters may have a significant effect on either the trustee or the non-bankrupt party. Therefore amendments have not sought to either protect or exclude a party but to provide for cross-vesting jurisdiction between Family Law and bankruptcy matters to ensure that relevant considerations, such as a creditor or trustees vested interest in property are taken into account before altering a parties existing interest in property settlement matters.
For more information on this update or any other family law matters please contact Loretta Caré on (08) 9321 3755.
The information published on this website is of a general nature and should not be construed as legal advice. Whilst we aim to provide timely, relevant and accurate information, the law may change and circumstances may differ. You should not therefore act in reliance on it without first obtaining specific legal advice.
 Stanford  HCA 52
 (2010) at paragraph 103
 The 12th National Family Law Conference in 2006, Federal Magistrate Walters, as he was then presented a paper “Some aspects of Interaction of Bankruptcy with Family Law” and Heinrich Moser, Stone Chambers paper “Bankruptcy and Family Law; what you need to know when two worlds collide”.
Article Source: Family Law And Bankruptcy: Does One Affect The Other?