Bankruptcy v Family Court: Navigating Creditor Rights

Legal Consolidated does not practice in Family Law. However, as taxation and superannuation lawyers, we were asked to prepare a paper for a family law conference. This was the conflict between bankruptcy and the Family Court. This article is an adaptation of that paper.

I am divorcing and going bankrupt at the same time: what rights do creditors have?

When family law and bankruptcy meet, the consequences are complex. Understanding how the Courts handle these matters is crucial if you are bankrupt. Your spouse tries to get some of your money in a family court property settlement and spousal maintenance proceedings. Your creditor may also want to get into that line.

Which court is more powerful if I am bankrupt and divorcing?

The Family Law Act 1975 and the Bankruptcy Act 1966 provide the legal framework for how the Court deals with this conflict.

The Federal Circuit and Family Court both have jurisdiction in any matter arising out of a property settlement under the Family Law Act 1975 (Cth) where one of the parties is bankrupt. This means that a trustee-in-bankrupt can apply to become a party to proceedings in the Federal Circuit and Family Court if they can show the Court that the creditors’ interests are affected.

What happens if my ex-spouse and trustee-in-bankruptcy fight and cannot agree on how to split up my assets?

If a dispute arises between the trustee-in-bankruptcy and the non-bankrupt spouse regarding the division of property, both the Federal Circuit and Family Court and the Federal Court (or the Federal Circuit and Family Court acting in its bankruptcy jurisdiction) may have concurrent jurisdiction.

In practice, the Federal Circuit and Family Court often deal with both family law and bankruptcy issues concurrently to avoid inconsistent outcomes and to streamline the legal process. However, in cases where the matters are particularly complex, especially concerning the interests of the creditors, the case might be transferred to the Federal Court. The courts aim to balance the interests of the creditors with the need to achieve a just and equitable division of property between the spouses under the Family Law Act.

Legal terms in Bankruptcy and Family Law

These are useful family law and bankruptcy terms:

• Bankrupt: A person whose estate is under a sequestration order or who has declared bankruptcy through a debtor’s petition, as per section 5 of the Bankruptcy Act 1966.
• Creditor: A person or company who is owed money.
• Debtor: A person who owes money to a creditor.
• Injunction: A court order forcing a person to do something or stop doing something.
• Personal Insolvency Agreement (PIA): A legal agreement between a debtor and creditors to avoid bankruptcy by distributing available assets and income to pay off debts. See Part X Bankruptcy Act 1966.
• Trustee-in-Bankruptcy: An official person appointed to administer the bankrupt’s estate (e.g. selling assets to pay creditors).

What Happens when Bankruptcy conflicts with Family Law proceedings?

If a person involved in a family law matter becomes bankrupt, their property vests in the trustee-in-bankruptcy. (Not including exempt property such as household goods, superannuation, and work tools.) The trustee-in-bankruptcy then becomes a party to the family law proceedings. The spouse, mistress and others now have to deal with the trustee-in-bankruptcy.

Who handles bankruptcy in family law proceedings?

The Federal Circuit and Family Court of Australia both handle bankruptcy in family law proceedings involving:

• Property settlements (sections 79 and 90SM)
  • E.g. my spouse gets the block of flats in Double Bay and I, as the bankrupt, get the home. Or rather the trustee-in-bankuprtcy gets the home.
• Declarations of interest in property (sections 78 and 90SL)
  • E.g. the 100,000 shares in BHP Billiton in the bankrupt person’s Family Trust are usually untouchable by the Trustee-in-Bankrupty. However, the Family Court has power over Family Trusts. The Family Court declares that the shares belong to you, the bankrupt spouse. With a smile on his face, the Trustee-in-Bankruptcy agrees to give the shares in the Family Trust to your spouse and takes some assets in the bankrupt’s name to balance the ledger.
• Setting aside property orders (sections 79A and 90SN)
  • E.g. last year the husband and wife consented to how they wanted their assets divided. The husband a loving and kind man consented to give 100% of his assets to his wife. The Family Court made the orders accordingly. The at-risk husband skipped away with no assets. The Trustee-in-Bankruptcy got a new Family Court order to set aside that order. Now, half of the assets go back to the husband, which the Trustee-in-Bankrupty will gleefully take.
• Spousal or de facto maintenance (sections 72 and 90SE)
• Enforcement of orders

Does the Non-Bankrupt Party get Priority?

One common misconception is that the non-bankrupt spouse automatically takes priority over creditors in property settlements. This is not the case. The Court must balance the interests of both the non-bankrupt spouse and creditors. Neither party has automatic priority, and the Court’s role is to assess all claims fairly.

Why did bankrupts stop using Binding Financial Agreements to hide assets?

Before 2005, individuals nearing bankruptcy often exploited Binding Financial Agreements (BFAs) to shield their assets from creditors. Typically, through the BFA they would transfer assets, for no stamp duty or Capital Gains tax, to ‘safe house‘ spouse or partner, leaving nothing for the trustee-in-bankruptcy.

The government stepped in and changed the law to prevent this sharp practice. Now, creditors and the trustee-in-bankruptcy intervene in the Family Court proceedings. They claim the assets along with the non-bankrupt spouse. This opened the doors of the Family Court to a broader range of financial disputes, making proceedings far more interesting as trustee-in-bankruptcy, creditors, and even mistresses are now involved.

Jodee Rich from One.Tel using the Family Court to protect assets

The Commonwealth by the end of 2003 had passed amendments to the Family Law Act. These were commonly referred to as the Jodee Rich amendments. They expanded the Family Court’s powers to override asset agreements between spouses.

This change was prompted by a case involving One.Tel founder Jodee Rich who, allegedly, transferred substantial assets to his wife shortly after his company failed. The court previously ruled it could not intervene in such structures.

Since the changes to the law, the Family Court can now consider applications from third-party creditors to set aside family court financial agreements.

Can the trustee-in-bankruptcy become a party in Family Law Proceedings?

Yes. The trustee has the right to apply to become a party to family law matters, particularly those dealing with property settlements.

Can the Court order the transfer of Property?

Yes, the Court can order the trustee-in-bankruptcy to transfer property vested in them to the non-bankrupt spouse. This can happen if the Court considers it just and equitable, considering both the rights of the spouse and creditors.

What if a Party Is Under a Personal Insolvency Agreement?

If a party to family law proceedings is under a Personal Insolvency Agreement (PIA), similar rules apply. The trustee-in-bankruptcy for the agreement takes on the same rights as a bankruptcy trustee. The debtor’s property is subject to control by the trustee-in-bankruptcy, and they may intervene in the family law proceedings.

When do You Need to Notify the Court and Trustee?

You must tell the Court if you are bankrupt or under a Personal Insolvency Agreement. Similarly, you must notify your trustee-in-bankruptcy if you become a party to family law financial proceedings.

Can a Non-Bankrupt Party Restrain the trustee-in-bankruptcy?

Yes, a non-bankrupt spouse or de facto partner can apply to the Court for an injunction to restrain the trustee-in-bankruptcy from distributing assets to creditors until the property settlement is complete. This protects the spouse’s interest in the property before it is divided.

Having your mistress, creditors, and wife all in the Family Court together creates an exciting situation

Bankruptcy and family law are complex enough on their own. When they collide, the legal challenges multiply. The Court must balance the interests of spouses, creditors, trustees, and even third parties like mistresses and partners. Thanks to the 2005 amendments, the playing field changed. The trustee-in-bankruptcy and creditors now enter the Family Court, making it a more dynamic arena.