What Happens if My Former Spouse Becomes Bankrupt During Property Settlement?

Why Bankruptcy Matters in Family Law

In a typical property settlement under the Family Law Act 1975 (Cth), the Court identifies the parties' property, liabilities and financial resources, assesses contributions and future needs, and makes orders that are just and equitable in the circumstances. Bankruptcy changes the starting point because much of the bankrupt party's property no longer belongs to them — it has vested in a trustee for the benefit of creditors. The trustee can apply to become a party to the family law proceedings, and once joined, the bankrupt generally cannot make submissions about property vested in the trustee without the Court's permission.

For a broader picture of how property settlement works generally, see our article on property settlement.

What Is Bankruptcy?

Bankruptcy is a formal personal insolvency process under the Bankruptcy Act 1966 (Cth). A person may become bankrupt in one of two main ways:

• Debtor's petition. The person voluntarily files a petition declaring that they are unable to pay their debts as and when they fall due.
• Creditor's petition. A creditor applies to the Court for a sequestration order. Under current Australian Financial Security Authority (AFSA) guidance, a creditor's petition is generally available where the debt owed is at least $10,000. The current threshold should be verified against AFSA's published guidance in any specific matter, as it has been adjusted in the past.

Whichever route is taken, the result is the same — bankruptcy begins, a trustee is appointed, and the bankrupt's divisible property vests in that trustee.

What Happens to Property When Someone Becomes Bankrupt?

When a person becomes bankrupt, most of their property vests in the trustee by operation of the Bankruptcy Act. The bankrupt loses the ability to deal with that vested property without the trustee's consent. Some categories of property are exempt and remain available to the bankrupt for ordinary day-to-day living. Exempt property typically includes:

• ordinary household furniture and effects;
• certain tools of trade up to a prescribed value;
• a vehicle up to a prescribed value;
• superannuation interests held in regulated funds, in most cases;
• certain life insurance and compensation payments, subject to the rules in the Bankruptcy Act.

The precise exemptions, thresholds and treatment of particular assets are technical and change from time to time. Specific advice should be obtained about any particular asset.

What Is Vested Property?

Vested property is property that, by operation of the Bankruptcy Act, has transferred to the trustee as part of the bankrupt estate. Common examples include:

• real estate owned in the bankrupt's sole or joint name;
• bank account balances above any protected minimum;
• shares, managed investments and other financial assets;
• valuable personal property above prescribed exemptions;
• business interests, including shares in private companies and interests in partnerships and trusts;
• causes of action of a proprietary nature, in some cases.

The trustee can ultimately realise vested property to pay the costs of the bankruptcy and distribute the balance to creditors.

What if the Family Home Is Jointly Owned?

Where the family home is jointly owned, the bankrupt spouse's interest typically vests in the trustee. The non-bankrupt spouse's registered interest does not automatically vest, and the trustee cannot simply sell the non-bankrupt spouse's share. However, the trustee can usually:

• negotiate with the non-bankrupt spouse to buy out the trustee's interest;
• seek to sell the bankrupt's share and, in appropriate cases, apply for orders supporting a sale of the whole property;
• participate in family law proceedings to protect the bankrupt estate.

In practice, this often leads to pressure on the non-bankrupt spouse either to refinance and buy out the trustee, or to agree to a sale and division of the proceeds. Family law proceedings can produce a different outcome where doing so is just and equitable, including by recognising the contributions and future needs of the non-bankrupt spouse. A caveat over property after separation may also be relevant where there is a risk of dealings before orders are made.

What if the Home Is in One Person's Name?

Legal title is not always determinative in family law. Even where the home is registered in one party's sole name, the Court has power under the Family Law Act to alter property interests between the parties. Bankruptcy adds complexity because the trustee's claim to the bankrupt's legal and beneficial interest must be considered alongside the non-bankrupt spouse's claim to an adjustment of property under family law principles. The outcome depends on contributions, future needs, the timing and nature of the debts, and the impact on creditors.

Can the Non-Bankrupt Spouse Still Seek a Property Settlement?

Yes. Bankruptcy does not, by itself, prevent the non-bankrupt spouse from pursuing property settlement. The Family Law Act and the FCFCOA Rules allow bankruptcy-affected property to be dealt with within family law financial proceedings. The trustee may be joined as a party so that the trustee can be heard, but the proceedings can still proceed and orders can still be made. If the parties were never married, the equivalent regime applies to de facto property claims.

Role of the Trustee in Bankruptcy

The trustee in bankruptcy administers the bankrupt estate in the interests of the creditors as a body. In family law proceedings, the trustee:

• may apply to become a party where property of the bankrupt is in issue;
• may take a position on whether property should be sold, retained or transferred;
• stands in the place of the bankrupt in relation to vested property; and
• may oppose, support or seek variation of proposed property orders.

Importantly, where the trustee has been joined to the family law proceedings, the bankrupt generally cannot make submissions about property vested in the trustee without the permission of the Court. This significantly limits the bankrupt's participation in respect of vested property.

Do Creditors or the Non-Bankrupt Spouse Have Priority?

Neither creditors nor the non-bankrupt spouse automatically have priority. The FCFCOA decides the competing claims having regard to both family law and bankruptcy principles, and makes orders that are just and equitable in the circumstances. The Court is empowered to consider the interests of creditors as a class, while also recognising the contributions and future needs of the non-bankrupt spouse.

What Does the Court Consider?

In a bankruptcy-affected property settlement, the Court typically considers:

• the ordinary property settlement factors — including identification of assets, liabilities, contributions and future needs;
• the nature, timing and purpose of the debts that gave rise to bankruptcy;
• whether the non-bankrupt spouse benefited from those debts, directly or indirectly;
• whether any of the debts were incurred recklessly, secretly or in circumstances amounting to wastage of the property pool;
• any family violence or economic abuse issues that affected the parties' ability to protect their financial position — see our guide to family violence intervention orders in Victoria;
• the realistic impact of any proposed orders on creditors;
• whether any transfer of property before bankruptcy was designed to defeat creditors or to manipulate the family law pool.

Can Property Be Clawed Back?

Transactions entered into before bankruptcy can be scrutinised by the trustee. The Bankruptcy Act contains a number of provisions that allow the trustee to challenge transactions, including:

• transfers for less than market value;
• transfers made with an intention to defeat creditors;
• certain transactions made within defined periods before bankruptcy.

The rules — including the so-called "relation back" period and the various clawback provisions — are technical and not accurately summarised by a simple "six month" rule. In family law, the Court can also take into account conduct that has wasted or dissipated the property pool. Specific legal advice is essential before relying on, or attempting to defend, any past property transfer.

Can Bankruptcy Be Used to Avoid Property Settlement?

Bankruptcy does not automatically defeat a family law property claim, but in some cases it is used strategically to delay or complicate a property settlement, or to reduce the pool of property practically available to the non-bankrupt spouse. The Court and the trustee can both scrutinise the timing of the bankruptcy, the conduct of the bankrupt party, and any related transfers. Where the bankruptcy appears designed to frustrate a property settlement, the Court can take that into account.

A separate guide will address the strategic question of whether bankruptcy can be used to avoid a family law property settlement in more detail. This article focuses on what actually happens when bankruptcy occurs during a property settlement.

What if Bankruptcy Occurs During Proceedings?

When a party to existing family law financial proceedings becomes bankrupt, the practical consequences include:

• the Court and the other parties must be notified;
• the trustee will usually need to be served with relevant material;
• proceedings may be delayed while the trustee decides whether to apply to be joined and what position to take;
• interim or urgent orders may be needed to protect the property pool or the housing of the non-bankrupt spouse and children;
• the bankrupt's ability to make submissions about vested property is significantly limited once the trustee is joined.

The non-bankrupt spouse should act quickly to obtain legal advice, understand the trustee's likely position and consider whether protective orders are needed.

Notification Requirements

A party to family law financial proceedings who is or becomes bankrupt generally must:

• notify the Court and other parties of the bankruptcy;
• provide notice of the family law proceedings to the trustee;
• comply with disclosure obligations under the FCFCOA Rules, including in relation to financial circumstances and any relevant transactions.

The precise timing and form of these notifications are dealt with in the current FCFCOA Rules and should be checked carefully or addressed with the assistance of a lawyer.

Child Support and Spousal Maintenance

Bankruptcy does not automatically discharge a parent's obligation to pay child support, nor does it automatically end an obligation to pay spousal or de facto maintenance. Thecapacity to pay may be affected, and either party can apply to review or vary the relevant assessments and orders where there is a material change in circumstances. See our article on spousal maintenance in Australia for a fuller treatment of the need-and-capacity test and the available orders.

Personal Insolvency Agreements

Similar issues can arise where a party is subject to a personal insolvency agreement (PIA) rather than full bankruptcy. The trustee of the debtor's property under a PIA may need to be considered in family law proceedings, and the treatment of property and obligations is governed by the Bankruptcy Act and the terms of the agreement. The complications are different from full bankruptcy and require specific advice.

Practical Steps for the Non-Bankrupt Spouse

If your former partner has become — or appears likely to become — bankrupt, the following steps are usually a sensible starting point:

• obtain urgent family law advice;
• find out whether bankruptcy has already occurred, and identify the trustee;
• preserve evidence of assets, debts, transfers and communications;
• investigate any suspicious transfers of property in the lead-up to separation or bankruptcy;
• consider whether a caveat or injunction is appropriate to protect particular assets;
• request and pursue full financial disclosure;
• consider whether urgent or interim family law orders are needed, including in respect of the family home;
• understand the practical impact on the family home, joint debts, refinancing and ongoing housing for any children.

Practical Steps for the Bankrupt Spouse

A bankrupt party also has obligations and decisions to make:

• notify the Court, the other party and the trustee where required;
• obtain advice before making or accepting any asset transfers;
• understand which property has vested in the trustee and which is exempt;
• continue to comply with family law disclosure obligations, even where vested property is involved;
• understand the limits on participating in proceedings about vested property;
• obtain advice about ongoing child support, spousal maintenance and other family law obligations.

Practical Examples

The following short hypotheticals illustrate how bankruptcy can interact with property settlement. They are illustrative only and do not constitute legal advice.

• Bankrupt spouse owns half the family home. A separated couple owns the home as joint tenants. The husband becomes bankrupt before final orders. His half-interest vests in the trustee. The wife and trustee negotiate, and ultimately the Court is asked to determine whether the property should be sold, or whether the wife should be permitted to retain it on terms that take account of creditor interests.
• Tax debts incurred during the relationship. A business operator runs up significant tax debts during the marriage to fund the family's lifestyle. After separation, he becomes bankrupt. The Court must consider the extent to which those debts were incurred for joint benefit, and how the resulting bankruptcy should be treated against the wife's contributions and future needs.
• Suspicious transfer before bankruptcy. Shortly before becoming bankrupt, a party transfers a valuable property to the non-bankrupt spouse for nominal consideration. The trustee may seek to challenge that transfer under the Bankruptcy Act, and the family law Court may consider whether it amounted to wastage or an artificial reshaping of the property pool.
• Protecting housing stability. A non-bankrupt spouse caring for young children seeks interim orders to remain in the family home, pending the resolution of the property settlement and the trustee's claim. The Court weighs the interests of the children, the parties and the creditors in deciding what interim arrangements are appropriate.

How Our Family Law and Litigation Teams Work Together

Bankruptcy-affected property settlements often sit at the intersection of family law and commercial dispute work. Our Family Law team advises on property settlement, parenting and maintenance, while our Litigation & Dispute Resolution team advises on dealings with trustees and creditors. Where business interests are involved, see our article on business interests in divorce and property settlement.

A Note on the Law

References in this article to the Bankruptcy Act 1966 (Cth), the Family Law Act 1975 (Cth), AFSA guidance and FCFCOA practice are based on the law and published guidance as at the date of this article. Thresholds (including the minimum debt for a creditor's petition), procedural rules and notification requirements change from time to time and should be verified in any specific matter.

Disclaimer

This article is general legal information only. It is not legal advice and should not be relied on as a substitute for advice tailored to your particular circumstances. Bankruptcy and family law are both technical areas, and the consequences of getting them wrong can be severe. If your former partner has become bankrupt, is threatening bankruptcy, or you are concerned about your own financial position, please obtain independent legal advice as soon as possible.

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