By Helen Suke, Partner, and Rachell Davey, Special Counsel
Money and love often go hand in hand. When the former disappears, the latter sometimes follows. The intersection between family law and insolvency law has historically been complex, leading practitioners down divergent legislative and judicial paths.
Simultaneous amendments to the Family Law Act 1975 (Cth) (the FLA) and the Bankruptcy Act 1966 (Cth) (the BA) in 2005 attempted to simplify the often conflicting and legitimate claims of both creditors and non‑bankrupt parties by ensuring that all such disputes were dealt with in the Family Court. [1]
This article will consider the approach taken by the Family Court to bankruptcy in the context of family law proceedings and identify issues for insolvency practitioners to consider when dealing with such litigation.
Jurisdiction of the Family Court
A significant aspect of the Family Court’s jurisdiction is to adjust property between parties following separation. [2] Since 2009, the Family Court has had jurisdiction to hear claims from those in de facto relationships as well as married couples. The relevant provisions of the FLA apply equally to all those in relationships, including same-sex relationships.
There is no requirement under the FLA that the legal and equitable ownership of property is to be adjusted following separation by virtue of the mere fact that parties were in a relationship. Following the High Court’s decision in Stanford v Stanford (Stanford), [3] practitioners have been reminded that a court must firstly determine that it is just and equitable to make an order altering the legal and equitable ownership of property before then considering which orders are to be made.
In the vast majority of cases, the fact of separation itself will provide sufficient justification for altering the ownership of assets. However, it may not. The parties may have kept their financial affairs entirely separate throughout their relationship and never intended to create mutual financial obligations towards the other.
Stanford is somewhat of a complication for insolvency practitioners as it clearly provides that it is an acceptable option for a court to simply leave assets where they lie. If all property is held by a non-bankrupt party, the court may not necessarily look to altering that simply by virtue of the end of the relationship.
In considering the settlement of property, the Family Court follows the well-known legislative path as referenced in s 79 of the FLA [4] of:
a. ascertaining the property of the parties by considering their legal and equitable interests in property
b. considering whether it is just and equitable to alter the legal ownership of property of the parties
c. considering the financial and non‑financial contributions made by each party towards the acquisition, conservation and maintenance of property
d. considering the so-called ‘future needs factors’ being the factors contained in s 75(2) of the FLA insofar as they are relevant
e. considering whether the overall intended adjustment of property is just and equitable.
It is of course, the step of identifying the property of the parties that creates complexity when one of the parties to that relationship is a bankrupt. The Family Court can only deal with and adjust the property of the parties as it stands at the time of determination. Upon bankruptcy, the bankrupt’s legal estate vests with the trustee. The Family Court has the power to adjust legal ownership of vested property, thereby reducing the availability of property to trustees with which to meet the claims of creditors. [5]
Thus, s 59A of the BA specifically identifies property that is exempt from vesting in a trustee, being property that is required to be transferred to a spouse or de facto partner, or former spouse or de facto partner of a bankrupt pursuant to an order made under the FLA. [6]
The central premise of s 79 of the FLA does not necessarily accord with the legislative approach contained in the BA insofar as the latter does not recognise equitable interests that can arise through financial and non-financial contributions made towards property by persons other than the legal owner. The FLA further recognises that adjustments to the legal ownership of assets may be necessary on account of future needs factors. These are concepts that are relatively unknown outside of the family law arena.
Bankruptcy and Family Law Legislation Amendment Act (2005)
Prior to 2005, a non-bankrupt party could not commence proceedings for property settlement against a bankrupt party, as the court had no power to make orders in relation to vested property. Any such claims were left to be dealt with in the Federal Court wherein the non-bankrupt party effectively had to prove a debt in order to become a creditor of the bankrupt estate; this was notoriously difficult.
In 2005, significant legislative amendments were made to the FLA through the enactment of the Bankruptcy and Family Law Legislation Amendment Act (2005) (Cth). As noted in the Explanatory Memorandum to the Bill, the chief objectives of the legislation were:
a. the vesting in the Family Court of additional jurisdiction to deal with bankruptcy matters where those matters arise concurrently with matter under the FLA;
b. the facilitation of the trustee in bankruptcy’s involvement in Family Court proceedings, so that bankruptcy and family law issues can be dealt with together.. [7]
Amendments to the BA at the same time provided for the Family Court to have jurisdiction in bankruptcy matters where the trustee was a party to the family law proceedings. [8]
Post 2005, trustees in bankruptcy are now able to be joined as parties to property proceedings in the Family Court (and effectively stand in the place of the bankrupt party for the purpose of responding to the claims of the non‑bankrupt). However, they cannot initiate proceedings under s 79 themselves, nor can they agitate for a greater share of the property pool other than that that has already vested in the bankrupt estate. (They can only defend claims against the transfer of vested property to the non-bankrupt party.)
It is open to a trustee to assert that the debts of the bankrupt ought be paid from assets held by the non‑bankrupt party. However, the success of this approach will depend entirely on the circumstances.
In the event that Family Court proceedings have not been initiated by a non-bankrupt party (which would be a likely scenario if the majority of the asset pool was legally held by them), or if the parties have not entered into orders approved by a court, then the only recourse for trustees to recover property formerly held by a bankrupt is to rely upon the claw-back provisions contained in ss 120, 121 and 122 of the BA if relevant, or to assert an equitable interest in the property of the non-bankrupt party.
These provisions cannot be relied upon by trustees if orders have been made by a court (either by consent or by a Judge) transferring property as such transactions are exempt. [9]
Family Court proceedings involving trustees in bankruptcy
It is evident that the impact of the amendments to both the FLA and the BA has been to strengthen the protection given to non-bankrupt parties as compared to unsecured creditors. By dealing with competing claims in the Family Court, where the judiciary is expert at assessing and determining the division of property following separation, it is to be expected that the rights of the non‑bankrupt party will take an implied priority over creditors.
That is, however, not to say that creditors’ rights are ignored. Section 75(2)(ha) of the FLA makes it clear that the court must consider the effect of any proposed order on the ability of a creditor of a party to recover the creditor’s debt. However, this is just one of many factors that the court considers when adjusting property between the bankrupt and non bankrupt party.
It would be a rare case when a non-bankrupt party was completely exonerated from sharing in a debt that was incurred during the relationship.
It is also important to note that all this section requires the court to do is to consider the ability to recover the debt – not the impact on the creditor of the debt not being paid, hardship to the creditor or recovery of the trustee’s costs. It is a narrow consideration at best.
Difficulties for Trustees
Judicial discretion
The Family Court has a broad discretion in exercising its jurisdiction under s 79. Judicial discretion is the cornerstone of the property settlement process, recognising that each family and its financial affairs are unique, and there is no ‘one size fits all’ approach. It is this allowable discretion that can be of surprise to insolvency practitioners when appearing in the Family Court.
Furthermore, while the 2005 amendments brought some certainty to the process for dealing with bankruptcy in the Family Court, there was scant judicial guidance, at that time, as to how to balance the conflicting interests of creditors and a non-bankrupt spouse.
There are now a sufficient number of cases for some general guidance to be provided to practitioners; however, once again, as every case involves a different factual matrix, precedents in this regard can be of marginal utility. Predictability in family law outcomes will always be subservient to the requirement to do justice and equity to each particular couple or family.
For example, there is no requirement for the court to include each and every liability of the parties (including any liability resulting in the bankruptcy) in the asset pool and deduct same from the gross value of the parties’ assets (albeit that this will be the usual course).
There is no requirement that liabilities be shared equally between parties, or be shared in the same proportion as the overall division of the asset pool. Indeed, the court can order that one party alone be responsible for debts depending on how they have been incurred or the court may disregard a debt in its entirety. Even if the parties’ debts exceed the value of their assets, property can still be adjusted providing for one party to retain assets, and for the other party to retain debt.
The court has a number of options available to it when dealing with a debt:
a. It can determine that a debt ought be shared equally between the parties and paid out prior to the division of the balance of the asset pool.
b. It can determine that each of the bankrupt and non-bankrupt pay the debt equally from their share of the asset pool.
c. It can determine that the parties each bear responsibility for payment of the debt in differing proportions according to their overall entitlement to the asset pool.
d. It can determine that the bankrupt alone be responsible for the payment of the debt from their share of the asset pool.
The general principle is that relationship partners take the good with the bad (the roller-coaster principle). It would be a rare case when a non-bankrupt party was completely exonerated from sharing in a debt that was incurred during the relationship. However, that is not to say that the court does not have the jurisdiction to order that outcome. Generally, in considering the allocation of debt, the court will consider:
a. Has one party been on a ‘frolic of their own’ with the other party unaware of their actions and the circumstances of the debt?
b. Has one of the parties embarked on a course of conduct designed to reduce or minimise the effective value or worth of the relationship assets?
c. Has one of the parties acted recklessly, negligently or wantonly with the assets of the relationship, the overall effect of which has been to reduce or minimise their value?
d. Did the debt arise during the relationship or post separation?
e. Did the non-bankrupt benefit from, or contribute to the debt in some way? For instance, did the non-payment of taxation increase income that the non bankrupt benefited from?
f. Is it just and equitable for the non-bankrupt to escape all responsibility for the payment of debts?
g. Does the debt comprise penalties, interest and fees on top of the additional liability and how have they arisen?
h. Do the separation and property settlement proceedings appear to be genuine or are they a strategy or tactic to reduce assets otherwise available to creditors? [10]
There have been two significant Family Court cases since the legislative amendments that have considered how debt is to be allocated between parties following bankruptcy. In Trustee of the property of G Lemnos & Lemnos & Anor, [11] the bankrupt husband had for a number of years incorrectly claimed certain taxable deductions in respect of the family home. His income taxation was re-assessed and together with penalties and interest he was required to pay the sum of $5,700,000 to the Australian Taxation Office. This led to a sequestration order being made.
His wife was unaware of his conduct and had no knowledge of the returns that were filed by the husband. However, she clearly benefited from the increased income available to the family. The main asset of the parties was their former matrimonial home, which was registered in the husband’s sole name (and accordingly vested in the trustee) and had net equity of $2,500,000. The trial judge decided that the trustee and the wife should each retain 50 percent of the equity in the property.
The trustee appealed and asserted that as the quantum of the debt exceeded the net asset pool, no property settlement orders could be made in favour of the wife. The Full Court, however, found that there was no requirement under the FLA for the parties’ liabilities to be deducted from the gross value of their assets, and the balance thereafter, if any, divided.
Although allowing the appeal on unrelated grounds, Justice Coleman agreed with the trial judge’s analysis of the intended outcome and noted that it would lead to a situation whereby the Australian Taxation Office would effectively miss out on a large portion of its debt being paid.
Nonetheless: The question should realistically be asked why the wife should ultimately prosper at the expense of the public purse. The answer so far as I am concerned is that the Family Law Act as now standing provides for that to be the outcome in appropriate cases. The legislation does not elevate the status of creditors to a ranking above the other considerations which the court is required to consider under s 75(2). In the circumstances of this case therefore the result which sees the wife receive half the equity in the [W] property and the Lexus motor vehicle is just and equitable. [12]
The majority upheld the appeal on the basis that they disagreed with the trial judge’s findings that the wife should not share in any of the penalties imposed by the commissioner because she was not complicit with her husband.
Accordingly: In our view the fact that the wife was or was not involved in the tax avoidance process which may lead to the imposition of penalties was only one consideration that His Honour needed to weigh up when determining liability for the penalties as between the parties. The benefits indirectly gained by the wife in having the pool of assets otherwise increased as a result of the availability of funds which would otherwise have been paid out in tax also have to be considered.
In the context of an examination of twenty years of financial dealings by the parties, which dealings were almost entirely within the province of the husband, in our view, unless there were compelling circumstances to the contrary, a just outcome demanded that the wife take the good with the bad. Whilst there is a sense of culpability about the penalties, they represent no more in this case than an outgoing incurred in creating the asset pool.
… Absent any suggestion that the husband was on a frolic of his own and acting contrary to the wife’s express wishes, we see no reason for His Honour to have left the husband to shoulder the burden of the tax penalties. [13]
Similarly, in Commissioner of Taxation & Worsnop & Anor, [14] the bankrupt husband had a taxation liability that greatly exceeded the value of the matrimonial assets. The trial judge again determined that the proceeds of sale of the home should be divided equally between the trustee and the wife. However, in this case, the Appeal of the trustee was dismissed on the basis that the decision came within the parameters of a reasonable exercise of discretion by the trial judge.
The Full Court specifically rejected the argument advanced by the trustee that it would be an error of discretion to permit the wife to retain the benefit of monies upon which tax had not been correctly paid. Were it not for the significant debt to the ATO, the wife could have expected to have received an adjustment of up to 15 percent on account of her future needs. The fact that this adjustment was not made led the Full Court to the view that the ability of the creditor to recover their debt had been adequately considered by the trial judge.
Future needs factors and adjustments to non-bankrupt spouses
It is important to note that there is no presumption of equality in family law matters. Nor is the legal registration of assets of particular relevance or definitive evidence of the contribution made by each party towards that asset. Generally, in long relationships, the courts will view the contributions of each party, which have been made over time, to be equal.
However, the necessary step of considering the factors listed in s 75(2) of the FLA then requires the courts to consider the likely future needs of each party. It is this step that can result in property settlements of greater than 50 percent in favour of one party.
A significant disadvantage to trustees of litigating in the Family Court is that of the 19 factors listed in s 75(2), only one is relevant to them – ‘the effect of any proposed order on the ability of a creditor to recover the creditor’s debt’. The balance of the factors usually favours the non‑bankrupt party. It is highly unlikely that a settlement involving a trustee in bankruptcy would result in the estate receiving an adjustment on account of future needs factors, whereas it is highly likely that the non-bankrupt party will.
Generally, the cases demonstrate that adjustment on account of future needs factors will, however, sometimes be reduced when balanced with the need to meet the interests of creditors. For instance, in Pippos v Pippos, [15] the trial judge gave the non-bankrupt wife an allowance of 10 percent for future needs factors, but reduced that to 5 percent after balancing the rights of the bankrupt husband’s creditors. [16]
Co-operation from the bankrupt
Difficulties may arise for trustees when the bankrupt refuses to co‑operate with them throughout the litigation or even participate in the litigation. There may be no incentive for a bankrupt to co-operate, as they may be unlikely to personally receive any of the fruits of the litigation, or they may have interests that align with the non-bankrupt spouse.
If the trustee is not appraised of relevant information as to the history of the relationship and the contributions made by each party and their future needs (noting that such information is most easily and best provided by the parties to the relationship), it can be difficult, if not impossible for them to respond to such allegations made by the non‑bankrupt spouse.
If the court is only provided with unchallenged evidence from one party as to these matters, then this can result in an effective ‘windfall’ to that party, and adjustments to property being made in their favour that may not necessarily have been made had the court been provided with more fulsome and complete evidence.
For instance, in West v West, [17] there was no evidence led by the trustees as to the contributions made by the husband to the former matrimonial home or the wife’s future needs because the husband failed to file any affidavit material or attend at Court. The trustees were seeking the former matrimonial home be sold and the proceeds divided equally between themselves and the wife. The Court, however, accepted the wife’s assertions as to the financial and non-financial contributions made by her, and her extensive future needs and divided the matrimonial asset pool as to 95 percent in her favour, resulting in no cash payment to the trustee.
Trustees need to be aware that they, like any other litigant, are also susceptible to costs orders being made against them in family law proceedings if they are unsuccessful.
Costs
Costs do not necessarily follow the event in family law proceedings. The general principle as contained in the FLA is that each party is responsible for the payment of their own costs. [18] The court can make orders for costs in certain circumstances; however, due to the discretionary nature of the jurisdiction, an order for the payment of costs will usually be the exception.
Even if costs orders are made, they are usually only a fraction of the quantum of the total costs actually payable. In certain circumstances, where the pool of assets is low, a trustee may well elect to make a commercially sound decision not to defend proceedings in the Family Court, or to compromise proceedings at an early juncture as the costs may well outweigh the return to creditors and the payment of their own fees.
For instance, in West v West, [19] the original debt, which was the subject of the bankruptcy, was $8,000. By the time of the final hearing, the trustees’ legal and other costs amounted to in excess of $70,000 or 55 percent of the net asset pool which was certainly the subject of comment from the Court. The Court declined to include those costs as a liability of the parties noting that ‘the court was not pointed to authority that required the interests of the trustees by way of recovery of their remuneration and other costs be taken into account, only the interests of the creditors’. [20] The trustee further needs to be aware that they, like any other litigant, are also susceptible to costs orders being made against them in family law proceedings if they are unsuccessful. In West v West an application was made to the Court for the trustee to pay the wife’s costs. However, this was not successful because the wife was being represented on a pro bono basis. Had she not, there is every prospect that the trustee may have been required to contribute to her fees as they were wholly unsuccessful.
Delay
As with all Family Court litigants, trustees in bankruptcy need to be aware as to the extent of any delay in the process. Currently, in New South Wales, it will take on average two and a half to three years from the date of filing an application in the Family Court to proceed to a final hearing. In Victoria, the current average is close to two years. This delay can be at odds with the role of the trustee to finalise the bankruptcy in a timely manner and the orderly payment of creditors.
In Summary
The amendments to the FLA and BA were intended to ensure one venue for the determination of competing claims in the context of separation and bankruptcy. From the perspective of family law practitioners, there is no doubt that the amendments strengthen the ability of a non‑bankrupt party to claim property from a bankrupt party that would otherwise have been unavailable to them.
As opposed to the comfortably familiar workplace of family lawyers, insolvency trustees may feel at a disadvantage when dealing with family court litigation. Expert advice as to likely outcomes in the context of family law proceedings ought be sought when trustees are pursuing or proceeding with a Family Court claim to take into account the nuances, and some would say, peculiarities, of the family law arena.
*This article was originally published in the Australian Restructuring Insolvency and Turnaround Association Journal – June 2018.
Contact Mills Oakley
If you require further advice on the issues raised in this alert, please do not hesitate to contact:
 Helen Suke | Partner T: +61 3 9605 0967 E: hsuke@millsoakley.com.au |
 Rachell Davey | Special Counsel T: +61 3 9605 0033 E: rdavey@millsoakley.com.au |
[1] In this article the term Family Court is used interchangeably with the Federal Circuit Court, which also exercises jurisdiction under the Family Law Act throughout Australia (except for Western Australia) and the Family Court of Western Australia. [2] The definition of spouse and parties in this context applies to those in marriages, as well as those in de facto relationships whose relationships came to an end after 1 March 2009 (or 1 March 2010 in South Australia) with the exception of those in Western Australia. When referring to specific sections in the Family Law Act throughout this article referable to married couples, there are usually, but not always, identical provisions with regards to de facto couples. [3] (2012) HCA 52. [4] Or s 90SM in the case of those in a de facto relationship. [5] s 79(1)(b) FLA. [6] See also ss 116(2)(q) and 116(2)(r) of the BA. [7] Explanatory Memorandum, Bankruptcy and Family Law Legislation Amendments Bill 2005, Paragraph 2. [8] s 35 BA. [9] s 59A BA. [10] See ‘Some Aspects of the Interaction of Bankruptcy with Family Law’ Federal Magistrate Walters, 12th National Family Law Conference 2006. [11] [2009] Fam CAFC 20 [12] [At 172]. [13] At [205 to 207]. [14] [2009] Fam CAFC 4. [15] [2008] FamCA542. [16] See also Commissioner of Taxation & Worsnop & Anor above. [17] [2007] FMCAfam 681. [18] s 117(1) FLA. [19] [2007] FMCAfam 681. [20] Ibid per O’Sullivan FM [at 74].
