What is bankruptcy?

In Australia, bankruptcy is governed by the provisions of the Bankruptcy Act 1966 (Cth). Bankruptcy is a process that enables a person to sort out their financial affairs by providing a mechanism through which the person’s creditors can be paid (but generally only in part, not in full).  Bankruptcy is generally for a period of three years from the date on which the bankrupt filed his/her statement of affairs, although this period may be extended if an objection is made.  Upon expiry of the relevant bankruptcy period the bankrupt is released from most, but not all, debts due to creditors from the date of bankruptcy.

Generally, bankruptcy is taken to have commenced at the time of the earliest act of bankruptcy of the bankrupt within the period of six months immediately before the date on which a creditor’s petition or debtor’s position (as the case may be) is filed.  This includes, amongst other things, payments or transfers of property that would be void against the trustee in bankruptcy.

What property is divisible amongst creditors and vests in the trustee in bankruptcy?

On bankruptcy, the bankrupt’s property vests in the trustee and any after acquired property vests in the trustee in bankruptcy as soon as it is acquired by, or devolves on, the bankrupt.  Such property is divisible amongst the bankrupt’s creditors.

Property is broadly defined to mean worldwide real or personal property, and includes any rights or powers (whether present or future, vested or contingent) in relation to any such property.  This includes jointly owned property, inheritances and debts due to the bankrupt.

Where a bankrupt owns property jointly (e.g. family home owned by a bankrupt and their spouse), the trustee in bankruptcy will generally lodge a caveat on the property to records its interest, give the spouse an opportunity to purchase the bankrupt’s interest in the property and if that is not possible or cannot be agreed then the property can be sold by agreement or application to the Supreme Court.  If the property is mortgaged then bankruptcy of one of the borrowers may be an event of default giving the lender the right to sell the property, discharge its mortgage (because the trustee in bankruptcy takes the property of the bankrupt subject to the mortgage) and pay the balance of the proceeds of sale to the trustee in bankruptcy and non-bankrupt spouse in proportion to their ownership interest in the property.

If a bankrupt inherits property as a beneficiary of a deceased estate then the bankrupt’s interest in the estate is after acquired property and vests in the trustee in bankruptcy, even if the estate has not been fully administered by the time the bankrupt has been discharged. This can be avoided by excluding ‘at risk’ persons from a Will (e.g. by giving their share of an estate to their spouse or children) or preparing a testamentary trust will.  In addition to protecting assets from a trustee in bankruptcy, testamentary trusts have significant tax advantages as income can be distributed in a tax effective way amongst beneficiaries and children under 18 are taxed at adult rates not penalty rates.

However, certain property is not divisible amongst creditors and is therefore protected from the trustee in bankruptcy.  This includes, amongst other things, property held by the bankrupt on trust for another person; certain household property (e.g. furniture and effects, but not antiques); certain personal property; property for use by the bankrupt in earning income from personal exertion; and motor vehicles (up to a specified value).

Property is best protected from creditors’ claims if it is paid or transferred by the bankrupt as early as possible.  A payment made or property transferred by the bankrupt before the relation back period is not the bankrupt’s property and is not divisible among the bankrupt’s creditors, unless it can be clawed back by the trustee in bankruptcy.

Conclusion

Bankruptcy is a serious issue. Make sure you work with a lawyer if you’re involved in a bankruptcy process.

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