An important concept in Bankruptcy or Insolvency law is the ability to recover assets disposed of before the date of the formal bankruptcy. This is what the idea of voidable transactions deals with. Basically, if the trustee investigates your bankruptcy transactions and believes you have improperly transferred your assets that would otherwise have been available to your creditors, the law has provisions in place that allow the trustee to cancel those transactions and get the property back.
For the trustee to be able to recover assets you have transferred before bankruptcy and therefore prove a ‘voidable transaction’, he or she has to do the following:
- Identify the transaction;
- Identify the other party to the transaction;
- Prove that the transaction occurred within a specific period of time or when you became bankrupt; and
- Prove that the transaction falls within one of the categories below.
Types of Pre-bankruptcy transactions that are voidable:
There are four main situations where the transactions will be held void:
- The transfer of property was under value: s120 Bankruptcy Act
- The transfer was made with the intention to deny or delay Creditors’ access to your property: s121
- The transfer was made to give one creditor preference over other creditors: s122; or
- Services provided by you to other entities indirectly benefited you: s123.
Let’s look at each of them individually.
1. Transfer of property that is under value
Imagine you decide to sell your car to a friend for almost 70% discount of the market value. That may be classified as transferring your property at an under value if it is proven that:
- there was a transfer of the property ie. the car;
- the transfer occurred within the prescribed time zone as set out below;
- All transfers that occurred up to 2 years before the commencement of the bankruptcy; or
- 4 years if the buyer was a related party to you; or
- 5 years unless the buyer can prove that you were solvent when you got the car.
- the payment given for the car must be less than the ‘market value’ of the car transferred.
If the car has moved on from your friend (who bought the car) to another buyer, that buyer is protected if they can show that they acted in good faith and gave market value for the car. For example, the car was worth $10,000 and you gave it to your friend for $5,000 who then sold it for $10,000 to somebody who did not know of how your friend first got the car. The trustee cannot recover the car from the second buyer because you alienated it for less than market value.
2. Transfers to defeat or delay creditors
A transfer of property that is made by you with the main purpose of preventing, hindering, or delaying creditors is voidable unless the transferee gave market value and was unaware of your purpose and could not have reasonably inferred that you were insolvent. This provision acts to protect people who acquire the value of the property and who were ‘innocent’ of what was going on with your bankruptcy. Let us say you knew you were going to become insolvent or bankrupt soon and you did not want your creditors to get their hands on your assets so you transfer your money to a family member. That would give grounding to have that transaction voidable and would need to be returned back to the trustee.
3. Preference transfer
This involves a transfer made by you in favour of a creditor that gives them a preference or advantage over the other creditors. The transfer would have to be made in a period of 6 months before the presentation of a creditors’ petition. Imagine you are a business owner who sells door-knobs. Your business is failing and your friend supplies you the door-knobs to sell. He supplied you with 100 door-knobs but you were only able to sell 2. You can tell him to come over to your factory to pick up the remaining 98 door-knobs. Your supplier gets $1000 worth of door-knobs back plus dividend. If your supplier friend gets more back than if he filed an ordinary claim just like the other creditors, he has essentially been preferred. Therefore the transfer is considered voidable.
4. Orders against other entities
This relates to the idea that you have indirectly benefitted another entity through your own services but have not been paid. For example, you worked for your brother’s business on weekends in return for a few cases of beer. In this situation, the trustee can go to your brother and say that he benefited from your work but you did not receive a proper wage. Depending on the circumstances of your brother’s situation, the trustee would be able to recover compensation.
The take-away lesson from this article is to understand that not all transactions when you are bankrupt or insolvent are valid. If the trustee can prove that you made transactions that fall under any of the above situations, he or she has proven a voidable transaction and is able to recover the property you transferred, subject to the circumstances of the situation. The complexities and impact of the insolvency/bankruptcy process can be overwhelming for anyone and this article only provides a general overview, so it is advisable you talk with a specialist insolvency lawyer about your situation and options.