Chamberlain’s S.B.R 

Chartered Accountants

 Conference Paper 2008

 Forbes/Parkes/Dubbo/Orange/Bathurst/Wagga/Albury/Griffith/Deniliquin/Wangaratta/Shepparton

Topics

• Bankruptcy Overview

(See Frequently asked questions/FAQ on website homepage)

• Demystifying Asset Protection & Bankruptcy

• Bankruptcy & Family Law

Demystifying Asset Protection & Bankruptcy

•Bankruptcy legislation (Anti Avoidance) Act came into effect 31st March 2006

•Relevant anti avoidance provisions of Bankruptcy Act are:

- Section 120 Undervalued Transactions

- Section 121 Transfers to Defeat Creditors

Section 120 of the Bankruptcy Act 1966

Section 120 (1) “Transfers that are void against Trustee” reads:

(1)  A transfer of property by a person who later becomes a bankrupt (the transferor ) to another person (the transferee ) is void against the trustee in the transferor's bankruptcy if:

(a)  the transfer took place in the period beginning 5 years before the commencement of the bankruptcy and ending on the date of the bankruptcy; and

(b)  the transferee gave no consideration for the transfer or gave consideration of less value than the market value of the property.

Under the Pre 2006 Legislation

Section 120 (3) “Transfers that are not void against the Trustee” Reads

(a) The transfer took place more than 2 years before the commencement of the bankruptcy: and

(b) The transferee proves that, at the time of the transfer, the transferor was solvent.

Under the NEW Anti Avoidance Legislation,

Section 120 (3) “Transfers not void against Trustee” reads:

(a)  in the case of a transfer to a related entity of the transferor:

(i)  the transfer took place more than 4 years before the commencement of the bankruptcy; and

(ii)  the transferee proves that, at the time of the transfer, the transferor was solvent; or

(b)  in any other case:

(i)  the transfer took place more than 2 years before the commencement of the bankruptcy; and

(ii)  the transferee proves that, at the time of the transfer, the transferor was solvent.

Main Difference

Section 120 (3) a) i) & ii) Reads.

(a)  in the case of a transfer to a related entity of the transferor and the value was less than fair consideration the transfer is not void (subject to Section 121 not being relevant) if:

    (i)  the transfer took place more than 4 years before the commencement of the

bankruptcy; and

  (ii)  the transferee proves that, at the time of the transfer, the transferor was solvent;

In Summary:

Under the pre may 2006 legislation a transfer for undervalue to any party during the relevant two (2) years prior to the Commencement of bankruptcy was void however if it was determined post this (2) two year period that the debtor was insolvent the relevant period was up to a maximum of (5) five years I.e.

Commencement

of Bankruptcy 2 years prior 5 years prior

|_______________________|_________________________|

Any undervalued transfer void Any undervalued transfer void if debtor proven

to be insolvent at time of transfer

New Legislation

Section 120 (3) a) i) & ii) now extends the (2) two year period to (4) four years if the undervalued transfer is to a related party regardless of state of solvency with the (5) five year rule to remain. I.e.

Commencement 2 years prior 4 years prior 5 years prior

of Bankruptcy

|______________________________|_______________________________________|__________________________________|

Undervalued transfer is void Undervalued transfer to related party is void Undervalued transfer to any party isvoid if determined insolvency at time of transfer

Solvency Determination – Rebuttable Presumption (Section 120 (3A)

Rebuttable presumption of insolvency

(3A)  For the purposes of subsection (3), a rebuttable presumption arises that the transferor was insolvent at the time of the transfer if it is established that the transferor:

(a)  had not, in respect of that time, kept such books, accounts and records as are usual and proper in relation to the business carried on by the transferor and as sufficiently disclose the transferor's business transactions and financial position; or

(b)  having kept such books, accounts and records, has not preserved them.

In summary where in the past establishing solvency/insolvency at the time of transfer was always difficult now with the new amendments where it was always convenient for a debtor/bankrupt to fail to keep or supply proper records this will have material consequences should a beneficiary to an undervalued transfer be trying to argue their case.

“Important”

Overview

Practitioners need to be aware that if advising their clients on asset protection and property is being transferred to related parties that they are well aware of Section 120 of the Bankruptcy Act and also Section 121 which is to be discussed next in this paper.

Section 121 of the Bankruptcy Act 1966

“Transfers to Defeat Creditors”

Section 121 (1) Transfers that are void

(1)  A transfer of property by a person who later becomes a bankrupt (the transferor ) to another person (the transferee ) is void against the trustee in the transferor's bankruptcy if:

  (a)  the property would probably have become part of the transferor's estate or would probably have been available to creditors if the property had not been transferred; and

  (b)  the transferor's main purpose in making the transfer was:

      (i)  to prevent the transferred property from becoming divisible among the transferor's creditors; or

    (ii)  to hinder or delay the process of making property available for division among the transferor's

Section 121 (2) Showing the transferor's main purpose in making a transfer

 (2)  The transferor's main purpose in making the transfer is taken to be the purpose described in paragraph (1)(b) if it can reasonably be inferred from all the circumstances that, at the time of the transfer, the transferor was, or was about to become, insolvent.

Section 121(4) Transfer not void if transferee acted in good faith

(4)  Despite subsection (1), a transfer of property is not void against the trustee if:

     (a)  the consideration that the transferee gave for the transfer was at least as valuable as the market value of the property; and

     (b)  the transferee did not know, and could not reasonably have inferred, that the transferor's main purpose in making the transfer was the purpose described in paragraph (1)(b); and

      (c)  the transferee could not reasonably have inferred that, at the time of the transfer, the transferor was, or was about to become, insolvent.

Comment

Section 121 was always a difficult section of the Act to base a void disposition claim around due to its subjective nature.

One of the strengths of the provisions is that there was no time limit attached to transaction and as such the Trustee effectively could go back an infinite period.

Once again as with Section 120 the question of Solvency (as well as intent) was paramount to the outcome of any claim.

As also with Section 120 a rebuttable presumption of Insolvency provision (Viz Section 121 (4A)) has now been added to Section 121.

This amendment has certainly assisted in strengthening this provision however the other major contributor has been the High Courts decision in the Cummins Case which in brief is summarised as follows:

Cummins Case Update

(The Trustee of the Property of John Daniel Cummins V Cummins HCAG)

Facts:

1. The proceedings concerned recovery by the trustee of the bankrupt estate of Mr Cummins of certain property and funds transferred by Mr Cummins to his wife and to a family trust.

2. Mr Cummins became bankrupt on his own petition in December 2000. At that time, he was a Queens Counsel in practice at the Sydney Bar.

3. Between 1955 and early 2000, Mr Cummins failed to lodge any income tax returns.

4. In early 2000, Mr Cummins filed returns for the taxation years 1992 to 1999. On the basis of those returns, the Deputy Commissioner of Taxation issued assessments being owed approximately $955,000.00.

5. The trustees claimed that certain transfers of property made by Mr Cummins in 1987, thirteen years before his bankruptcy, were void as against them pursuant to section 120 & 121 of the Bankruptcy Act.

6. The transfers were:

1. A transfer by Mr Cummins to his wife of his half interest in the Matrimonial home at Hunters Hill for an expressed price of $205,250.00

2. A transfer of Mr Cummins shares in Counsel’s Chambers Limited to a family Trust for an expressed price of $360,000.00: and

3. The payment by Mr Cummins of various sums of money to Mrs Cummins between 1992 to 1999.

7. It is significant to note that despite the fact that each transfer was expressed to be for monetary consideration, neither Mrs Cummins nor the family trust paid anything for the properties transferred.

Judgement of Federal Court at first instance

One of the main issues before Justice Sackville of the Federal Court was whether the Court was to draw the inference that Mr Cummins in making the transfers in 1987, had the “main purpose” required by section 121(1)(b) of the Bankruptcy Act I.e:

(1)  A transfer of property by a person who later becomes a bankrupt (the transferor ) to another person (the transferee ) is void against the trustee in the transferor's bankruptcy if:

(b)  the transferor's main purpose in making the transfer was:

    (i)  to prevent the transferred property from becoming divisible among the transferor's creditors; or

   (ii)  to hinder or delay the process of making property available for division among the transferor's creditors.

Mrs Cummins Argument

•Mrs Cummins argued that because she has contributed 68.5% to the purchase price of the property back in 1970 she should only have to remit the remaining 31.5% to the Trustee.

•Mrs Cummins was relying on a long established principle regarding resulting trusts and the High Courts own decision in Calverly & Green. (This decision was though in relation to a defacto relationship)

•This argument is not uncommon and arises quite often in Bankruptcy Administrations.

Federal Court Decision

Even though there was no argument over whether Mrs Cummins did or did not contribute the 65.8% of the initial purchase price Justice Sackville rebutted the resulting Trust argument as he considered back in 1970 when the property was purchased the intention was that they acquire the subject property as joint tenants legally & beneficially and accordingly should share equally in the spoils I.e 50/50.

Justice Sackville’s matters of persuasion when considering “Main Purpose” for Section 121 (1)(b)

1. Mr Cummins was well aware in August 1987 that he had incurred very substantial liabilities to the Deputy Commissioner, contingent only on the Deputy Commissioner issuing assessments in respect of past income years.

2. Mr Cummins was well aware at the time that the Deputy Commissioner would issue assessments once his long standing tax delinquency became known, an event that could occur at any time.

3. Mr Cummins denuded himself voluntarily of virtually of all his substantial assets in August 1987.

4. In any event, the assets retained by Mr Cummins were not sufficient to meet his taxation liabilities, if the Deputy Commissioner decided to issue assessments;

5. Mr Cummins saw the transfers as increasing the chances that his assets would be protected from any claims made by the Deputy Commissioner.

6. In addition, the evidence uncovered in the course of the trial included notes of the solicitor, Mr Harris acting for Mr Cummins at the time of the 1987 transfers, showing that he had paid attention to section 121 of the Bankruptcy Act and to section 37a of the Conveyancing Act and documents from Mrs Cummins bank referred to assets being in her name for reason to do with her husbands occupation.

The majority of the full court did not agree with J Sackville and the matter then proceeded to the High Court.

Full Court Decision

High Court Decision

The High Court agreed with Justice Sackville that the 1987 transfers were void under section 121 of the Bankruptcy Act.

In coming to its decision, the High Court discussed the presumptions that have until now been in operation in relation to matrimonial relationships. As you know, embedded in Australian Law are doctrines such as the presumption of resulting trust (where a Court will presume, unless there is a husband and wife relationship, that parties who contribute in unequal shares of the purchase price, will hold the property in those same shares, even though the property is held as joint tenants) and the presumption of advancement (where it will be presumed that the husband intended a gift to his wife where the husband has contributed a greater percentage of the purchase price).

The High Court has in its judgement embraced the concept that “where a husband and wife purchase a matrimonial home, each contributing to the purchase price and title is taken in the name of one of them, it may be inferred that it was intended that each of the spouses should have one-half interest in the property regardless of the amount contributed by them.”

Essentially, the High Court has embraced a modern view on the conventional legal and equitable principles that the law has otherwise found to be applicable in marriage relationships. This is only, however, a presumption and can be rebutted by contrary facts existing at the time.

Summary

What does this mean in practice?

In my opinion, the judgement of the High Court does not mean that the starting point in every bankrupt estate is that a trustee is entitled to a half interest in the matrimonial home where it is registered in the name of the non-bankrupt spouse.

It must be remembered that the High Court’s Decision was enlivened because Mr Cummins transferred his interest in the properties for no consideration at a time when he knew he had significant liability to the Deputy Commissioner.

Further, it is not sufficient to make out an allegation of a threat of creditor claims leading to a transfer of property into the name of a non-bankrupt spouse simply because the bankrupt spouse was a professional and feared being sued for negligence. In my view, there has to be something more than asset protection in mind at the time the matrimonial property is purchased or transferred for a trustee in bankruptcy to make a claim on the property. (Viz Insolvency and intent to defeat hinder or delay creditors rights)

Cases Since Cummins

Nguyen - Bankrupt Husband

- Property in name of Mr & Mrs Nugyen. She argued she had made all of the payments.

- She argued that she was not married, notwithstanding a traditional wedding ceremony in Vietnam; that the couple had always told everyone they were married, and that the bankrupt husband wore a wedding ring.

- This was to assert that Cummins did not apply, and that the principles in Calverley v Green meant the whole property was held on resulting trust for her.

- Held, per Raphael FM, that they were married, and that she had not made the deposit and initial mortgage payments to purchase the property anyway.

- Trustee awarded 50% interest.

Huen

- August 2003 Purchase of property in name of Mr & Mrs Huen.

- 1st September 2003 Mr Huen left Mrs Huen and signed an ‘agreement’ that she owned 100% of the subject property..

- 22 August 2005 Mr Huen went Bankrupt

- October 2005 Application for divorce, effective 31st January 2006

- Official Trustee argued void transfer under section 120 bankruptcy Act. Further, following Cummins decision that the bankrupt at all times owned 50% of the property and so the relative contributions of the parties are irrelevant

Wife argued resulting trust arising from payment by her of mortgage payments after husband left.

Held that Cummins principle applied, giving rise to an inference of equal ownership of property, irrespective of unequal contributions. Held there was nothing to rebut this inference & 50% interest awarded

Bankruptcy & Family Law Legislation

Amendment Act 2005

Effective 2005 the Family Court of Australia has had jurisdiction in Bankruptcy matters under this new legislation.

This new legislation opens the door for Trustees and aggrieved spouses to effect the outcome of property distributed whether it be to the spouse or providing a priority right to claim against those assets within a bankrupt estate.

.

There are three main scenarios that can be effected by this legislation

1) Bankruptcy after separation and prior to property orders being finally dealt with under the Family Law Act. The Trustee in Bankruptcy will be given an automatic right to intervene where a party becomes bankrupt in the course of family law property proceedings. This will enable the Trustee to put forward submissions in relation to the claims of creditors.

2) Bankruptcy after separation and subsequent to property orders being finally dealt with under the Family Law Act. Where orders have been made by the Family Court but not implemented prior to bankruptcy the doctrine of relation back may continue to apply. The new provisions will allow the Trustee to bring an application to have the proceedings reheard to take into account the interest of creditors where those interests had not been properly considered

Scenario 1: Bankruptcy after separation but prior to Orders

Scenario 2: Bankruptcy after Separation & subject to Orders

3) Separation after bankruptcy, but prior to property orders being finally dealt with by the trustee in Bankruptcy. Where a couple separate after one party has become Bankrupt but during the period of bankruptcy, the non bankrupt spouse will be able to have his/her interest in the property recognised and lodge a Proof of Debt to participate in a distribution from the Bankrupt estate of any property, which has not been dealt with. For reason of certainty, no claim can be made against property that has already been distributed by the Trustee. The Family Court will deal with this claim.

Scenario 3: Separation after Bankruptcy and prior to Orders

The first decision under this new legislation had been given by the Family Court in Livanes V Melluish as Trustee on 30th August 2007

Family Court Decision in the matter of Livanes V Melluish

Facts:

- Husband had ATO liability of approx $6 Mil and equity that vested in the Trustee in the order of $2.5 mil.

- Wife had Family Law Court proceedings on foot.

- Trustee argued at best wife should receive a money order against the husband and claim in the Bankrupt Estate receiving on a pari parsu basis the same distribution as those other creditors.

- The court even though expressing some concern that the outcome of this case would principally see the ATO and therefore the tax payers of this land loose out, awarded a 50% interest of the bankrupts equity in the property to the wife.

Commentary

In summary family law is now clearly going to have a far greater impact on bankruptcy Administrations and from experience where in particular under Scenarios 1) & 2) previously detailed any claim made by the Trustee will have to have significant merit and funds to support that claim as the Family Court appears at present very much pro the spouse.

Final Note

For a more comprehensive viewing of those cases referred and others of interest please click on Relevant Bankruptcy Cases of Interest on the home page