Retaining the family home in bankruptcy


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Retaining the family home in bankruptcy

There are many adages about the family home, such as ‘home is where the heart is’, ‘home sweet home’ and ‘there is no place like home’. This is because the family home is where cherished lifetime memories are made.

The family home is also often the single biggest asset available to a trustee in many bankrupt estates. Understandably, the biggest fear of any individual who is struggling to pay their debts is losing their family home.  It can represent the worst consequence of financial failure bringing distress and displacement to not only the insolvent debtor, but also the family who is affected by the financial failure.

To the ordinary person who has little or no knowledge of bankruptcy laws, the natural reaction to financial distress is panic and fear and this is why the first question someone considering bankruptcy may have is, “what will happen to my home?”.

On the other hand, creditors seeking to recover their debts are faced with the predicament of initiating bankruptcy proceedings against a debtor which could be costly and ultimately, not commercially favourable.  An unfavourable outcome might arise where there is minimal equity in the debtor’s family home or there is likely to be difficulties in a trustee entering into possession of the property.  An example may be resistance from a non-bankrupt spouse of the prospect in a family law proceeding.

 Are there different options available to a trustee? 

Fortunately, the sale of the family home is not the only option available to a trustee in recovering their interest.  There are different methods the trustee can take to realise the bankrupt’s beneficial interest in the property thanks to the flexibility and commerciality the Bankruptcy Act affords to a trustee.

A trustee is able to conduct the administration in a way which not only achieves the best result for creditors, but also minimises the harm to the bankrupt and their non-bankrupt partners/relatives. A trustee has at their disposal a range of options in dealing with estate property that maximises the outcome for the mutual benefit of creditors and debtors.

In other words, it is often the case that the best outcome is to reach a commercial settlement that results in the bankrupt retaining the family home and, at the same time, provide for a maximum dividend rate to creditors.  In effect, a win-win scenario plays out which is entirely equitable and in accord with the relevant bankruptcy laws and applicable code of ethics.

Discretionary powers of trustee

Under sections 116(1) and 58(1) of the Bankruptcy Act, the bankrupt’s divisible property, including the beneficial interest in their family home, become assets in their bankrupt estate.  The trustee is then required to realise the assets for the best possible value to obtain funds to distribute to their creditors.

However, Section 134(1) of the Bankruptcy Act, allows a trustee to exercise the following discretionary powers:

  1. Sell all or any part of the property of the bankrupt;
  2. Accept, a sum of money payable at a future time as the consideration or part of the consideration for the sale of any property of the bankrupt;
  3. Make a compromise in respect of any claim;
  4. Make such allowance out of the estate as they think is just to the bankrupt, the spouse or defacto partner of the bankrupt or the family of the bankrupt; and
  5. Administer the property of the bankrupt in any other way.

Maximising outcomes for debtors and creditors  

The classic scenario for optimising the outcome for both the debtor and the creditor is where there is marginal equity in the property, and a forced sale of the property by the trustee would result in all proceeds being diminished by the costs of recovery.

Costs of recovery can include court costs to enter into possession, Family Court intervention, adverse family reaction and the usual array of conveyancing and selling costs. The trustee’s costs are also likely to increase during a difficult court-ordered possession.

The alternative solution would be for the trustee and the non-bankrupt spouse to negotiate a settlement of the trustee’s interest in the property whereby the trustee releases the bankrupt from a sale of the property for an agreed upon price paid either as a lump sum or instalments or as a hybrid lump sum/instalment arrangement. The trustee’s interest would ordinarily be sold to a third party, usually the spouse of the bankrupt.

A settlement on the property is a cost-effective means of realising the trustee’s interest in the property, which could maximise the dividend to creditors whilst allowing the bankrupt and their family to retain the family home.

Settlements may also be possible in scenarios where the equity level is much higher. At first instance, it may appear that with a high level of equity a settlement, would not be possible given the size of the trustee’s interest. However, there are many factors which could affect a trustee’s claim which are discussed below.

Factors affecting trustee’s claim 

The value of the bankrupt’s realisable beneficial interest in a property is calculated by deducting from the current market value of the property, the amounts owed to the mortgagee(s) and other security holders, council and water rates and selling expenses. If the property is owned jointly with a non-bankrupt person, the value of their net interest is, likewise, deducted in arriving at the value of the bankrupt’s interest in the property.

However, various areas of law including common law, equity law and in particular, family law may alter the extent of the trustee’s claim to the bankrupt’s beneficial interest in the property.

The variables which will affect a trustee’s interest in the property can include:

  • The registration of the bankrupt on the title of the property ie. Sole proprietor, joint tenant with another person (eg. spouse), tenant in common with another person(s);
  • The intention of the owners at the date of purchase if the property is owned by a number of persons as tenants in common in unequal proportions.
  • The borrowers in the loan agreement which is secured by the mortgage on the title.
  • The amount of any claim for exoneration by the non-bankrupt owner.
  • The financial contributions towards the acquisition of the property and subsequent improvements to the property;
  • Judgements under the Family Law Act concerning the property or proceedings on foot;
  • Claims by persons/parties that they have either an equitable interest in the property or a secured interest, that has not been registered on the title of the property.

Each of the above factors will influence the size of the trustee’s claim to an interest in the property.

Example 1 – Joint ownership – repayment plan for 50% 

A typical example is where the bankrupt and their non-bankrupt spouse own a property as joint tenants, are both parties to the home loan secured by a mortgage and earn a similar level of income. If the gross net equity in the property is $200,000, the trustee will have a claim for $100,000. Where it is appropriate to do so, the trustee may be able to allow the settlement amount to be paid over a period of time in regular instalments. Given the appropriate circumstances, this may be the best outcome for all concerned including creditors, particularly if any attempt by the trustee to recover the property by force through a court of law could be met with resistance by the non-bankrupt spouse. Escalating costs of a dispute could erode the funds available for a dividend to creditors.

Example 2 – unequal proportions – intention of the parties

A more complex example may involve a property held in unequal proportions as tenants in common between bankrupt and non-bankrupt spouse.  The intention of the non-bankrupt was to purchase the property for their own benefit, but they needed to purchase the property in joint names to meet the lender’s eligibility criteria for the home loan on the house.  Therefore, the intention of the parties at the time of the purchase in regarding the beneficial ownership of the property, will reduce the size of claim by a trustee.  The intention of the parties has been well established in case law:  Weston v McAuley [2017] FCCA 1.

Conversely, insolvent debtors and their advisors ought to carefully consider the trustee’s potential claim in scenarios where the insolvent debtor has a smaller proportion of ownership or is not registered on title of a matrimonial home. A 1% ownership of a property as an owner in a tenant in common could potentially expose the insolvent debtor and the non-bankrupt owner to a claim of 50% or more by a trustee. Also, a trustee may have a claim to an interest in a matrimonial home, the title of which is registered in the sole name of the non-bankrupt spouse.

In other words, the trustee’s claim can be higher or lower than the nominal value of ownership registered on title in scenarios where the insolvent debtor has an equitable interest in the property that does not correspond to the ownership proportion. The doctrines of resultant trusts, presumption of advancement, constructive trusts and survivorship may apply. Advisers and solicitors should familiarise themselves with these concepts to better assess the trustee’s claim and the overall consequences of bankruptcy.

Example 3 – trustee’s claim larger than ownership proportion on title

The following scenarios could lead to a trustee making a larger claim to a beneficial interest in the property than the interest of the bankrupt recorded on the title of the property:

  1. The property was purchased with the intention of the bankrupt being the ultimate beneficial owner of the property;
  2. The bankrupt has made significant financial contributions to the acquisition of the property registered in the sole name of another person.
  3. The property was purchased in the sole name of one of the spouses whilst it eventuates that it was intended to be their matrimonial property. (Re: Trustees of the Property of Cummins (A Bankrupt) v Cummins(2006) 227 CLR 278.)

Settlements for minimal or no equity

Where there is no net equity in the family home at the date of bankruptcy, the bankrupt and their family can continue to occupy their home as long as they maintain their payments of the mortgage, rates and insurance plus maintain the property. Then, when the bankrupt is discharged from bankruptcy which is normally after a 3-year period, they can re-acquire the net equity in the property based on the market value of the property at that time and the amount owing to the mortgagee(s)

Alternatively, where there is a small net equity in the property, but it is not commercial for the property to be sold, the trustee may enter into an agreement whereby the bankrupt or the purchaser (usually the non-bankrupt spouse) agrees to pay an amount equal to the value of the net equity in the property in either a lump sum or by instalments and the trustee agrees that upon receipt of the agreed amount, the trustee will make no further claim to the bankrupt’s interest in the property.

The means by which a trustee can realise the bankrupt’s beneficial interest in a property without the sale of the property is with a formal document or contract known as a Deed of Settlement or Deed of Release normally executed by the trustee and the non-bankrupt co-owner(s) of property.

The deed will ensure that the trustees have no legal right to pursue their interests in the property pursuant to Section 116(1) and 58(1) of the Bankruptcy Act.

The deed will also ensure the trustees have no legal right to pursue their interests in the property after the discharge date pursuant to Sections 127 and 129 of the Bankruptcy Act.

Helping debtors and creditors find the best alternative    

As a professional advisor or solicitor, you will often be confronted with a difficult position of providing advice to insolvent clients facing financial hardship and risk losing their family home. Having a knowledge of these factors which influence a trustee’s claim to a beneficial interest in the property, will enable you to provide your clients with an accurate prognosis on the likely consequences of bankruptcy and determine the most optimal alternative available to the insolvent debtor.

Creditors and their advisors can also benefit from a knowledge of the alternatives available by a trustee and the various commercial settlements. Such knowledge will better enable a creditor and their advisor to consider the most optimal strategy in recovering their debt and the cost-benefit analysis of undertaking a court-appointed bankruptcy.

The takeaway from this article is that no matter how difficult the home equity position may appear, there are many different variables at play which could result in the bankrupt and their family retaining possession of their family home.

Furthermore, there is scope for a creditor to derive a dividend from an estate even when the equity in a property is negative, marginal or claimed by other parties.

If you would like to discuss your or your clients’ financial circumstances to ensure you understand the consequences of a potential bankruptcy scenario, please contact Anthony Bagala at dVT Group on 0417 935 681 or by email abagala@dvtgroup.com.au.

dVT Group is a business advisory firm that specialises in business turnaround, insolvency (both corporate and personal), business valuations and business strategy support.

Author profile – Anthony Bagala

Anthony recently became a registered trustee in bankruptcy and senior manager at dVT Group and has over 15 years of knowledge handling a wide range of personal and corporate insolvency administrations and restructuring.

Anthony engages clients and stakeholders with empathy and compassion and conducts himself with a strong sense of ethics and a service orientation to the stakeholders and affected parties.