Understanding bankruptcy

Property that can be taken by the trustee is called ‘divisible property’. This includes houses, land, and motor vehicles worth over $8100 (as at April 2021, indexed).

The general rule, to which there are important exceptions, is that all property owned by the bankrupt at the time of the bankruptcy, or acquired during the bankruptcy, is divisible or ‘vests in’ the trustee (s 116(1)(a) Bankruptcy Act 1966 (Cth) (‘Bankruptcy Act’)).

This means that the trustee becomes the legal owner of the property and has a duty to sell the property so that the proceeds can be distributed to creditors.

The trustee will also sell any part share that the bankrupt has in jointly owned or mortgaged property if commercially practicable.

Section 116(2) of the Bankruptcy Act and Part 6 Division 3 of the Bankruptcy Regulations list the property that the trustee cannot take from a bankrupt. This includes:

1. necessary household property (e.g. beds, fridges);
2. property the bankrupt uses to earn income, such as tools of trade, plant and equipment, professional instruments and reference books of the bankrupt to the value of $3800 (as at April 2021, indexed) in value, and such other items of the same nature as the creditors or the court might allow;
3. a motor vehicle that does not exceed the value of $8100 (as at April 2021, indexed). If the vehicle is worth more than this, the trustee can take the vehicle and must refund the bankrupt $8100 (see ‘Keeping a mortgaged car during the bankruptcy’, below);
4. the interest of a bankrupt in a regulated superannuation fund, or a payment from such a fund received on or after the date of bankruptcy, if the payment is not a pension (see ‘Superannuation’, below);
5. the proceeds of certain damages claims for compensation, and any property purchased with, or substantially with, the proceeds of such a claim;
6. policies of life insurance or endowment assurance in respect of the life of the bankrupt or the bankrupt’s spouse, or the proceeds of such policies that are received on or after the date of bankruptcy;
7. the amount of money a bankrupt holds in a retirement savings account (RSA), as defined in the Retirement Savings Accounts Act 1997 (Cth) (‘RSA Act’), and any payment to a bankrupt from an RSA received on or after the date of bankruptcy if the payment is not a pension;
8. money paid by way of loan or grants through certain government rural support schemes, generally where the money was for household support or rehabilitation;
9. a payment to the bankrupt under a payment split under Part VIIIB (Superannuation Interests) of the Family Law Act 1975 (Cth) (‘FL Act’) where the eligible superannuation plan involved is a regulated superannuation fund or an RSA and the splittable payment involved is not a pension under the Superannuation Industry (Supervision) Act 1993 (Cth) or the RSA Act; and
10. any property that, under an order under Part VIII (Trustees) of the FL Act, the trustee is required to transfer to the spouse of the bankrupt.

Market value of divisible property

When considering whether to seize and sell certain assets, the trustee must have regard to the costs of seizing and selling the asset in relation to the item’s value (e.g. reg 27(4)(e) Bankruptcy Regulations). The trustee must also have regard to any special or health or medical needs of members of the bankrupt’s household and whether the property is reasonably necessary for the functioning of the bankrupt’s household (reg 27(4)(d)).

Offering to buy an asset from the trustee

Sometimes, the trustee might ask if the bankrupt knows someone (usually a spouse/partner) who is prepared to purchase an asset or a share in an asset. This might happen where the bankrupt has equity in a house, or where the asset would not attract a good price. If you are in this situation, make sure that you are not paying more than market value for the asset or share of the asset.

Defence services homes mortgages

The trustee cannot take the equity of a member of the Defence Force in a house subject to a Defence Service Homes Mortgage without the approval of the Secretary of the Department of Veterans’ Affairs (‘DVA Secretary’) (s 45A Defence Service Homes Act 1918 (Cth)). Whether or not consent is given depends on the government’s policy at the time and therefore should be checked with the department before bankrupting. 

If the DVA Secretary does not consent, the trustee can ask for the DVA Secretary’s refusal to consent to be reviewed internally and can make a further appeal to the Administrative Appeals Tribunal (AAT). If the house is sold before the bankrupt is discharged, the trustee will be able to take the proceeds of sale.

The trustee can take any divisible property the bankrupt acquires after the date of becoming bankrupt and before being discharged.

This might include:

• property given to the bankrupt; 
• property won by the bankrupt (e.g. Tattslotto);
• property inherited by the bankrupt; or 
• mortgaged goods paid off during bankruptcy. 

Can a mortgagee sell a security property if the bankrupt does not default on loan payments?

No. A mortgagee retains its right to sell the mortgaged property or goods if the bankrupt defaults under the mortgage during the period of the bankruptcy. However, there must be a default: the Bankruptcy Act (s 302) prevents a mortgagee from selling property simply because a debtor becomes bankrupt.

If there is a mortgagee sale, the proceeds will go first to pay the debt owing to the mortgagee. If any money is left over, it will be claimed by the trustee to pay the creditors in the bankruptcy.

Can a trustee sell a security property even if the bankrupt does not default on loan payments?

Yes. Whether or not the bankrupt defaults on loan payments, the trustee can sell mortgaged goods or land if the bankrupt has sufficient equity in them. Equity equals the market value of property minus amounts owed to mortgagees. If the equity is so low that the trustee is not interested in repossession, a bankrupt can keep the mortgaged goods, so long as payments to the creditor are maintained.

Keeping a mortgaged car during the bankruptcy

A bankrupt can keep a mortgaged car provided:

1. they do not default on payments; and
2. the equity in the car is so low that it is not commercially practicable for the trustee to seize and sell the car.

The bankrupt needs to be aware that the equity in the car will likely increase as payments are made (even though most cars depreciate in value). If the equity becomes more than the protected amount for a car used for transport (i.e. $8100, as at April 2021, indexed) before the bankruptcy ends, the trustee might become interested in selling the car. However, the increase in equity might not be significant if the car also depreciates significantly over the bankruptcy period.

For example, if a car is worth $11 00 and the bankrupt owes $2500 to the creditor, the bankrupt’s equity is $8500. The trustee could seize the car, but is unlikely to be interested if the amount of seizable equity is only $400. By the time three years of bankruptcy is completed, even if the bankrupt pays out the mortgage, the effect of depreciation will probably keep the bankrupt’s equity in the car at less than $8100. If this is the case the trustee will not be able to claim the car.

The trustee is only likely to claim jewellery, antiques and collections of significant value. The trustee does not claim the average wedding or engagement ring.

A bankrupt can keep trophies and awards that are described in the Bankruptcy Regulations. At present, the Bankruptcy Regulations protect sporting, cultural, military or academic awards made to the bankrupt in recognition of their performance (s 116(2)(ba)(ii) Bankruptcy Act; reg 28 Bankruptcy Regulations).

Closing bank accounts

The trustee is entitled to claim money held by the bankrupt in accounts with banks, credit unions, building societies, etc. In general, the trustee will not close the bankrupt’s bank accounts or stipulate how many accounts the bankrupt can keep open.

If a bank is a creditor in the bankruptcy, Australian Financial Security Authority (AFSA) sometimes recommends that a bankrupt close any old accounts with that bank in order to prevent the bank from attempting to freeze accounts or set off debts.

How much can a bankrupt keep in a bank account?

While all the money in the accounts of a bankrupt vests in the trustee upon bankruptcy, under section 134(1)(ma) of the Bankruptcy Act the trustee ‘may make such allowance out of the estate as he or she thinks just to the bankrupt, the spouse or de facto partner of the bankrupt or the family of the bankrupt’. Accordingly, the trustee may allow the bankrupt to keep some monies in a bank account that are necessary for normal living expenses. If there is money set aside for a specific expense, such as rent, school expenses or a fuel bill, the bankrupt should either make this clear to the trustee, or withdraw the money and pay the bill before entering into bankruptcy.

Closure or freezing of account by trustee or bank

If a trustee fails to provide the bankrupt with sufficient funds for living expenses, the bankrupt should contact AFSA, which may then investigate the matter.

If a bank follows section 125 of the Bankruptcy Act and freezes its bankrupt customers’ funds (including Centrelink payments) on being advised of the bankruptcy, the bankrupt should give their trustee the account number and the bank’s facsimile number so the trustee can instruct the bank to unfreeze the funds.

Withdrawing money from bank accounts before bankruptcy

It is not advisable to transfer money to another account or withdraw it before bankruptcy in an attempt to hide the asset from the trustee. Concealing or removing property that is valued $20 or more in the 12 months before bankruptcy is a criminal offence (s 265 (4)(a), (7) Bankruptcy Act). The trustee has the right to investigate the matter and claim the money, even if it is not in the bankrupt’s name at the time of the bankruptcy.

A bankrupt can keep a motor vehicle if their equity in the car does not exceed $8100 (as at April 2021, indexed), or more if the court or creditors agree. The bankrupt must use the vehicle primarily for transport. Therefore, if the vehicle is unregistered and just sitting in the garage, the bankrupt will not be able to keep it. If the vehicle is worth more than $8100 (indexed), the trustee can sell it but must return $8100 (indexed) to the bankrupt (s 116(2C) Bankruptcy Act).

Superannuation received after the date of bankruptcy

In general, the trustee cannot claim superannuation contributions received on or after the date of bankruptcy if the payment is a lump sum. If the payment is a pension it will be treated as income (see ‘What happens to the bankrupt’s income?’, below) and the trustee can claim it.

However, trustees are empowered to claw back (reverse) contributions to an eligible superannuation plan made by a person who later becomes bankrupt in circumstances where the property would probably have become part of the bankrupt’s estate, or would probably have been available to creditors if the property had not been transferred and the bankrupt’s main purpose in making the transfer was to defeat creditors by preventing the property becoming divisible among the creditors (s 128B Bankruptcy Act). Section 128C of the Bankruptcy Act extends this power to contributions made by a third person for the benefit of the bankrupt.

Superannuation received before bankruptcy

The trustee can claim superannuation contributions received by a debtor before the date of bankruptcy.

The trustee cannot seize:

• damages money that the bankrupt has received for a personal injury; or
• any property bought with, or substantially the whole property bought with, damages money.

If the trustee sells property and the bankrupt has used damages money to pay some (but not substantially the whole) of the property’s purchase price, the trustee must pay the bankrupt ‘so much of the proceeds of realising the property as can be fairly attributed to the protected [compensation] money’ (ss 116(2)(g), 116(4) Bankruptcy Act).

Pain and suffering vs loss of income component of damages

Courts will not:

• split personal injury damages amounts into amounts for pain and suffering and amounts for loss of income; nor
• allow a trustee in bankruptcy to claim the loss of income component of the damages amount paid to a bankrupt. As long as the damages are awarded on a claim for personal injury rather than property, the whole amount of a damages payment is protected by section 116 of the Bankruptcy Act.

While valuable art collections or antiques will vest with the trustee, the Official Receiver (AFSA) will not claim assets that would be considered normal house­hold property.

For a list of items a bankrupt can keep, see reg 27 Bankruptcy Regulations and ‘Warrant to seize property’ under ‘Enforcement of court orders‘ in Chapter 5.2: Are you in debt?

Payment of claims

Insurers cannot refuse to pay a claim just because the insured person goes bankrupt. Section 54 of the Insurance Contracts Act 1984 (Cth) (‘IC Act’) requires the insurer to pay a claim if the insured’s conduct did not cause or contribute to the loss. Most insurance claims relate to damage to a house, car or person, and so have no connection with any conduct leading to bankruptcy.

Cancellation of a policy

Insurers cannot cancel a policy just because a person becomes bankrupt, unless the policy has a specific term allowing this to be done. (Section 60 of the IC Act provides that an insurer can cancel an insurance contract in certain circumstances, but bankruptcy is not one of these circumstances.)

Note that bankruptcy may make it difficult to obtain or renew some types of insurance policies.

Refusal to cover

Some insurers automatically refuse new applications from bankrupts for insurance coverage. This can be a particular problem for tradespeople who need public liability insurance to work. Consumer advocates argue that such policies are outdated and are pushing for reform.

If an insurer refuses a claim or cancels a policy

If an insurer does refuse a bankrupt’s claim, or cancels a policy on the sole ground that the insured is a bankrupt, without there being a specific term in the contract, the bankrupt should lodge a complaint with the Australian Financial Complaints Authority (tel: 1800 931 678).

The trustee’s power to sell

A trustee can sell a bankrupt’s house or land whether or not it is secured by a mortgage.

The mortgagee’s power to sell

A creditor who holds a mortgage over the property can sell the property without the trustee’s consent if mortgage payments fall into arrears.

Proceeds of sale

In general, after payment of loans that are secured by a mortgage over the house, legal fees and selling expenses, the proceeds of sale are divided between any joint non-bankrupt owners and the trustee.

What happens if there is no equity in the property?

The trustee will not take action to sell property if the bankrupt has no equity in the property. However, the trustee might still lodge a caveat on the title even where there is no equity. 

Equity in the property might increase during the time allowed to the trustee to sell the property, due either to increases in property values or to payments made by the bankrupt or another person.

Selling equity to the non-bankrupt spouse

While the trustee generally has an obligation to sell any property, the trustee might choose not to sell property immediately if the bankrupt’s equity (share) is not valuable enough to leave any surplus for the creditors after paying expenses and the trustee’s costs. In such a case, the trustee is often happy to accept an offer from a friend or relative of the bankrupt to purchase the bankrupt’s share.

Trustee’s power to sell property after discharge

The trustee has the power to make a claim on any equity that the bankrupt might have in the property for a certain period of time after the bankrupt is discharged (ss 127, 129AA(3) Bankruptcy Act).

The length of time available to the trustee to make a claim is:

1. for property disclosed in the statement of affairs – six years after discharge; 
2. for property acquired before the bankruptcy and not disclosed in the statement of affairs – 20 years from the date on which the person became a bankrupt;
3. for property that is acquired after the bankruptcy and disclosed to the trustee prior to discharge – six years after discharge; and
4. for property that is acquired after the bankruptcy and disclosed after discharge – six years after disclosure.

The trustee can extend the six-year period referred to above by giving the bankrupt written notice within the six-year period. The notice can extend the period for up to three years. There is no limit on the number of extension notices that a trustee might give.

Challenging a trustee’s claim to equity in a property that has increased in value after the date of the bankruptcy

Depending on the facts, a discharged bankrupt might be able to defeat a trustee’s claim for equity built up in a property after bankruptcy. For example, if the trustee allowed bankrupts with no equity in their property to remain in the property without properly explaining to them that the trustee could later claim the property, the trustee’s behaviour may amount to a representation that the trustee was no longer interested in the property and had abandoned it to the bankrupts.

Jointly owned house

If a bankrupt, B, owns a house jointly with a non-bankrupt, C, the trustee can register as joint owner with C. C is often given an option to purchase the trustee’s interest in the property. If C cannot afford to do this, C might join with the trustee in the sale of the house. C and the trustee will then usually receive equal shares of any money that is left after paying all mortgages and expenses. If C refuses to cooperate in a sale, the trustee can apply to the court to obtain an order of sale. The trustee can then sell the house without C’s consent.

Family Court issues

Where a bankrupt is, or becomes, involved in family law property or spousal maintenance proceedings, the Family Court must, on the application of the trustee, join the trustee to the proceedings in circumstances where the court is satisfied that the interests of the bankrupt’s creditors may be affected by the proceedings (see Part VIII FL Act).

Once the trustee becomes a party to family law property or spousal maintenance proceedings, the bankrupt is not entitled, without the court’s consent, to make any submissions in relation to any property that is vested with the trustee (see Part VIII FL Act). The court is required to consider the effect of any proposed order on the creditors’ ability to recover a debt when making family law property orders.

Where a person becomes bankrupt after the finalisation of family law property or spousal maintenance orders, the trustee may also apply to vary or set aside those orders (s 79A FL Act).

A bankrupt is obliged to tell the trustee if they are involved in family law property or spousal maintenance proceedings. They must also disclose to the trustee any family law property or spousal maintenance orders that they have been a party to.

The above information also applies to a person who has entered into a personal insolvency agreement under Part X of the Bankruptcy Act. Under section 35A of the Bankruptcy Act, both the Federal Court and the Federal Circuit and Family Court of Australia may order that bankruptcy proceedings be transferred to the Family Court.

Expert advice should be obtained in relation to family law proceedings where one party to the marriage is bankrupt or becomes bankrupt (whether or not Family Court orders have been made).

Where the bankrupt partner has used house equity solely for their own benefit

If the bankrupt has mortgaged a house to raise money solely for their own benefit (e.g. the bankrupt got a loan in their own name for overseas travel), the non-bankrupt spouse should get advice on whether the trustee should be claiming less than 50 per cent of the equity.

Non-bankrupt spouse contributed more than 50 per cent of sale price and/or mortgage repayments

Get advice, as the non-bankrupt spouse might be able to claim more than 50 per cent of the property. 

When can’t the trustee sell the bankrupt’s house?

The trustee cannot sell a bankrupt’s house if:

• the bankrupt bought the house with ‘protected money’; or
• the house is subject to a Defence Service Homes Mortgage (see ‘Mortgaged property’, above).

‘Protected money’ is defined in section 116(2D) of the Bankruptcy Act. Protected money includes money received as damages for personal injuries, money received through a rural adjustment scheme, and superannuation money received after the date of bankruptcy (subject to the regulations referred to above under ‘Superannuation’).

In theory, a trustee can take action against a bankrupt’s overseas property.

In practice, the trustee is unlikely to take any action unless the creditors agree to pay all costs.

Whether or not the trustee is able to obtain control of any property overseas also depends on the domestic law of the place where the property is held.

Jointly owned property

See ‘Jointly owned house’, above, for discussion of jointly owned houses. If there is other jointly owned property (e.g. a joint bank account) the trustee will try to find out the contribution to the property and then claim the proportion contributed by the bankrupt.

Property in the sole name of the non-bankrupt spouse

Where the bankrupt has made no contributions to the purchase of the property 

If the non-bankrupt spouse has property in their own name (e.g. money in the bank, a car) and this property has been purchased without the aid of the bankrupt, then the trustee cannot take that property.

Property transferred by the bankrupt prior to bankruptcy

The trustee can sometimes claim property that is in the name of the non-bankrupt spouse (or another person) if the bankrupt contributed to the purchase of property and then transferred ownership to the non-bankrupt spouse before the bankruptcy.

These antecedent transactions are void against the trustee, so the trustee can claim property that the bankrupt has transferred:

1. for no or little consideration in an undervalued transaction within five years prior to bankruptcy if the property was transferred for less than market value (s 120 Bankruptcy Act);
2. to defeat creditors prior to bankruptcy and the bankrupt was insolvent at the time of the transfer (s 121 Bankruptcy Act); and
3. to a third party in an undervalued transaction or to defeat creditors at any time prior to bankruptcy if the transfer was made with the intention of defrauding creditors (s 121A Bankruptcy Act).

A transfer by an insolvent person to a creditor before bankruptcy may give the creditor a preference over the other creditor(s) and is void against the trustee (s 122 Bankruptcy Act).

The trustee will not be able to claim property, even if it falls within the first two of the above categories, if:

• the transfer was made in order to pay tax debts or maintenance liabilities (not including liabilities under a binding financial agreement within the meaning of the FL Act); or
• the transfer was under a debt agreement; or
• the cost of recovering the property would outweigh the benefit to creditors.