Many small business owners are coming under significant financial pressure as a result of economic uncertainty and rising costs. A common concern is whether the family home may be at risk if they find themselves facing bankruptcy.

There are actually a variety of ways to protect the family home against bankruptcy. If advice is sought early, a refinance of the family home to fund a Personal Insolvency Agreement (PIA) may provide a pathway out of bankruptcy.

What happens to a person’s ownership interest in the family home if they become bankrupt?

When a person becomes bankrupt, a trustee-in-bankruptcy is appointed who takes control of their property for the purpose of recovering and realising its value to divide among the bankrupt’s creditors. Such property includes any ownership interest of the bankrupt in the family home.

A person is typically bankrupt for 3 years. Upon discharge from bankruptcy, their debts are extinguished.  

What if the bankrupt’s spouse is the sole registered owner of the family home?

If the bankrupt’s spouse is the sole registered owner, the Court can still inquire whether it was intended for the bankrupt to retain an ownership interest.

This issue arises most commonly where the bankrupt contributed financially to the purchase of the property in their spouse’s name.

In a decision of the High Court in Trustees of the bankrupt estate of Cummins v Cummins [2006] HCA 6:

• The family home was initially acquired in joint names and subsequently transferred into the sole name of the bankrupt’s spouse prior to bankruptcy.
• The trustee-in-bankruptcy claimed a 50% interest in the family home on the basis that the purchase of the property in joint names established an intention by the spouses to be equal owners.
• The bankrupt’s spouse claimed a bigger share (76%) based on the alleged percentage of her financial contributions to the purchase price of the property.

The High Court decided in favour of the trustee-in-bankruptcy finding that the evidence disclosed that the spouse and the bankrupt had always intended to be equal owners of the property.

Some commentators interpreted the Cummins decision as giving rise to a new doctrine of a “marital trust” whereby matrimonial property would be presumed to be owned 50/50 in the absence of evidence of contrary intention.

However, the High Court rejected the above interpretation in Bosanac v Federal Commissioner of Taxation (2022) 275 CLR 37.

In Bosanac:

• Mr and Mrs Bosanac were married in 1998. In 2006, they purchased a property registered in Mrs Bosanac’s sole name, which became the family home.
• The home was paid for using sale proceeds from the couple’s previous home, which they had jointly owned, plus a home loan facility in their joint names.
• The ATO subsequently obtained judgment against Mr Bosanac for $8 million in unpaid taxation liabilities.
• The ATO brought a claim against Mrs Bosanac alleging that she held the family home on trust for herself and Mr Bosanac as to 50% interest, reflecting their presumed intention as husband and wife, alternative their respective percentage contributions to the purchase price of the property.

The High Court dismissed the ATO’s claim and rejected the existence of a so-called marital trust. In circumstances where Mr and Mrs Bosanac had contributed equally to the purchase price of the property, the High Court found that they made a deliberate decision that the property would be owned solely by Mrs Bosanac.

Interestingly, the Court took into account that Mr Bosanac was a sophisticated businessman who would have understood the consequences of registering the property solely in his wife’s name.  

Consequently, Mr Bosanac had no ownership interest in the family home against which his creditors, including the ATO, could make a claim.

What if ownership of the family home is transferred to the non-bankrupt spouse prior to bankruptcy?

The Bankruptcy Act contains provisions whereby a trustee-in-bankruptcy can claw back certain transfers of property undertaken prior to bankruptcy. Such transactions are deemed to be “void” against the trustee-in-bankruptcy.

Where the trustee-in-bankruptcy can establish that a transaction was undertaken for the purpose of defeating the interests of creditors, there is no time limit for how far back the trustee can investigate transactions: section 121 of the Bankruptcy Act.

The onus under section 121 is on the trustee-in-bankruptcy to prove that a creditor-defeating purpose existed, however this purpose is deemed to exist if the trustee-in-bankruptcy can prove that the bankrupt was insolvent at the time of the transaction.

More commonly, the trustee-in-bankruptcy can attack a transfer of property to a related party for less than market value, if it occurred in the period of 5 years before bankruptcy: section 120 of the Bankruptcy Act. If the transferee can prove the bankrupt was solvent at the time of the transfer, the “claw-back” period reduces to 4 years.

Because of sections 120 and 121 of the Bankruptcy Act, we strongly advise against transfers for natural love and affection where one spouse is facing bankruptcy.  

There are better ways to approach this problem.

Purchasing the ownership interest of the bankrupt estate in the family home

In a common scenario where the family home is jointly owned, a 50% ownership interest will vest in the trustee-in-bankruptcy upon appointment.

However, it is not a straightforward matter for the trustee-in-bankruptcy (or anyone) to sell a 50% interest in a property. If the non-bankrupt spouse refuses to cooperate, the trustee has to apply to the Court for orders to vacate the property and facilitate the appointment of estate agents and lawyers to market and sell the property.

As taking these steps requires the trustee-in-bankruptcy to incur considerable expense, the non-bankrupt spouse can be in a strong position to negotiate a discounted price for the trustee’s ownership interest, if this will increase the net proceeds received by the bankrupt estate by avoiding those expenses.

Another factor that can reduce how much the non-bankrupt spouse needs to pay for bankrupt estate’s ownership interest is where joint borrowings against the property include money which was invested in the bankrupt’s failed business.  

For example, if the property is worth $1 million and the bank loan is $600,000 of which $300,000 was invested in the failed business, this will reduce the value of the bankrupt estate’s ownership interest as follows:

The above scenario would typically be achieved through a refinance of the property into the non-bankrupt spouse’s sole name.

Leveraging the family home to fund a Personal Insolvency Agreement (PIA)

There is a formal process under the Bankruptcy Act whereby a person who is facing bankruptcy (“a debtor”) can make a PIA proposal to their creditors as an alternative to bankruptcy.

The terms of a PIA typically involve creditors sharing in a fixed upfront cash payment procured by the debtor as final settlement of their debts, instead of waiting for whatever proceeds (if any) that may be recovered through the bankruptcy process.

To commence the PIA process, the debtor appoints a controlling trustee who investigates the debtor’s financial affairs and provides a report to creditors comparing the estimated dividend to creditors under the debtor’s PIA proposal against the estimated dividend to creditors in bankruptcy.

If the return to creditors is quicker, larger and/or more certain than bankruptcy, the controlling trustee makes a non-binding recommendation to creditors to accept the proposal.

Creditors then vote on the PIA proposal at a meeting convened by the controlling trustee. The proposal is approved if it is voted for by a numerical majority of creditors who are also owed at least 75% of the value of the bankrupt’s debts.  

The amount to be offered to creditors under the PIA proposal can often be raised through a refinance of the family home. This avoids bankruptcy altogether.

Takeaways

• Small business owners facing actual or potential bankruptcy should seek specialist advice as soon as possible to maximise their options to protect family assets including the family home.  
• Transfers for natural love and affection when facing bankruptcy are not a good strategy for protecting the family home.
• Other strategies include purchasing the bankrupt estate’s ownership interest in the family home for a discounted price after bankruptcy.  
• If advice is sought early, it may be possible to avoid bankruptcy altogether by refinancing the family home to fund a Personal Insolvency Agreement.

To discuss asset protection planning and how to mitigate bankruptcy risks, please contact Velocity Legal’s specialist disputes and insolvency team.