In family law property settlement proceedings, if a spouse is declared bankrupt, the trustee in bankruptcy may join the proceedings in an effort to recover funds from the property pool to pay the bankrupt’s creditors.
While in theory this approach sounds sensible, it may not always be prudent for a trustee in bankruptcy to seek to be joined or consent to being joined. In particular, recent trends suggest that trustees are being very cautious about getting involved in proceedings between a bankrupt and their spouse.
The involvement of a trustee in bankruptcy
Becoming bankrupt will not only rid a spouse of liability for their debts, it will also divest them of any interest in their divisible property. The right to take or continue proceedings in respect of their property will vest in the trustee in bankruptcy.
The Bankruptcy Act 1966 (Cth) governs the vesting of a bankrupt spouse’s property in a trustee in bankruptcy. In 2005, amendments were made to both the Bankruptcy Act and the Family Law Act 1975 (Cth) to clarify the law when the competing interests of trustees in bankruptcy and non-bankrupt spouses appear before the courts.
These amendments provide that the vesting of property is subject to Part VIII of the Family Law Act, which governs matrimonial property, spousal maintenance and financial agreements. In 2009, this was expanded to include parties to a de facto relationship.
As a result, the Family Court can alter the interests of the trustee in bankruptcy in ‘vested bankruptcy property’ and order the trustee to transfer such property as the Court determines for the benefit of the non-bankrupt spouse.
The trustee in bankruptcy may be joined to proceedings as a party where:
- the trustee applies to be joined; and
- the Court is satisfied that the interests of the bankrupt spouse’s creditors may be affected by an order.
The non-bankrupt spouse may also make such an application.
If the trustee is joined, the bankrupt spouse will be prevented from making any submissions in the proceedings without leave of the Court.
Despite the availability of this option to be joined to proceedings as a party, recent cases show trustees in bankruptcy are cautious, even reluctant, in electing to do so.
In Grange & Grange  FAMCA 81, Justice Forrest discussed the reason for this at paragraph 5:
… Trustees in bankruptcy are most unlikely to voluntarily expose the vested bankruptcy property that is to be distributed among the bankrupt spouse’s creditors to being subject to adjustment in favour of the non-bankrupt spouse.
Therefore, depending on:
- the vested bankruptcy property;
- the value of the other property in the matrimonial pool; and
- the funds owing to the bankrupt’s creditors,
there may be a risk, if the trustee is involved in the proceedings, that the Court will order some or all of the vested bankruptcy property to be transferred to the other spouse.
In particular, the Court is faced with challenges in cases where the bankrupt’s debts exceed the value of the vested property. The Court is required to balance the interests of the non-bankrupt spouse, who may sometimes have the primary care of children of the marriage, against the bankrupt’s unsecured creditors.
Depending on the nature of the debt and the non-bankrupt spouse’s involvement with its accrual, the Court may be inclined to shift the balance in favour of the non-bankrupt spouse over the interests of a commercial creditor.
Should the trustee in bankruptcy be joined?
It is important for the trustee to obtain full disclosure of all of the property and liabilities of the matrimonial pool outside of the vested bankruptcy property.
Ideally, this includes disclosure of the knowledge or involvement of the non-bankrupt spouse in the accumulation of debt of the bankrupt spouse. Importantly, any benefit the non-bankrupt spouse derived from the debt should also be assessed.
With the assistance of an experienced family lawyer, the trustee should consider the likely outcomes if the proceedings are conducted in their absence, compared with any potential benefit if they are joined as a party.
Similarly, if a trustee in bankruptcy is on the opposing side, the non-bankrupt spouse should consider whether their likely entitlement will increase or decrease if the trustee is joined as a party.