Property acquired by a bankrupt after the date of bankruptcy becomes property that is divisible amongst the bankrupts’ creditors. However, case law supports the conclusion that after-acquired income remains vested in the bankrupt. The question then becomes: what happens to property that is purchased by the bankrupt with after-acquired income? This question was considered in the recent case of De Santis v Aravanis [2014] FCA 1243.

Background 

This case was an appeal from an earlier decision. Mr and Mrs De Santis were married, though later separated but did not divorce. In 2006, Mr De Santis purchased property, which was registered in his name. Mr De Santis subsequently mortgaged the property and was required to make loan repayments.

Mr De Santis was made bankrupt in 2007 and Mr Aravanis was appointed as his trustee in bankruptcy.

Mrs De Santis claimed that an agreement existed whereby Mr De Santis held the property on trust for her. At first instance the court declared that the whole of the property was vested in Mr Aravanis as trustee in bankruptcy of Mr De Santis.

This decision was appealed by Mrs De Santis, who sought a declaration that Mr Aravanis held the property on trust for her. Mr Aravanis also cross-appealed, raising the question of the extent to which any indemnity vested in him.

The Court declared that Mrs De Santis was entitled to a declaration that Mr Aravanis held the property on trust for her.

After-acquired property?

As a trustee, Mr De Santis had a right to recoup mortgage payments properly incurred in the pre-bankruptcy period. However, on Mr De Santis’ bankruptcy this vested in Mr Aravanis, pursuant to section 58(1) of the Bankruptcy Act 1966 (Cth) (Bankruptcy Act).

One of the issues in contention on appeal was whether any right of recoupment acquired by Mr De Santis in the post-bankruptcy period constituted “after-acquired property”, under s 58(1)(b) of the Bankruptcy Act, making it divisible among creditors, pursuant to section 116(1)(a) of the Bankruptcy Act.

Mr Aravanis argued that he was entitled to be indemnified via the right of recoupment as the loan repayments occurring after Mr De Santis’ bankruptcy were ‘after-acquired property’. Mrs De Santis argued that because the post-bankruptcy mortgage payments were attributable from Mr De Santis’ wages, they were not ‘after-acquired property’.

The Court considered the distinction between after-acquired property and after-acquired income, noting that after-acquired property is divisible among creditors while after-acquired income, as supported by case law, is not but instead remains vested in the trustee. The right of indemnity by Mr De Santis was after-acquired property derived from after-acquired income.

The Court considered existing case law on this point and were particularly persuaded by the views of the Full Court in Meriton Apartments[1] where the it was noted that, “Income is not property under the Bankruptcy Act” and that “the Bankruptcy Actrecognises classes of property other than the section 116(2) classes, may fall outside the notion of property divisible amongst creditors.”[2] Therefore, the fact that Mr De Santis’ mortgage payments were not specifically exempted by s 116(2) of theBankruptcy Act was not an issue.

The Court concluded that any property acquired by a bankrupt with after-acquired income does not vest in the trustee in bankruptcy. This position was not viewed to limit the scope of section 58 and section 116 of the Bankruptcy Act but instead as avoiding injustice. The injustice being that if property acquired with income earned by a bankrupt was to vest in the trustee then this means that, although the Bankruptcy Act permits a bankrupt to earn income, it does not permit the bankrupt to acquire any property with that income.  

The Court was of the view that if a bankrupt may keep property acquired with after-acquired income then they will be encouraged to generate the income. By encouraging a bankrupt to optimise income there will be benefits for creditors, as well as encouraging the bankrupt to be usefully employed.

So did Mr Aravanis have a right to indemnity?

Ultimately the Court believed the ‘after-acquired property’ argument failed to have regard to the special nature of the property which Mr De Santis derived from the mortgage payments. The Court concluded that even though the payments were not ‘after-acquired property’ Mr Aravanis still had a right to indemnity out of the payments, as Mr De Santis’ right to recoupment vested in Mr Aravanis on his appointment as trustee in bankruptcy.

It made no difference that the mortgage payments were attributable to Mr De Santis’ after-acquired income, the principle still remained that upon a trustee’s bankruptcy the right of indemnity vests in the bankrupt’s trustee in bankruptcy.

Whilst in this case the trustee in bankruptcy ultimately had a right to the ‘property’ this was a special circumstance where the property was a trustee’s right to recoupment. Generally speaking, if a bankrupt uses after-acquired income to purchase property this will not be divisible among creditors.