Since the Global Financial Crisis it has been increasingly common for parties involved in property settlement disputes to be fighting over property with a net negative value or, in extreme cases, for one party to be declared bankrupt.

Despite common perception, a spouse being declared bankrupt in the middle of court proceedings for property settlement does not automatically end the proceedings or mean that the bankrupt’s assets are put out of reach of the other spouse in a property settlement.

When a party is declared bankrupt, a trustee in bankruptcy is appointed who will manage the orderly sale of the bankrupt’s assets and the payment of their creditors. The assets (and liabilities) that come within the power of the trustee in bankruptcy are known as “vested bankruptcy property”.

In family law proceedings, the trustee does not automatically stand in the shoes of the bankrupt spouse. Rather, either a party or the trustee in bankruptcy must apply to the court for the trustee to be joined as a party to the proceedings.

The advantage of joining the trustee in bankruptcy is that upon their appointment, pursuant to s 79(12) of the Family Law Act 1975 (Cth), the bankrupt spouse loses the power to make any submissions to the court with respect to the vested bankruptcy property. From that time on, only the trustee can make those submissions or agree to Orders affecting that property. On the other hand, there are also risks in joining the trustee in bankruptcy as the Court may also then make Orders transferring property from the non-bankrupt spouse to the trustee in bankruptcy if it considers that to be just and equitable or the non-bankrupt spouse might receive less of the bankrupt’s vested property through family law proceedings than if they pursued their legal entitlements as, for example, a joint owner of real estate.

It is also important to be aware that not all property that is the subject of family law proceedings will become part of a bankrupt’s vested bankruptcy property. Property that generally falls outside the power of the trustee in bankruptcy includes:

  1. Ordinary household items;
  2. Tools used to earn income worth up to a $3,700 (as at 20 September 2015);
  3. Vehicles used mostly for transport, where the net equity in each vehicle is no more than $7,600 (as at 20 September 2015);
  4. Superannuation funds received on or after the date of bankruptcy;
  5. Life insurance policies and any proceeds from those policies received after the date of bankruptcy;
  6. Personal injury compensation payments;
  7. Assets held by the bankrupt on trust for another person;
  8. If creditors agree, awards of a sporting, cultural, military or academic nature made to the bankrupt which have sentimental value.

The trustee will also not make a claim upon any income of a bankrupt up to a certain limit (being $54,081.30 net of tax for a person with no dependents as at 20 September 2015).

Most importantly, property that a spouse owns on trust for other people does not form part of the vested bankruptcy property. This means that the bankrupt spouse will still have the power to make submissions in family law proceedings with respect to property they hold on trust for others and may still be able to deal with that property subject to the terms of the relevant trust deed.

Further, it is important to note that the mere fact that property is held on trust for another person does not put it beyond the reach of the family law courts in a property settlement.