This paper examines, in a limited way, the interaction between the Family Law Act 1975 (Cth) and the treatment by the Family Court of the nature and characteristics of liabilities in the determination of a property settlement.
It is often said that the Family Court is a creature of debt creation. That is to say, parties often come to Court attempting to convince a trial judge that the net pool of assets is either greater than it is or lesser than it is.
Frequently debts suddenly appear in circumstances where the marital assets are about to be divided between the parties. One party may not be aware of the existence of such debts.
Parents suddenly seek repayment of loans made to one spouse during the marriage.
In this paper we will consider the following:
- Matrimonial property and the discretion of the Family Court to recognise liabilities.
In circumstances where the Court or the parties are in the process of deciding how the division of matrimonial assets should be structured, generally the exercise which is adopted is to follow the four step process to determine the basis of the net pool of assets. However, even though we are all familiar with the four step process, we need to bear in mind the decision in Stanford’s case1 which raises issues about that very process (though the High Court specifically did not address this directly). The High Court found that the Full Court failed to address whether it would have been just and equitable to make the orders, if the wife had not died. In any event, however we look at the priority of the steps we apply when working out a property settlement, a fundamental step is to look at the assets of the parties as well as the liabilities of the parties. This is a given in any property settlement where we are concerned to ascertain the net wealth of the parties.
In considering the division of matrimonial property there are two approaches, either a global approach (namely adding up all of the assets and deducting all of the liabilities thereby deriving a net pool) or an asset by asset approach (looking at each individual asset and considering the parties contribution to each individual asset) is acceptable. Re: Norbis v Norbis2.
As with arguments about what constitutes the property of the parties, similar issues apply with respect to the liabilities of the parties, for example:
- Is the liability in fact a debt of the parties which must be repaid or were monies advanced as a gift?
- Is the liability a joint debt or a debt incurred by one party to the marriage?
- Is the liability in the form of a loan which is secured or unsecured?
- Is the liability vague or uncertain?
- In relation to a company or a trust, should those liabilities be taken into account in the same way as other debts?
- Is the liability a debt to a third party? If so, should it be included in the net pool of assets and repaid at settlement?
- Should the whole of the liability be included in the net asset pool or should the debt be discounted?
- Is the liability one which should be taken into account if it was incurred post separation?
- Loans or advances from parents
If it is asserted that a loan from a third party is bona fide, then we would normally look at the evidence. This may be in the form of a loan agreement or a mortgage. For example, does the agreement have clear and precise terms as to the amount of the debt, the terms of the repayment of the debt and whether the debt attracts interest? Parties can enter into an oral contract in respect of a loan which can make proving the debt harder.
A significant Family Court decision highlights loan agreements and gives an example of how parents who lend money to their married children are at risk of not being able to recover their loan in the event of a separation.
In Sulo & Colpetti3, the Court found that two substantial unsecured loans from a wealthy father to his married adult son could not be treated in the proceedings as a debt owing to the father.
His Honour Justice Watts gave several reasons for not including the loans totalling $380,000 (plus interest on the second loan) in the pool of assets to be divided:
First, the two loans had become unenforceable because of the six-year deadline to recover a debt. Such loans were determined as being “statute barred”.
Second, there was no evidence from the husband’s father that he intended to “actively pursue a claim” against his son for repayment.
“I accept that the husband does not enjoy a close and loving relationship with his father,” Justice Watts stated in his decision, “but I conclude there is nothing in the husband’s father’s mind to attempt to recover the monies against the husband.”4
“In fact,” Justice Watts added, “the husband indicated during the trial that his main fear was that after his father died his five siblings would attempt to enforce the debt.”5 The father was aged 84 at the time of the Family Court hearing.
The treatment by His Honour that the statute of limitations applied underlined the fact that the father could not legally demand repayment of his loans to his son at any time in the future.
The husband’s father had made a $150,000 interest-free loan to his son in late 1995, repayable on demand. (The son’s wife unsuccessfully argued before the Family Court that this loan was, in fact, a gift.)
And in September 2002, the father made a second loan to his son, this time of $230,000 at 10% annual compound interest – repayable on or before April 2003.
Under the written loan agreement for the second loan, no interest was payable provided the debt was repaid by the due date. Again, the loan was not repaid.
In Sulo v Colpetti, the son had signed an acknowledgement of both debts in August 2009 – after the six-year period had expired in both instances. The acknowledgement of both debts after the six year period did not cure the unenforceability of the loan.
In CT v TK Kessey6, the Court looked at the treatment of contributions to marital assets made by a parent to a spouse. The wife’s mother sold her home and used the monies from the sale to build an extension on the property owned by the husband and wife at Earlwood. The wife’s mother contributed approximately $75,000 to the construction costs. After the extension was built, she lived in the home for a number of years until her death.
At first instance, Justice Coleman in the absence of any evidence from the wife’s mother, analysed the mother’s contribution and took into consideration the relationship between the wife and her mother, including the fact that the wife had cared for her mother and looked after her welfare prior to her death. His honour found that the contribution was made as a result of the mother-daughter relationship thereby accepting the mother’s financial contribution in the wife’s favour.
The husband appealed the orders made by His Honour on a number of grounds one of which was the provision to the wife of 62.5% of the net proceeds of sale of the Earlwood property. The husband contended that the amount of approximately $75,000 from the wife’s mother should be treated as a contribution by him alone (he had given evidence about his concerns for the wife’s mother and stated that it was he who had initially suggested that the wife’s mother should live with he and his wife). In the alternative the husband contended that the parties’ contributions should be assessed as being made by the parties equally.
The Full court dismissed the Appeal. In relation to the contribution from the wife’s mother, the Court looked at a number of authorities concerning the treatment of gifts by one of the parents to both parties in the context of s79. Their Honours noted:
“It was submitted by counsel for the appellant husband that Gosper is distinguishable from the present case because Gosper was concerned with the matter of gifts and in the present case there is no evidence of a gift. In our opinion the application of the principles enunciated in Gosper should not be so limited. Rather those principles should be regarded as being applicable in all cases where there has been an advance of money or property by a parent ( or perhaps even by some other relative) of one of the parties, to one or both of the parties (or to their property), and the circumstances of the advance cannot be categorised as a loan, or as any other recognised commercial transaction.” 7
Finally, in Reynolds (KD and PA)8, the husband’s Appeal related to a number of findings arising out of the husband’s dealings with his parents. The husband and wife operated a family company and a family partnership, as a result of their farming activities in WA. The husband was a shareholder in a company which also included other shareholders, namely his parents. His parents transferred land to the company. The partnership which also included the wife and the husband’s parents farmed the land rent free. His Honour found the company and the partnership to be shams.
In giving evidence the accountant for the company referred to the financial situation as being akin to a “bickie barrel”. There were a number of interrelated transactions between the company and the partnership which resulted in the husband at the trial submitting to the Court that a debt to the partnership (which at that time was stated to be worth $109,950) should be included in the matrimonial asset pool. His Honour declined to include the debt in the pool of martial assets. He stated:
“However, I am not prepared to make a finding to the effect that as against the property owned by the husband I should offset a debt to the partnership of $195,950 other than in the sense that the notional debt represents the source of payments for assets acquired by him. Part of those assets are his shareholding in the company. The shareholding has a present value of $171,211.07 even though it is highly unlikely that presently it could be realised in that sum or any sum at all by reason of the control of the husbands parents as directors of the company. I think that the only realistic way of looking at the debt of the husband to the partnership and his shareholding in the company is in terms of a financial resource of indefinable but substantial value available to him through, but subject to, the dynastic control of his parents while they live.”9
On Appeal the husband’s counsel submitted that the debt was real and not fictional and that by way of a concession his client was prepared to submit to the Court that the debt should be discounted because there was no evidence that the debt should be repaid immediately.
Their Honours rejected this submission and stated:
“The generosity of the family coffers appears to have been bestowed upon all members of the partnership, each of whom have substantial debts to the partnership. The evidence is that no member of the partnership has been required to pay back any portion of these debts, which were in existence for a considerable period prior to the trial. In our view, it was open to his Honour on this evidence to find that it was unlikely that the family members of the partnership would call in the debt from the husband. We are therefore of the view that his Honour was not in error in disregarding the debt and treating it as a nominal one only…”10
- Unsecured Liabilities and Third Party Creditors
In Biltoft v Biltoft11, the husband claimed that the assets of the parties should be sold and their debts repaid because at the time of the hearing the parties were insolvent. The wife claimed that she should receive a property at Bulls Creek and a cash payment to provide her with an amount of 60% of the net pool of assets.
In this case the Court examined the issue of third party creditors and unsecured loans.
The trial judge determined the assets of the parties to be two properties (at Greenwich and Bulls Creek) and mining shares. The husband had some superannuation savings which were taken into account as a financial resource. In considering the liabilities of the parties the husband claimed that his liability to Mr Horrocks (a business associate) arising out of payment by Mr Horrocks to BNZ of a bank loan, which was secured by a joint and several guarantee given by the husband and Mr Horrocks, constituted a liability of the marriage which should be taken into consideration by the trial judge when calculating the net pool of assets. If this occurred there would be no assets left after the repayment of the debt.
However, the trial judge had difficulty given the state of the evidence in quantifying the loan to Mr Horrocks. The evidence regarding the circumstances surrounding the guarantee for the loan was vague. The trial judge was justifiably suspicious about the recovery of the loan, based on the evidence given by the husband and Mr Horrocks. His Honour decided that the loan was equivalent to the value of the Greenwich property; therefore the only asset he would deal with in the final settlement would be the Bulls Creek property. He left the Greenwich property in the husband’s hands.
The husband cross appealed the order by the trial judge which provided for the Bulls creek property to be sold and giving the wife 60% of the net proceeds of sale. The Full Court dismissed the husband’s cross appeal.
Their Honours noted:
“In the present case, the liability of the husband to Mr Horrocks is unsecured. Mr Horrocks gave evidence before the trial judge but did not seek to intervene in the proceedings and had, up to the date of the trial not taken any steps to recover the amount due to him from the husband. In 1991, he was aware of the marital problems of the husband. He has taken legal advice to protect his interests but has not instituted proceedings in the Courts to recover the debt because he said he does not believe in litigation to resolve commercial matters where the parties are talking and, because in 1993, the husband raised these proceedings with him as a reason why he was unable to settle with him. He did not seek to intervene in the present proceedings. Moreover between 31 July 1991 and the commencement of the hearing, he has not sought to negotiate with the husband to recover his debt. The evidence disclosed that he has at all times been slow and/or reluctant to pursue his rights against the husband.”12
Furthermore, their Honours also looked at the position of unsecured creditors (as opposed to secured creditors). In the joint judgement their Honours quoted from Ascot Investments Pty Ltd v Harper & Anor13 where Gibbs J said that the Court:
“must take the property of a party to the marriage as it finds it. The Family Court cannot ignore the interest of third parties in the property, nor the existence of conditions or covenants that limit the rights of the party who owns it.”14
There are circumstances therefore where the Family Court has the discretion to;
- take into consideration unsecured liabilities; or
- ignore such a liability; or
- discount such a liability.
These circumstances would depend on the factual merits of each case for example, whether a loan is likely to be enforced or not.
Their Honours also commented on the obligations of both parties to give notice to any significant creditors or third parties stating:
“If as a result of the order of the court in the property proceedings, the ability of a creditor or claimant to recover his or her debt or claim is likely to be affected, notice of the Family court proceedings must be given to that creditor or claimant.”15
Also in that case, the Court noted that there was no rule of priority as between a creditor or a spouse. Their Honours said:
“There is no requirement that the rights of an unsecured creditor or a claim by a third party must be considered and dealt with prior to the court making an orders under s 79, nor is there a rule of priority as between a creditor claimant and a spouse. Those rights, however, cannot be ignored. They must be recognised, taken into account and balanced against the rights of the spouse.”16
In the marriage of AF Petersens C.F.S. and AF Petersens LM17, the Court looked at third party loans and loans from one parent to a spouse. Justice Nygh looked at inter alia:
- the existence of a debt owed by a family company to a third party, namely the husband’s father; and
- was the debt in fact recoverable.
In this case, the parties were married for 14 years and had three children, all of whom lived with the wife after separation. When the husband and wife first came to Australia they purchased a property in NSW. The husband claimed that the purchase price for the property was derived from his father in Sweden. As there was no evidence that the husband was to repay the purchase price the Court inferred that the monies were either a gift or his entitlement. The parties sold their first property and purchased a second property; on this occasion again the purchase price came from monies advanced by the husband’s father (and partly funded by a loan from the ANZ bank). There was no evidence that the fathers second advance to purchase the second property had to be repaid. Therefore, the Court characterised the second advance from the husband’s father as a gift.
Subsequently the husband’s father visited Australia and made further monies available to the parties to purchase an adjoining property known as Bimbil Park. The monies were also used to purchase stock; and provide funds to their family company which the husband and wife established and in which they each held a share. However, the voting rights attached to the husband’s share, gave him effective control over the company. The loan from the father was recorded in the minutes of the company meeting. The loan was recorded as being payable by a certain date with an interest rate of 10% and secured by way of a mortgage against Bimbil Park. That property was registered in the name of the company. The amount of the loan was recorded as $300,000 and a date was set when the principle was repayable. Interest was payable on the 7 July each year.
The parties also operated a farming partnership (CMS and LM AF Petersons). The company leased the Bimbil Park property to the partnership under a tenancy at will.
After the parties separated and the wife commenced proceedings, the husband’s father, on the day the husband filed a cross claim in the Family Court, served notice on the parties of his intention to recover his debt and sought to exercise his power of sale over Bimbil Park pursuant to the mortgage. The husband’s father did this notwithstanding payment of the principal had fallen due earlier and repayment of the debt has not been demanded by him at the earlier date.
Before the final hearing, the parties had agreed to sell Bimbil Park and pay all debts, save and except the debt to the company. The balance of the net proceeds of sale was to be held in trust for the parties pending settlement. Afterwards a provisional liquidator was appointed. The father commenced proceedings in the Supreme Court to recover the debt.
Predictably, the wife denied the existence of the debt to the husband’s father and the husband asserted that it existed and should be paid as a matter of priority.
Because the husband’s father was not a party to the proceedings the Court found that it could not determine conclusively if the debt was truly owed to the father. However the Court held that it was necessary for the Court to reach a conclusion regarding whether or not the debt was owed to the third party. It held that the Court had the jurisdiction to determine the existence of the alleged liability to the husband’s father, which it did.
Ultimately, the Court found the shares in the company were of no value but the husband’s father could still pursue the repayment of the debt from the parties and thereafter deal with the proceeds as he wished. The Court made a number of significant findings namely:
- that the Court will not normally take into account debts incurred after separation;
- the Court will sometimes ignore debts for which one party should bear exclusive responsibility even though the debt was incurred during a long marriage;
- the Court can deal with property undiminished by debts, because a debt does not diminish property until it is paid or executed on a property;
- although a loan to a party by his/her parents may create a legally enforceable debt and may be an “obligation”, if it is not in fact enforced, and is not likely to have been met, it should not be taken into account.
The debt owing to the husband’s father was recognised – there was evidence to support this, for example the mortgage over the property at Bimbil Park. The existence of the debt could hardly have been said to have been a device in order to defeat the wife’s claim.
His Honour said:
“making assumptions most favourable to the wife, all that could be said is that the father lent money for the benefit of his son and was prepared to wait for his money. If the family had remained united, the father may have been prepared to wait indefinitely. However, the marriage broke up and the father decided to enforce his claim. Whether he did so out of a genuine concern that his investment might be lost as the result of the division of the parties assets or because he wanted to assist his son by pre-empting the assets with a view eventually of giving the money back to his son, is a matter of pure speculation. Even if the latter were correct, there is nothing this court could do to prevent the father from enforcing a lawful debt and dealing with the proceeds he recovered as he saw fit.”18
Though it appeared that the husband’s father had not forgone his claim, the quantum was not taken into account by the Court specifically. However, the husband received by way of final distribution 60% of the net pool of assets and the wife 40% because the bulk of the assets had been derived from monies advanced by the husband’s father. The husband was left with an indefinite obligation to his father. The effect of the orders was to take the loan into consideration in a general way rather than in a specific way.
His Honour noted:
“the next question is to what extent I should discount the assets of the parties having regard to their indebtedness. I do not for these purposes for any moment doubt the existence and enforceability of the debts that I have listed above. But in taking account the “obligations” of the parties, I must consider how pressing such an obligation is.”19
His Honour recognised the debt owing to the husband’s father but he went on to discount the amount owed to the father in his judgment and gave orders to the effect.
- Pt V111AA
Pt V111AA of the Family Law Act relates to orders and injunctions binding on third parties.
Prior to the introduction of Pt VIIIAA, the decision of Ascot Investments clarified the position of secured creditors. After that decision the Family Court could not make orders which would subordinate the legitimate interests of third parties to the interests of the husband or wife, and it could not make an order to the detriment of third parties.
Pt VIIIAA now allows the Court to make orders binding on third parties. It can:
- Bind a creditor to one party as opposed to both;
- Bind a creditor to accept payment of different proportions of the debt as opposed to the position before the orders were made;
- Restrain a third party from repossessing property;
- Restrain a third party from commencing legal proceedings against a party to the marriage.
Section 90AE allows for the Court to make an order under s79 binding on a third party.
4.1 Section 90AE(1)
In proceedings under s.79, the Court may make any of the following orders:
- An order directed to a creditor of the parties to the marriage to substitute one party for both parties in relation to the debt owed to the creditor;
- an order directed to a creditor of one party to a marriage to substitute the other party, or both parties, to the marriage for that party in relation to the debt owed to the creditor;
- an order directed to a creditor of the parties to the marriage that the parties be liable for a different proportion of the debt owed to the creditor than the proportion the parties are liable to before the order is made;
- an order directed to a director of a company or to a company to register a transfer of shares from one party to the marriage to the other party.
4.2 Section 90AE(2)
In proceedings under s.79, the Court may make any other order that:
- directs a third party to do a thing in relation to the property of a party to the marriage; or
- alters the rights, liabilities or property interests of a third party in relation to the marriage.
Section 90AF(1) allows for the Court to make an order under s114 binding on a third party.
4.3 Section 90AF(1)
In proceedings under s.114, the Court may:
- make an order restraining a person from repossessing property of a party to a marriage; or
- grant an injunction restraining a person from commencing legal proceedings against a party to a marriage.
- Valuing liabilities
Just as assets are valued in proceedings where there is no agreement between the parties as to their value, liabilities can also be the subject of a valuation exercise. Such liabilities can involve personal or business debt. A single expert may be asked to look at loans to or from a company with a view to including those loans in the valuation or excluding them.
If for example a loan is made to one of the parties on concessional terms, its value at the date when the parties assets are to be split may be different to its notional face value. Such a liability can be discounted to convert the loan into its present day value. In O’Connell’s case (which is an unreported judgement of Justice O’Ryan in 1996), His Honour determined the value of a $600,000 debt to be $265,000, taking into consideration a long interest free period over which the loan was repayable.
- Loans to and from related companies or trusts
Often family entities, such as a company or a trust, receive the benefit of loans from shareholders (generally the husband and the wife). Such loans are recorded in the financial accounts (in the shareholder loan accounts) either as a debit or a credit.
The treatment of such loans has been considered by the Court in a number of cases in varying ways.
In Kowaliw JI v Kowaliw AG20, Justice Baker considered amongst other issues the treatment of liabilities arising out of a failure of a business. During the marriage the husband had left his employment and purchased a 25% interest in a company which engaged in door to door selling. To purchase the interest the husband borrowed $20,000 from the bank. The loan was secured against the home of the husbands parents. When his parents sold their home, the husband then became indebted to his parents.
The company was subsequently wound up and the husband’s interest in the company ceased to exist. The husband was left with substantial debt. The wife was neither a director or shareholder of the company and had had no involvement in the day to day running of the business. The wife’s position at the trial was that all of the debt associated with the company should be regarded solely as being the debts of the husband. The husband’s position was that the debt should be considered as a matrimonial liability and included therefore in the pool of assets to be divided by the Court.
His Honour noted:
“Marriage is for most couples an economic partnership. Married couples live together and work together with the ultimate object of purchasing a home, paying it off, acquiring other assets with the overall object of attaining a higher standard of living. The reported decisions in respect of applications for settlement of property under s 79 of the act are unanimous that both parties should share the economic fruits of a marriage, having regard to the provisions of s79(4) and s 75 (2) although not necessary equally.”21
He also stated:
“As a statement of general principle, I am firmly of the view that financial losses incurred by parties or either of them in the course of a marriage whether such losses result from joint or several liability, should be shared by them (although not necessarily equally) except in the following circumstances:
(a) where on the parties have embarked upon a course of conduct designed to reduce or minimise the effective value or worth of matrimonial assets, or
(b) where one of the parties has acted recklessly, negligently or wantonly with matrimonial assets, the overall effect of which has reduced or minimised their value.”22
His Honour found that the husband’s investment in the company was an attempt by him to produce income and assets for the parties and to improve their overall financial position. For 6 years the husband derived an income from the business. The fact that the company ultimately failed was not due to any deliberate fault or otherwise occasioned by the husband. In his judgement, His Honour characterised the debt remaining from the business venture as a debt incurred by both parties and it was included in the net pool of assets to be divided.
There were other debts in this case which were incurred by the husband as a result of his inept and economically reckless behaviour which were excluded from the net pool of assets. The husband had allowed the prospective purchaser of the former matrimonial home to live in the property rent free for 12 months until the property was sold. Payment of the mortgage, the arrears and rates were not made during that period. These debts were calculated by His Honour and remained the husband’s sole responsibility as a result of his reckless conduct. Those debts were left for the husband alone to pay.
- Loans and Division 7A issues
Under the Income Tax Assessment Act Pt 111 Div 7A (s109B to 109ZE) amounts paid, forgiven or lent by a private company to certain associated entities (including individuals) are treated as dividends unless they come within specified exclusions. This means that any loans made by a company to a private shareholder or shareholders associate made on or after 4 December 1997, which are not repaid prior to the end of the income year in which the loan was made are potentially treated as a deemed dividend and therefore become assessable income in the hands of the shareholder or associate. However, if the loan is subject to a loan agreement in writing which has a specified date for repayment and an interest rate charged at the minimum benchmark rate, then broadly the deeming provisions will not apply. The loan agreement must be in place at the time the loan is made and minimum repayments of the loan must be made each year.
A deemed dividend may occur when a private company pays an amount to a shareholder or an associate or forgives a loan to the shareholder or an associate. A payment can include cash, the transfer of property, a guarantee or an obligation arising out of a guarantee.
An associate shareholder is defined as a relative, partner, trust controlled by the shareholder or company controlled by the shareholder.
The rules regarding deemed dividends are complex.
In Campbell v Kuskey23, the husband’s Appeal arose in part as a result of the treatment by the trial judge of the parties’ loan accounts in a company operated by the husband and wife during the marriage. Prior to the hearing the parties accountants had each prepared a joint statement recommending that the loan accounts be reduced by payment of a fully franked dividend in order to limit the husband and wife’s exposure to taxation. The effect of the proposal would leave a reduced liability of $86,328 which would be paid by the husband rather than an amount of $193,724.
The loan accounts had changed between 1993 and 1996, from $87,726 credit to $178,431 debit in the case of the wife and from $30,032 credit to $221,000 debit in the case of the husband.
At first instance, His Honour made orders which did not take into account the parties contingent tax liability in respect of their loan accounts. He made no specific order in regard to the debt. He ordered that the husband indemnify the wife for any liability she may incur arising out of her involvement with the company. He also made a vague adjustment in favour of the husband which appeared to take into consideration the husband’s possible tax liability pursuant to s 75(2).
Both parties had urged the trial judge to accept the proposals from their respective accountants namely that the company declare a fully franked dividend which would be applied to extinguish their loan accounts. His Honour refused to do so.
During the Appeal the wife accepted that there was a possible tax liability in relation to the parties’ loan accounts.
The Full Court criticised the treatment by the trial judge of the loan accounts as a s75(2) factor:
“In our opinion, in most cases it would not be appropriate for trial judges to treat a contingent tax liability in this fashion. As a general rule, trial Judges should make a finding on the balance of probabilities as to whether or not such a liability exists, and if so in what amount. If it be found that such a liability exists, the Court should take it into account when calculating the net amount available for distribution between the parties, but in an appropriate case discounting the amount of such liability of circumstances warrant, for example, through uncertainty as to the time for payment.”24
The Full Court granted the husband’s Appeal and was able to readjust the orders made by the trial judge because of significant findings made at the trial. The Full Court in fact followed the advice of both parties’ accountants finding that it would be a just and equitable result.