Bankruptcy and the family home: the impact of recent developments.

• Jurisdiction: Australia
• Author: Sarmas, Lisa
• Date: 01 August 2016

CONTENTS I The Issue II The 2005 Bankruptcy Amendments A The Amendments and their Legislative Intention B A Range of Possible Approaches Available to Family Law Courts after the 2005 Bankruptcy Amendments 1 'Section 79 Approach' 2 'Non-Bankrupt Spouse Shares the Debt Approach' 3 'Property and Trusts Approach' 4 'Combination Exercising Broad Discretion Approach' III The Case Law A FLA Cases 1 Worsnop and Lemnos 2 First Instance Decisions of the Family Law Courts B Trusts Analysis: Cummins and Non-FLA Cases after the 2005 Bankruptcy Amendments IV Settlements Outside of Adjudicated Outcomes V Evaluation of Current Law and Practice Regarding Bankruptcy and the Family Home VI Conclusion I THE ISSUE

In Australia, the owner-occupied home remains something of a cultural icon--the 'Great Australian Dream'--having ongoing psychological and emotional, as well as financial, significance. (1) Home ownership, while increasingly difficult to achieve, 'is the most common and most desired form of housing in Australia'. (2) The family home is the asset most commonly divided on spousal and de facto partner relationship breakdown, (3) and more broadly, its fate is likely to be an issue of crucial importance when financial adversity strikes.

In this article, we explore the issue of how the family home is divided when a spouse (used throughout to include a de facto partner) becomes bankrupt with unsecured liabilities that are at least partly paid through sale or buy-out by the non-bankrupt spouse of the bankrupt spouse's interest in the family home. (4) The Federal Court of Australia ('Federal Court') and, from 2000, the Federal Circuit (previously Magistrates) Court of Australia ('Federal Circuit Court') (collectively referred to in this article as 'generalist federal courts') have traditionally had jurisdiction in disputes involving beneficial ownership of the family home in a bankruptcy context. (5) But following amendments to the Family Law Act 1975 (Cth) ('FLA') in 2005, (6) it is now the Family Court of Australia ('Family Court'), the Family Court of Western Australia ('Family Court of WA') and the Federal Circuit Court (collectively referred to in this article as the 'family law courts' when exercising FLA jurisdiction, which includes altering the interests in the property (7) of parties to a marriage or a de facto relationship) that effectively have jurisdiction where a party to FLA property proceedings is or becomes bankrupt. (8) The jurisdiction of the Family Court and the Federal Circuit Court was further extended from 1 March 2009 (with the exception of Western Australia), to include financial disputes on breakdown of de facto relationships, (9) adding to its pre-existing jurisdiction regarding financial disputes arising out of marital relationships. (10)

In our research on the fate of the family home in the context of bankruptcy of a spouse, we noticed that since 2010 there have not been many substantive contested cases dealing with bankruptcy and the family home that have gone to final judgment, whether in the family law courts or generalist federal courts (which continue to retain jurisdiction when there are no FLA proceedings on foot). Prior to 2010 and after the passage of the Bankruptcy and Family Law Legislation Amendment Act 2005 (Cth) ('2005 Bankruptcy Amendments'), the high watermark in terms of case law activity in the Full Court of the Family Court was two cases decided in 2009 by the differently constituted benches of the Court, and adopting divergent approaches: Trustee of the Property of Lemnos v Lemnos ('Lemnos') (11) and Federal Commissioner of Taxation v Worsnop ('Worsnop'). (12) In this period, we noticed that the volume of decided cases dealing with this issue in federal courts exercising jurisdiction under the Bankruptcy Act 1966 (Cth) continued much as it had before, until slowing down in 2010 and thereafter. (13)

We sought to determine specific and dominant trends, outcomes and approaches to this issue by courts post-Worsnop (14) and Lemnos. (15) In the course of trying to do so, we also became interested in why there were not more cases being decided by the family law courts, given the presence of the 2005 Bankruptcy Amendments which we had thought would be likely to lead to more rather than fewer cases, at least in the family law courts. Are there procedural, doctrinal, institutional or strategic reasons behind trustees' (as representatives of unsecured creditors) or non-bankrupt spouses' reasons for not going ahead with litigation? Does it have something to do with the family law courts now having jurisdiction in some of these cases, and with trustee perceptions of how those courts would approach and decide cases (including the deterrent effect of family law cases where judges have been critical of the amount of fees claimed by trustees) (16) and/or uncertainty generated by the amendments themselves, (17) or more specifically by Lemnos (18) and Worsnop? (19) Or, perhaps the 2005 Bankruptcy Amendments struck the right balance between the interests of trustees and non-bankrupt spouses, thereby promoting settlement of these matters rather than litigation? Perhaps the early cases represent a 'blip' effect; a testing of the new provisions? We know that the decline in litigation was not due to a lack of bankruptcies--which have declined since 2010 but remain significant in number (17 202 in 2015-16 compared to 22 163 in 2011-12, as recorded by the Australian Financial Security Authority). (20) In terms of the paucity of cases decided by generalist federal courts post-2010, it is likely that the slowdown in the case law would at least be partly due to the fact that cases involving the trustee's claim to an interest in the family home which occurred in a relationship breakdown context and which would have been heard by them before the 2005 Bankruptcy Amendments are now being heard by family law courts exercising FLA jurisdiction. However, the apparent rarity of cases in the family law courts is more difficult to explain. (21)

We also wondered what sorts of settlements were being reached between trustees and non-bankrupt spouses, in cases where there is no adjudicated outcome. Perhaps the goals of the 2005 Bankruptcy Amendments--in essence, to resolve uncertainty and achieve a better balancing of interests between unsecured creditors and non-bankrupt parties--are being achieved?

II THE 2005 BANKRUPTCY AMENDMENTS

A The Amendments and their Legislative Intention

The 2005 Bankruptcy Amendments have particular significance for non-bankrupt spouses and the trustee in bankruptcy in circumstances where there are FLA property proceedings on foot.

The legislative intention in enacting the reforms was to improve the interaction between bankruptcy law and family law, as part of the federal government's response to the recommendations of the Joint Taskforce Report on the Use of Bankruptcy and Family Law Schemes to Avoid Payment of Tax. (22) Problems in this area were longstanding. (23) In 1992, the Attorney-General's Family Law Council had described the non-interaction of bankruptcy and family law as follows:

It is well recognised that bankruptcy and family law conflict in such a way that when both systems apply simultaneously to a given situation the claims of the non-bankrupt spouse and family and that of the bankrupt's unsecured creditors are in competition. To date that conflict has remained largely unresolved because each piece of legislation, and the policy behind the legislation, favours or gives some sort of protection to the rights of the parties to whom that legislation relates without due regard to the needs and rights of others. (24) Consistent with this, the federal government sought to address 'inconsistencies between family law and bankruptcy law which create uncertainty for all involved and can cause hardship for either or both creditors and non-bankrupt spouses.' (25) The Revised Explanatory Memorandum to the 2005 Bankruptcy Amendments notes that the amendments seek to clarify 'the rights of the bankruptcy trustee and the non-bankrupt spouse ... [by enabling] concurrent bankruptcy and family law proceedings to be brought together to ensure all the issues are dealt with at the same time.' (26) The Memorandum further explains that:

From a bankruptcy perspective, trustees can find themselves in an uncertain position when having to resolve or reconcile competing claims ... The special interest of the non-bankrupt spouse in the marital property created through both financial and non-financial contributions, which may be recognised by the Family Court in exercising its discretion to alter property interests, is not expressly recognised under the Bankruptcy Act ... Different outcomes result depending upon the order in which events occur (those events including separation, bankruptcy and distribution of property by the trustee in bankruptcy). (27) As we discuss below, in bankruptcy matters dealt with by generalist federal courts (where there are no FLA property proceedings on foot), the effect of applying the Bankruptcy Act 1966 (Cth) provisions is that the trustee will be allocated the bankrupt spouse's share of the proprietary interest in the family home using relevant property and trusts principles. (28) Prior to the 2005 Bankruptcy Amendments, when a bankruptcy occurred after a FLA property order was made, the non-bankrupt spouse would be subject to the doctrine of relation back, with the effect that (depending on the time period that had elapsed between the bankruptcy and the making of the FLA property order) the FLA property order is treated as not having been made and any interest in property of the bankrupt that may have been altered in favour of the non-bankrupt spouse is clawed back. (29) Where bankruptcy occurred before FLA proceedings, the practical effect would be that, in the court's view, there was no property of the bankrupt spouse for orders in favour of the non-bankrupt...