One of the aims of bankruptcy law is to provide a ‘fresh start’ for the person after being discharged from bankruptcy. The concept of a fresh start is embodied in laws which release the person from the future liability to pay existing debts upon discharge. Consequently, the individual can start afresh in rebuilding financial security.
Superannuation (subject to contributions recovered by the trustee in bankruptcy) has a special status in bankruptcy as it is property which is not divisible among the creditors of a bankrupt. The protection of super from creditors recognises that the accumulation of super over a person’s working life is instrumental in giving them a fresh start. This protected status is given to few other assets and those assets may be restricted in value. Super has a ‘special’ status in bankruptcy law because an unlimited value is protected and its status is above the family home, which has prime status in other areas of the law, for example social security and tax.
THE PERSONAL EFFECTS OF BANKRUPTCY
Bankruptcy doesn’t only affect a person’s economic status but can also affect them personally. For example:
- a bankrupt must surrender their passport and cannot travel overseas without the consent of the trustee;
- a bankrupt is automatically disqualified from managing a corporation and ceases to be a director;
- a bankrupt cannot be a member of an SMSF;
- a bankrupt is disqualified from being an individual trustee and ceases to be a director of a corporate trustee. A bankrupt member has six months to exit the fund or restructure the fund to a small APRA fund.
WHAT PROPERTY IS DIVISIBLE AMONG CREDITORS?
Property owned by the bankrupt at the commencement of bankruptcy and property acquired by, or devolves on, the bankrupt, from the commencement of bankruptcy until discharge, vests in the trustee in bankruptcy and is divisible among creditors, subject to some exceptions. Property owned by the bankrupt at the commencement of bankruptcy which vests in the trustee could include:
- their home or share of the home -the rights of secured creditors, normally a mortgagee, are generally not affected.
- superannuation payments and life insurance proceeds received before bankruptcy.
Property that vests in the trustee as soon as it is acquired by or devolves on the bankrupt during bankruptcy may include:
- an inheritance from a deceased estate;
- a lottery win.
WHAT SUPERANNUATION CONTRIBUTIONS ARE VOIDABLE?
Superannuation contributions made, by a person who later becomes bankrupt, at any time before bankruptcy are void against the trustee, if the trustee can establish:
- the property would probably have become part of the bankrupt’s estate or been available to creditors if the contribution was not made, and
- the person’s main purpose in making the contribution was to prevent (or hinder or delay) the property becoming divisible among creditors (‘to defeat creditors’).
Void means ‘voidable’ which generally requires the trustee in bankruptcy to undertake legal proceedings to have the transfer declared void by a court. This is an important point because unless the trustee takes action and succeeds in recovering the property, the contribution remains valid.
HOW IS IT DETERMINED THAT THE MAIN PURPOSE WAS TO DEFEAT CREDITORS?
In determining whether the person’s main purpose in making the contribution was to defeat creditors:
- The trustee needs to establish the person’s actual intention was to defeat creditors. However, an inference may be readily drawn in circumstances where the contribution leaves the person without sufficient assets to meet their debts, since the result is the property is not available for division among creditors.
- The bankrupt is deemed to have that main purpose, if it can reasonably be inferred that at the time of the contribution the person was or was about to become insolvent. The actual intention of the contributor is irrelevant.
- The court must consider whether, at any time before the contribution was made, the person had established a pattern of making contributions and whether that contribution is out of character.
- ‘Out of character’ contributions are not automatically assumed to be made with the main purpose to defeat creditors.
- ‘Out of character’ contributions may indicate the contributor was aware of impending insolvency.
Superannuation contributions made by a third party, for example an employer or spouse, for the benefit of the bankrupt are voidable under similar conditions, except the contribution was made under a scheme, to which the bankrupt was a party and the bankrupt’s main purpose in entering the scheme was to defeat creditors. Employer salary sacrifice and spouse contributions made from a joint bank account could be captured under this provision.
THE IMPORTANCE OF ESTABLISHING A PATTERN OF CONTRIBUTIONS
Irrespective of circumstances which may clearly indicate the person was insolvent or was to become insolvent, the court ‘must’ consider whether the person had established a pattern of contributions. If the contribution forms part of an established pattern of contributions, it would not be ‘out of character’ and not indicate that the person was aware of impending insolvency. By establishing a pattern of contributions, superannuation of an unlimited amount may be accumulated and protected in bankruptcy.
PROPERTY NOT DIVISIBLE AMONG CREDITORS
Property which is protected in bankruptcy includes:
- an interest of the bankrupt in a super fund, except super contributions recovered by the trustee;
- a payment, except a pension, from a super fund, received on or after the date of bankruptcy;
- life and endowment insurance policies on the life of the bankrupt or their spouse and proceeds from such policies received on or after the date of bankruptcy;
- damages and compensation for personal injury, wrong or death, in certain circumstances, whether recovered before or after bankruptcy;
- property held by the bankrupt in trust for another person;
- household items reasonably necessary for the domestic use of the bankrupt’s household;
- a vehicle primarily used for transport worth up to $7,900 – the current threshold;
- tools of trade worth up to a total of $3,750 – the current threshold.
ARE PAYMENTS FROM A SUPER FUND PROTECTED?
Apart from pensions, all payments from a super fund received on or after bankruptcy, are protected and are not divisible among creditors. The protection is not qualified by who receives the payment from a super fund and reflects that a payment may be made not only to a member, but also to a spouse, child or other dependant of a deceased member. However, only payments made directly from a super fund are protected. A super death benefit may be paid to the legal personal representative (‘estate’) in which case a beneficiary receives the payment from the deceased estate. The payment loses its character as a payment from a super fund and is not protected from creditors of a bankrupt beneficiary.
Bankruptcy of a beneficiary is an important aspect of estate planning for super. Provided the beneficiary is an eligible dependant, a binding nomination in favour of a bankrupt beneficiary will ensure the payment is made from a super fund and protected from creditors. Careful consideration is required when nominating a beneficiary who is at risk of bankruptcy. If the super death benefit is paid prior to bankruptcy, the payment is divisible among creditors. If the direct payment occurs after bankruptcy it is protected.
Protected money includes a payment from a super fund and any proceeds of life and endowment policies on the life of the bankrupt or their spouse, received on or after bankruptcy. Property which is acquired wholly or substantially with protected money is also protected and not divisible among creditors.
WHAT INCOME CONTRIBUTIONS MUST BE MADE DURING BANKRUPTCY?
A bankrupt is required to make income contributions if their income exceeds the relevant threshold – currently $57,866.90, net of tax, for a person with no dependants which increases depending on the number of dependants. Half of any income which exceeds the threshold is a contribution for the benefit of creditors. Income is according to ordinary concepts but also includes specific items such as:
- employer super contributions in excess of an employer’s obligation to make superannuation guarantee contributions (currently 9.5%), under an industrial agreement solely between the employer and bankrupt;
- an annuity or pension paid from a super fund;
- a payment to the bankrupt in consequence of termination of employment;
- an annuity or pension from a policy of life or endowment insurance.
Bankruptcy statistics indicate that income contributions are a far more effective means to recover property. Registered trustees recover almost three times the amount of money from income contributions than voidable transfers of property.
WHEN IS A BANKRUPT DISCHARGED?
A bankrupt is automatically discharged three years after the date of filing a statement of their affairs. However, the period of bankruptcy can be extended up to eight years if the trustee objects to discharge using any of a broad range of grounds. Failure to comply with requests by or disclose information to, the trustee are grounds for objection, therefore a bankrupt has a strong incentive to co-operate during bankruptcy.
SUPER’S SPECIAL STATUS IN BANKRUPTCY PROVIDES THE POSSIBILITY OF A FRESH START
Making regular super contributions helps clients achieve their retirement objectives. The added benefit of establishing a regular pattern of contributions is that the client is reassured that if they become bankrupt, their superannuation will be protected from creditors. Upon discharge from bankruptcy, a client who has accumulated super in this way, may have ample resources to facilitate a fresh start.
Claudine Siou is senior technical services manager at IOOF TechConnect.