On 29 March 2006, the Bankruptcy Legislation Amendment (Anti-Avoidance) Bill 2006 (the amendments) was passed by the Senate. The amendments are not retrospective and are expected to commence before the end of the 2006 financial year.
The amendments arguably represent the most controversial bankruptcy legislation in recent history. The amendments first emerged on 22 March 2001, when the Attorney General’s department announced the establishment of a Taskforce to consider whether changes should be made to Australia’s bankruptcy and taxation legislation to address high income earners using bankruptcy to avoid paying debts. Since 2001, the Federal Government has released draft legislation, withdrawn it, revised it and released it again, all in response to over 40 submissions lodged in response to a Discussion Paper by registered trustees, professional bodies, financial advisors and lawyers.
So what’s the result? Well, in this, our third Insolvency Update for 2006, we dissect the major amendments and examine how they are likely to assist trustees and creditors to recover assets for the benefit of creditors. We also explain the justification for the various amendments and, where practical, we explore working examples to demonstrate how the amendments will operate in practice. We conclude this Insolvency Update with a summary of how the amendments are likely to benefit trustees and creditors.
Objectives of the amendments
The amendments are intended to strengthen the ‘claw-back’ provisions in the Bankruptcy Act 1966 (the Act) by:
- Increasing claw-back provisions from two to four years for transfers of property by a bankrupt to a related entity for less than market value.
- Introducing a rebuttable presumption of insolvency where a bankrupt has failed to keep proper books, accounts and records.
- Making transfers to defeat creditors voidable if it was reasonable for the transferee to infer that the bankrupt's main purpose in transferring the property was to defeat creditors.
- Allowing trustees to recover consideration given to third parties prior to bankruptcy.
- Empowering the Court to make orders in relation to property or money held by natural persons where the bankrupt derived a benefit from the property and made a financial contribution to the property prior to bankruptcy.
We examine each of these amendments below.
The amendments will increase the time period under section 120 of the Act from two to four years where property was transferred to a related entity during that period for less than market value. The term ‘related entity’ includes parents, children, relatives, trustees and beneficiaries of trusts and business partners who are related to the bankrupt or the bankrupt’s spouse.
The justification for targeting related entities is empirical evidence that gifts designed to dissipate assets prior to bankruptcy are more likely to be given to relatives than strangers.
The claw-back period has been doubled because it is now commonplace for people to be aware that they are likely to become bankrupt more than two years before they become technically insolvent. It is believed that the pre-bankruptcy period of two and four years previously afforded too much scope for the deliberate divestment of assets.
The amendments create a rebuttable presumption of insolvency for the purposes of sections 120 and 121 of the Act. The presumption holds that the transferor was insolvent at the time of the transfer if it can be established that the transferor did not, during that time:
- Keep proper 'books, accounts and records'; or
- Preserve books, accounts and records for the relevant period.
These amendments have been introduced to remove the incentive to avoid maintaining, hiding or destroying records that would otherwise demonstrate insolvency. The presumption will be rebuttable by the bankrupt.
Inference of purpose
Section 121(4) has been amended to place additional limits on the circumstances in which a transfer will be protected by that provision. In its previous form, section 121 protected a situation where, for example, a person was approaching bankruptcy and transferred all their assets to their spouse. A transfer in those circumstances was previously protected by section 121(4) if the transferee spouse could establish that they did not know why the transfer occurred.
Importantly, the amendments introduce a test of reasonableness in relation to the transferee’s knowledge of the transferor’s intention at the time of the transfer.
Recovery of third party consideration
To enable trustees to recover property transferred as an avoidance measure, a new section 121A has been inserted into the Act which allows trustees to recover consideration paid to third parties in certain circumstances.
Section 121A will apply where, for instance, four years before bankruptcy a bankrupt transfers his Harley Davidson to a friend for $25,000 in an arm’s length transaction where the transfer was performed as part of a plan to place assets beyond the reach of creditors in anticipation that the bankrupt was likely to become insolvent at some point in the future. The bankrupt directs the transferee of the Harley Davidson to pay the bankrupt’s brother the $25,000 purchase price which the bankrupt treats as a gift. Pursuant to section 121A, the payment to the brother would be void where the trustee could prove that the brother knew of the bankrupt’s intention in transferring the Harley, and that the brother failed to provide market value consideration for the $25,000 ‘gift’.
Recovering property from natural persons
Perhaps the most radical amendments are those that now extend the provisions contained in Division 4A of Part VI of the Act. These amendments empower trustees to recover property of a bankrupt from natural persons, in addition to the existing power to recover property disguised as an asset of a trust, company or similar. These amendments have been introduced to combat people hiding their assets by placing them with a spouse or relative in the same way as a trust or company. In this respect, the amendments apply to all relatives of the bankrupt.
The applicable ‘examinable period’ is either four years prior to the commencement of the bankruptcy, or from the first point of insolvency in the prior year, if the bankrupt became insolvent in that year. The ‘record keeping’ rebuttable presumption of insolvency applicable under sections 120 and 121 of the Act is also applicable to these provisions.
These amendments have far-reaching consequences because they allow the Court to make orders in relation to property owned by a natural person where:
- During the examinable period, the person acquired an estate in property as a direct or indirect result of financial contributions made by the bankrupt during that period; and
- The bankrupt used or derived (whether directly or indirectly) a benefit from the property during the examinable period; and
- The person still holds an estate in the property.
The extent of these amendments is best demonstrated by the common situation where a bankrupt’s spouse holds the family home in her name solely, the bankrupt lived in the home and serviced outgoings on the property within four years of bankruptcy. In these circumstances, the Court may order the spouse to pay into the bankrupt’s estate, the value of the spouse’s interest in the home which is attributable to the financial contributions made by the bankrupt within the four year’s before bankruptcy.
These provisions extend to any financial contribution, regardless of size, and regardless of the benefit derived by the bankrupt from the property which may be as simple as living in the home for only one week. The provisions also do not require the bankrupt to have been insolvent at the time of the contribution, the bankrupt need not have had an intention to defeat creditors, and the bankrupt need not be deriving a benefit from the property (ie. living in the home) at the time of bankruptcy.
Summary of impact of amendments
If the number of submissions lodged by interested parties is anything to go by, the amendments are likely to substantially enhance a trustee’s ability to recover assets for the benefit of creditors. In short, we believe the amendments are likely to have the following impact:
- The increased time period of four years under section 120 of the Act should allow trustees to attack more related party based avoidance transactions.
- The third party 'reasonableness test' should assist trustees to pursue previously unprovable recovery actions.
- The third party consideration provisions reach into previously protected transaction to enable trustees to recover property and more importantly, the proceeds of sale of property, disposed of by the bankrupt via other parties.
- The rebuttable presumption of insolvency which arises when a bankrupt fails to maintain or preserve proper books and records should assist trustees in establishing a bankrupt's intention to defeat creditors under section 121, especially given the usual lack or complete absence of direct documentary evidence to establish insolvency.
- Trustees now have the ability to recover a bankrupt's contribution to the 'family home' and other assets held in the name of a spouse and relatives.
Overall, the amendments will have a significant impact on all risk takers, including the well-advised, who may seek to protect their wealth in the event of insolvency. From now on, such strategies will only be effective if more complex asset protection measures are implemented at a much earlier time well before insolvency looms.
This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.