28 December 2022

The lingering impact of bankruptcy on assets

HHG Legal Group


HHG Legal Group has been serving Western Australians for over 100 years. With a large team across five offices, we offer top-notch legal advice and representation, exceeding expectations for all clients.
When a person becomes bankrupt, all assets and property of the estate that is not exempt vests in the Trustee.
Australia Insolvency/Bankruptcy/Re-Structuring
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Special Counsel, Blair Campbell, in our Insolvency team has outlined the lingering impact of bankruptcy on assets.

'It ain't over 'til it's over'

This immortal quote from Yogi Berra, famous baseballer and baseball coach/manager (and immortalised in song by Lenny Kravitz) is true not just of baseball, but of many other things - including bankruptcy.

Many people believe that when they are discharged from bankruptcy, they no longer need to worry about their trustee, or any claims that might be made over their assets. Unfortunately, this is not the case.

A case study

Mary was made bankrupt in March 2018. She co-operated with her trustee (the Official Trustee) and disclosed her assets and liabilities straight away. The trustee did not deal with her assets other than her cash/savings, and after three years - in March 2021 - Mary emerged from bankruptcy and got on with her life.

Prior to and during the period of Mary's bankruptcy, she owned a house with her husband. The house was worth about $500,000 - and the mortgage over the property was about $480,000. As a result, Mary's equity in the property was only about $10,000 (after splitting the equity with her husband and co-owner). Mary approached her trustee about buying out her equity in the house - but given the relatively small equity, nothing was done about it prior to her bankruptcy ending.

Thinking her bankruptcy was over, Mary and her husband worked on the house, improving it and paying down the mortgage. With rates low (until recently), and demand for workers high, Mary and her husband did their best to improve their financial position, including improving the equity they held in their house.

Then, without warning, Mary received a letter from an accountancy firm in Queensland. They informed her that they had been appointed new trustees to replace the Official Trustee. They told her that they obtained a new appraisal on the house. They claimed it was now worth $600,000 (between increasing house prices and improvements done by Mary and her husband), and that they now believe the equity in the property is worth $120,000.

Mary knows she has paid down her mortgage since her bankruptcy ended to $450,000 - so if the new trustee's valuation is correct, there is $150,000 equity in the property - of which her share is worth $75,000.

What can she do - she doesn't have $75,000 to pay, and she can't afford to lose her house.

We have recently experienced several examples of exactly the above scenario. Someone has completed their period of bankruptcy, believed it was over, and then sometime later received a letter from a new trustee demanding payment to redeem their equity in their home, or lose it.

While it is a normal and ordinary part of the role of any trustee in bankruptcy to realise the value of real property owned by the bankrupt, receiving a demand AFTER a bankruptcy is much more disconcerting - not just because the bankrupt believed their bankruptcy to be over, but because they now face the prospect of losing their home after they thought their issues had been resolved.

This situation largely arises because these matters are not dealt with during the three years of bankruptcy, however many former bankrupts see the actions of the new trustee as self-interested, believing the trustee is acting this way simply to fees for themselves, and take the benefit of the bankrupt doing the right thing in maintaining the mortgage and the property, while property prices have increased.

What is the 'vesting' period?

When a person becomes bankrupt, all property of the estate that is not exempt automatically vests in the Trustee. The Trustee is entitled to (and indeed obliged to) deal with that property for the benefit of creditors before it revests in the bankrupt.

Most people believe that the end of the (typically) three year bankruptcy period means the end of the Trustee's powers over property - but that is not correct.

Section 129AA of the Bankruptcy Act provides that the revesting period for property other than cash which was disclosed by the bankrupt in their statement of affairs does not revest until six years after discharge from bankruptcy.

So, in Mary's case, the new Trustee could have waited until February 2027 to sell her house. Imagine what the equity might have been at that point?

What to do?

One option for Mary would have been to have her husband purchase her equity from the Official Trustee while the equity was low. This is regularly done, thereby removing any claim by the estate over the property.

Another option is to ensure the value proposition is not there so that Trustees do not consider enforcing a sale worthwhile. If there is no equity in the property - there is no point in a sale. Accordingly, Mary could do her best to make sure the Property's value did not increase while keeping the mortgage as high as possible. In fact, so long as the bank does not enforce its own sale, negative equity would be a positive for Mary.

Lastly, Mary could redeem her equity herself, extinguishing the Trustee's claim. This is what my recent clients have been forced to do - negotiate the valuation of the property and any deductions and pay out the agreed figure.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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