Do mortgage payments equate to an interest in the property?
While property bubbles in Sydney and Melbourne are reportedly bursting, the Gold Coast is still experiencing a little upsurge in property prices, so I thought I'd share an overview of who owns property affected by bankruptcy, and for how long, because it has caught a few bankrupts and their advisers out.
You see section 58 of the Bankruptcy Act 1966 says that a bankrupt's property vests in (belongs to) the bankruptcy trustee. Some property is excluded under section 116, but real property is not one of the exclusions. And during that vesting period a bankruptcy trustee may decide it is in creditor's interest to realise that property ( click here for what happens in that scenario).
But for how long could a bankruptcy trustee hold this power, and what effects does it have on homeowners?
Sections 127 and 129AA of the Bankruptcy Act say that the property vests in the bankruptcy trustee for:
- Six years after the date of discharge from bankruptcy (i.e. usually nine years after being declared bankrupt) if the bankrupt discloses the property.
- Twenty years after being declared bankrupt if the bankrupt doesn't disclose the property.
Once expired, the property automatically revests in (goes back to) the former bankrupt.
A bankruptcy trustee may give the bankrupt an extension notice of the revesting period during the unexpired six-year period for up to a further three years after the "current" revesting period. No limits apply to how many extensions can be made, and therefore, in theory, the bankruptcy trustee can keep extending the revesting period indefinitely.
So, you can see that there is a difference between when a person is discharged from bankruptcy, and when the bankruptcy administration is finalised. Ordinarily a person is discharged three years after filing their Statement of Affairs, but the administration may not be finalised for sometime after that. If undisclosed property vests in a bankruptcy trustee for 20 years, then it is entirely possible that even if the bankrupt is discharged after three years, the bankruptcy estate may not be finalised for another 17 years.
Once you understand this, it is easier to see that discharge does not mean a bankruptcy trustee's administrative powers cease thanks to the combined effect of these sections.
But what about the fact that the bankrupt (pre- or post-discharge) is still making mortgage payments?
The somewhat peculiar quirk of the Bankruptcy Act means that paying the mortgage payments doesn't mean that the bankrupt obtains an interest in the property. Most bankruptcy trustees will confirm that the bankrupt can occupy the property—without paying rent to the trustee—if they continue to service the mortgage, maintain property insurance, and keep the property in a good condition. Obviously if the bankrupt doesn't meet these conditions, then the mortgagee or the bankruptcy trustee may seek to evict the bankrupt, enter into possession of the property, and sell it.
So, any equity that develops before it revests in the bankrupt—is not the bankrupt's equity. Of course, if the bankruptcy trustee does nothing to realise the equity during the nine years (three-year bankruptcy period plus the six-year additional vesting period) or the 20 years for non-disclosed property, then the bankruptcy trustee and creditors miss out.
The critical lesson here, and particularly in view of any upsurges in property values, is that your clients don't need to wait for the bankruptcy trustee to initiate the conversation about getting the interest in the property back. I suggest that if your clients are concerned that property prices might increase during the bankruptcy then you have a chat to the trustee about purchasing the property early in the administration for a potentially lesser sum than what is required at the end of the bankruptcy.
As always, your local Worrells Partner can help assess and advise on bankruptcy matters.
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.