When two worlds collide

bankrupt spouse 2 worlds collide

Published 12 July 2016

In matters where one spouse is a bankrupt and the other is not and they separate, family law and bankruptcy law intersect or collide.  What then forms is a competition between the non-bankrupt spouse and the unsecured creditors of the bankrupt spouse.  Judges are called upon to balance the interests of spouses and creditors.  In this context, a principle known as the “roller coaster principle” is often espoused.  In essence, it is that often spouses are not innocent victims of their partner’s dealings, that they have enjoyed the pre-insolvency prosperity and lifestyle and therefore should be prepared to share the downside of such ventures.  However, not all Judges see it that way.  In determining how the competing claims of a trustee in bankruptcy and the bankrupt’s spouse are to be resolved before Court orders are made, the Court must have regard to Section 75(2)(ha) of the Family Law Act which states:

”(ha)    The effect of any proposed order on the ability of the creditor of a party to recover the creditor’s debt so far as that effect is relevant …”

A similar provision exists for de facto relationships as well.  What is clear is that this sub-section does not give a priority to creditor’s interests, simply that their interests are to be taken into account alongside all of the other interests and needs articulated in Section 75(2) of the Family Law Act and the exercise of discretion involves balancing the often competing needs and interests of two spouses and sometimes of new families they have formed. 

When reading carefully this sub-section of Section 75(2), one possible view is that this sub-section provides little guidance as to how competing priorities are to be determined.  What the cases decided in this area of the law do, however, provide are a limited set of principles that can be summarised as follows:

  1. There is no special priority to be given to unsecured creditors over that of a spouse;
  2. The Court needs to formulate an order that is “appropriate”;
  3. The Court should not make an order unless it is “just and equitable”;
  4. If in making an order on the basis that bankruptcy had not occurred, the non-bankrupt’s claims can be satisfied without making an order against the vested bankruptcy property then such an order is appropriate and just and equitable;
  5. If it is necessary to make an order against vested bankruptcy property, the extent to which a dividend to creditors will be diminished is a relevant factor to be considered;
  6. As the legislation is designed to give protection to the non-bankrupt spouse that was not previously available before amendments were made in 2005, the interests of the non-bankrupt spouse must receive considerable weight and must at least in part be protected.

These principles should be reviewed and considered when clients seek your advice after finding themselves in a position where their marriage has broken down and their spouse may be or has been declared bankrupt.

 

Ben Farmer is a partner of Clelands Lawyers in Adelaide, South Australia, practising in family law and employment law.