Bankruptcy and the Family Home
How the Bankruptcy Act applies to a bankrupt’s family home is often misunderstood. The loss of the bankrupt’s family home is usually felt more intensely than the loss of any other asset. Understandably, many bankrupts know that the loss of the home will cause disruption to the family unit, not only affecting the bankrupt, but also their children and solvent partners.
Because of these factors, trustees in bankruptcy must approach the realization of a bankrupt’s interest in a family home with tact and understanding, while also protecting the rights and interests of creditors.
Is the home protected?
No. The family home is not a protected asset under the Bankruptcy Act. If there is equity in the property after paying out any proper mortgage and selling costs, the trustee is obliged to realize the property.
What about joint ownership?
The realization process is relatively straightforward when the bankrupt is the only owner of the home. However, often the bankrupt and his or her spouse will own the family home together as “joint tenants”. Even if the family home is jointly owned by the bankrupt and a solvent (non bankrupt) co-owner, the trustee can still insist on the bankrupt’s share of the equity being realized. The options available are discussed below.
What happens to joint tenancies?
A joint tenancy is automatically severed upon the bankruptcy of one of the joint tenants. This occurs due to the “Involuntary Alienation” or severing of the fundamental legal rights of the parties necessary to create a joint tenancy. This practice is long established, having been mentioned in the 1862 case of Paten v Cribb. The trigger to this alienation of legal rights is the vesting of the property in the trustee.
After the severing of the joint tenancy, the interests in the property are held as a tenants in common. This is important if a bankrupt dies after bankruptcy. If the joint tenancy had not been severed, the bankrupt’s share of the equity would automatically vest in the co-owner upon the death of the bankrupt, and the value would be lost to the estate.
How is the equity determined?
The trustee must have the property valued by a qualified valuer or estate agent. A trustee is under a duty to obtain the best price for the home and will always attempt to sell at market value. From that value, secured debts are deducted and the bankrupt’s share of the equity is determined.
How are properties realized?
Where there is a co-owner, the trustee will usually take the following steps:
(1) give the co-owner the opportunity to buy the estate’s share;
(2) if that is not possible, see whether the co-owner will join with the trustee in marketing the property on agreed terms; or finally
(3) if an agreement on selling the property cannot be reached, the trustee can ask the court to appoint a “Statutory Trustee for Sale” over the co-owners interest to force a sale of the property.
The appointment of a statutory trustee compels the sale of the home, notwithstanding that the co-owner is solvent and has not contributed to the bankruptcy in any way. Although the court will often attempt to soften the effect of such an order by allowing the spouse time to relocate, the ultimate effect is that the property will be sold.
What is entering transmission?
The sale process usually begins with the trustee “entering transmission”. This is the legal process to have the trustee’s name placed on the title deed in place of the bankrupt’s. This is necessary so that the trustee can execute a sale contract and transfer forms.
Usually the trustee will only enter transmission if he is satisfied that equity exists and a sale is likely. If there is doubt about the final outcome, the trustee may initially lodge a caveat over the title to protect the estate’s interests for the short term.
What about mortgagees?
The vast majority of family homes are subject to a mortgage. The mortgage can still be enforced, possible even when the mortgage payments are up to date, as the bankruptcy itself may be a default that the mortgagee. Although mortgagees have the power to sell the bankrupt’s home, in most cases they will leave the task to the trustee.
What if the bankrupt can continue with mortgage payments?
If the bankrupt has the capacity to continue making mortgage payments, the mortgagee will usually not insist upon possession of the property, preferring to allow the loan repayments to continue. The trustee will have no objection to this, provided that the bankrupt arranges for the equity in the property to be paid to the bankrupt estate.
This type of arrangement benefits everyone. The bankrupt estate obtains the equity in the property, the mortgagee retains a performing loan and the bankrupt’s family avoids the sale of their home. But the property can still be sold by the trustee even if the mortgage payments are kept up to date, and they will be able to benefit from the extra equity created in the property because of these payments.
What about vacant possession?
The trustee will normally be required to provide vacant possession when selling a property so it will be necessary for the bankrupt to vacate the property before settlement. The trustee usually does not expect a bankrupt to vacate the premises immediately on bankruptcy and will, in normal circumstances, provide a few weeks for the alternative arrangements to be made.
In some cases the trustee may allow the bankrupt to stay in residence during the selling period provided the bankrupt assists that process, contributes a fair rent and maintains the property, and when the trustee is fully satisfied about the bankrupt’s ongoing cooperation.
How are the proceeds distributed?
If the property is wholly owned by the bankrupt, the estate will get the entire surplus of the sale after any mortgagee is paid. If the property is co-owned, the trustee will share the surplus with the solvent owner on the basis of the legal entitlement as shown on the title deed.
Although the title to a property may be held equally, occasions will arise where uneven contributions have been made towards the acquisition or development of the property. This may lead to one party holding the property for the other party in a constructive or resultant trust – and possibly alter the distribution.
When does the Doctrine of Exoneration apply?
The property may be encumbered by a mortgage that secures an advance for the sole benefit of one owner, even though both owners have agreed to the mortgage. This may cause an uneven distribution of the surplus under the Doctrine of Exoneration. The Doctrine says that the person that received the benefit of the loan should have the first obligation to repay the loan – and the co-owner should only be considered a surety (guarantor) and their share should only be used to meet any shortfall.
A simple example of the doctrine would be a family home worth $400,000 owned by the bankrupt and his solvent spouse. Prior to bankruptcy they agreed to the bank taking a mortgage over their property to support an advance of $150,000 to the husband’s business. On a sale of the property $250,000 would be available for distribution to the owners ($400,000 sale price less the mortgage of $150,000). Because each owner had an equal share in the legal title to the property it might be thought that they should each receive $125,000.
However the Doctrine of Exoneration may require that the amount due under the mortgage should be deducted from the husband’s equity so that the following equitable distribution would apply:
Bankrupt’s share = $200,000 less $150,000 = $50,000 Wife’s share = $200,000
The principle of the Doctrine of Exoneration is not applied without a full review by the trustee who must find compelling evidence that it should apply.
Is there a timeframe for realization?
Trustees will generally realize property in a timely fashion. Section 129AA of the Bankruptcy Act requires trustees to realize property within a period ending six years after the discharge of bankrupt. This generally allows 9 years to arrange sales. If the trustee does not do so, the property could revest in the discharged bankrupt, but the trustee may obtain an extension of this time period.
The six year rule only applies to property disclosed to the trustee. If the property is not disclosed in the bankrupt’s Statement of Affairs or as after-acquired property, the trustee will have 20 years to deal with the property.
War Service Homes
A bankrupt or a debtor under Part X of the Bankruptcy Act cannot have a war service home taken from them, except in extraordinary circumstances. This arises from the provisions of the Defense Service Homes Act which state:
DEFENCE SERVICE HOMES ACT 1918 – SECTION 45A Bankruptcy of purchaser or borrower
(1) Except with the approval of the Secretary, the estate or interest of a purchaser or borrower in any land, land and dwelling-house or right of residence in a retirement village that is the subject of a contract of sale, or of a mortgage or other security securing a Corporation advance or a subsidised advance:
(a) shall not be taken from the purchaser or borrower under the Bankruptcy Act 1966; and
(b) shall not be sold in satisfaction of a judgment debt, otherwise than by the Bank or another mortgage in the exercise of powers under a contract of sale, or a mortgage or other security.
(2) Where a husband and wife are joint purchasers or borrowers in relation to land, land and a dwelling-house or a right or residence in a retirement village, the Secretary may give an approval under subsection (10) in relation to the estate or interest of both of them if either of them becomes bankrupt or incurs a judgment debt.
Although the secretary of the department has discretion to allow a trustee to sell up the bankrupt’s property, in reality this discretion is very seldom applied. In our experience the secretary will not exercise his discretion even where the bankrupt has incurred very substantial business debts.
There can be no doubt that some bankrupts have taken business risks which would otherwise have been avoided in the knowledge that they would not lose their home. This is inequitable as far as creditors are concerned, but that currently is the law.
- A bankrupt’s home can be sold even if the bankrupt only has a part interest in the property
- The trustee will normally offer the property for sale to any co-owner prior to having the property placed on the market
- The trustee will normally sell the interest in the property without undue delay
- The trustee must recover the value for the property but has a wide discretion regarding how to sell
- The trustee will normally allow the bankrupt a few weeks to arrange alternative accommodation
- The Doctrine of Exoneration or a constructive or resultant trust may adjust the distribution of the sale proceeds
- War Service homes are excluded from realization.