Void Transactions under the Bankruptcy Act

What do these provisions do?

Trustees of bankrupt estates investigate pre-bankruptcy transactions entered into by the bankrupt with other parties when they believe the transaction improperly removed assets that would have come under the trustee's control. The Bankruptcy Act will sometimes void these transactions and require the other party to return an asset or make a payment to the trustee.

Who may recover money under these provisions?

Both trustees of bankrupt estates and Personal Insolvency Agreements that give access to these recoveries may use these provisions to void these types of transactions. The procedure is not available to trustees of estates under Part IX of the Bankruptcy Act or to trustees of Part X Personal Insolvency Agreements that do not include these rights.

What must the trustee do?

To void a transaction, the trustee must show that:

1. a transaction was entered into;
2. they can identify the other party to the transaction;
3. the transaction occurred within a specific time period, or while the bankrupt was insolvent;
4. the transaction was either under value or had the required intention;
5. it does not involve protected property.

Why do trustees void some transactions?

One of a trustee's functions is to ensure that all of the bankrupt's assets are available for distribution to creditors. Part of that role is to discover whether the bankrupt entered into a transaction that reduced the amount of assets that are available for distribution. The trustee will want to recover these assets.

Some debtors, realizing that they are about to be made bankrupt, want to protect some of their assets from their creditors. Some debtors hide, move or transfer these assets to a friendly person to hold during the period of bankruptcy. These provisions are meant to deter debtors from moving assets out of their own hands, at the expense of their creditors, and recover the assets when it occurs.

What type of transactions may be examined?

These powers are set out in the Bankruptcy Act and enable the recover of two types of transactions:

1. Undervalued transactions (section 120); and
2. Transfers done with the intention to defeat creditors (section 121)
3. Transfers where the consideration was paid to a third party (section 121A)

Undervalued Transactions - Section 120

What are undervalued transactions?

Sometimes a debtor will sell or transfer assets to friendly parties shortly before their bankruptcy, and attempt to make the transaction look commercial. These transactions may be:

(i) a sale for less than the market value of the asset - moving a valuable asset to another party; or
(ii) a purchase of something at a greater consideration than it is worth - dissipating money to another party.

Examples of these transactions include a debtor:

(a) selling their share of the family house to their spouse for $1.00 or "natural love and affection";
(b) granting a mortgage or security to someone for monies that were lent in the past;
(c) purchasing an asset of limited worth and paying a high price.

The trustee may void transfers of property if they were done within 5 years before the commencement of the bankruptcy.

Are some transfers protected?

The Act will protect transactions from being voided if:

(a) it occurred more than 2 years before the commencement of the bankruptcy; and
(b) it did not involve a party related to the debtor; and
(c) the debtor was solvent at the time of the transfer, and remained solvent after the transaction.

Transactions undertaken with non-related parties whilst the bankrupt was solvent should be protected as a solvent debtor will not be prejudicing creditors by transferring surplus assets. The other party to the transaction has the onus of proving that the bankrupt was solvent at the time of the transaction and remained solvent immediately thereafter.

The 2 year period extends to 4 years if the other party to the transaction is related to the bankrupt. This means that transactions occurring in the period 4 years before the commencement of the bankruptcy are automatically void if they involve related parties, defined as 'related entities' in the Bankruptcy Act.

What is insolvency?

The debtor must have been insolvent at the time of the transaction for it to be void, if it occurred outside the 2 or 4 year period mentioned above - but still within the 5 year time limit. A person is solvent if they are able to pay all of their debts as and when they become due and payable. A person who is not solvent is insolvent.

The court will usually look to the trustee to provide some evidence on insolvency at the time of the transfer. But the onus of proving solvency to defend a claim by a trustee lies with the party seeking to rely on the defense.

The Act provides a presumption of insolvency if the debtor did not keep proper records of their financial affairs during that period. That presumption is rebuttable, i.e. it may be disproved by positive evidence of solvency. This may be quite difficult if there are truly no records on the financial affairs of the bankrupt.

Are some transactions exempt?

Not all transfer of property and payments may be void. The Act provides protection to some classes of transactions. Generally they are the payment of tax, payments under family law agreements and payments under Part IX debt agreements.

A transfer is exempt if it is:
(a) a payment of tax payable under a law of the Commonwealth or of a State or Territory; or
(b) a transfer to meet all or part of a liability under a maintenance agreement or a maintenance order; or
(c) a transfer of property under a debt agreement; or
(d) a transfer of property if the transfer is of a kind described in the regulations.

Payments or transfers that have been made under Maintenance Agreements or Orders made in the Family Court are protected. The Family Court will have to overturn the original maintenance order before the trustee will be able to make any recovery under this section. It would be difficult for any trustee to convince the Family Court that it should overturn its own decision in order to allow the trustee to recover assets from an ex-spouse.

The trustee must refund the consideration received

Section 120 voids the whole transaction, there is not just a recovery of an asset or money. This means that the trustee must refund any consideration received as part of that transaction, placing everyone back into the position they held before the transaction was undertaken. If this was not the case, the estate may end up with both the consideration provided by the other party, even if it was less than the value of the asset transferred, and the asset that was transferred that can be realised.

Some things are and are not consideration, and things that are not consideration cannot be refunded. These provisions are designed to stop people using non-commercial consideration to try to validate the transaction.

Specifically the fact that the transferee is related to the transferor; the transferee making a deed in favour of the transferor that is a spouse or de facto spouse; the transferee's promise to marry, or to become the de facto spouse of, the transferor; love or affection; the transferee granting a spouse a right to live at the transferred property.

How long does the trustee have to take the action?

Actions under section 120 must be commenced by the trustee within 6 years of the bankrupt becoming bankrupt.

Transfers to Defeat Creditors - Section 121

What are transfers to defeat creditors?

Sometimes debtors enter into transactions that are primarily used to protect assets from creditors. The Act allows transactions to be voided where the intention of the bankrupt was to stop divisible assets becoming available to creditors, or where the intention of the bankrupt was to defeat or delay the proper distribution of assets to creditors.

What makes a transfer fall into this category?

To be a transaction to defeat creditors, it must involve:

1. property that probably would have become part of the estate or been available to creditors and that property being unavailable to the trustee; and
2. the intention of making that property unavailable to creditors, permanently or temporarily.

What type of transactions are caught?

There must be a transfer of property. Generally something must pass from the bankrupt that would have become a divisible asset in the estate. A transfer of property can also be property created by the debtor that results in another person becoming the owner of something that did not previously exist. The prime example of this is the creation of mortgage, securities or other interests over property owned by the bankrupt, where the security would stop the property becoming available to the trustee.

How do you tell the bankrupt's intention?

One of the main purposes of the transaction must be to protect the asset from creditors. This is subjective and usually must be inferred from the circumstances of the transaction, the financial position of the bankrupt at that time, and the result of the transaction.

Intention can be deemed by the actual or impending insolvency of the debtor - but only if it can be shown that the bankrupt was or was about to become bankrupt at the time of the transaction. If the debtor was solvent at the time and remained solvent for some time after the transaction, it will be difficult to connect the eventual insolvency to the transaction.

It is common that transactions with this intention are done when a debtor has a pending legal action against them and it appears likely or inevitable that judgment will be brought down against them, or that a loan or other agreement has been breached and will lead to a demand that will not be able to be met.

What is insolvency?

The trustee must refund the consideration received

Section 121 voids the whole transaction, there is not just a recovery of an asset or money. This means that the trustee must refund any consideration received as part of that transaction, placing everyone back into the position they held before the transaction was undertaken. If this was not the case, the estate may end up with both the consideration provided by the other party, even if it was less than the value of the asset transferred, and the asset that was transferred that can be realised.

Transfer not void if done in Good Faith

The Act will protect transfers where the transferee acted in good faith. To be able to reply on these provisions, the other party to the transfer must have:

(i) provided consideration at least to market value (calculated at the time of the transfer);
(ii) have no knowledge of or could not have reasonably inferred the intention of the bankrupt; and
(iii) could not have inferred at the time that the transferor was insolvent or about to become insolvent.

To be able to use this defense, the other party must have been completely oblivious of the debtor's financial position and intention. As many of these transactions are done with relatives or other related parties, this lack of knowledge may be difficult to prove. It is not common that transaction examined under this section are done with complete strangers.

If these factors are proved, the transfer will not be voided.

How long does the trustee have to take the action?

Actions under section 121 may be started at any time after the trustee uncovers the transaction. The difference is that the 121 transaction has a flavor of fraud and may be pursued more vigorously.

Transactions where consideration given to a third party - Section 121A

Who may be involved in these actions?

Third parties not actually involved in a transaction between the bankrupt and another party can be the subject of recovery actions by the trustee under sections 120 and 121 if they have received the consideration that should have been paid to the bankrupt. Section 121A is designed to allow the trustee to collect money from a third party where they received money that should have been paid to the bankrupt.

It is not necessary that the original transaction was undervalued or had the intention to defeat or delay creditors, it is the payment of the consideration to the third party that will be examined. That is, did the third party give valuable consideration to the bankrupt for that money, or was the intention of directing the payment to the third party done with the prerequisite intention?

What can be done?

The Act deems that the receiving of the consideration under transactions should be viewed as if the receiving of the consideration was a transferred of property by the bankrupt to that third party. That consideration constitutes the property transferred and the transfer may be viewed under section 120 and 121.

These provisions are new and not entirely tested in Court. It is possible that the trustee will be able to take an action against the original party to the transaction and separately against the third party that received the consideration.

Protection of Certain Transfers

What protection can the Bankruptcy Act give people?

The Act provides some protection to people dealing with a debtor before bankruptcy. It says that transaction are not automatically invalid because the debtor later becomes bankrupt. Essentially the section says that people acting with the bankrupt with no knowledge of the impending bankruptcy and in normal business circumstances have protection - unless the transaction can be voided through one of the recovery provisions - including preferential transfers.

Who gets that protection?

This provision protects an innocent, unknowing party who entered in a commercial transactions in ordinary dealings with the bankrupt as long as the following factors are met:

(a) the transaction happen before the bankruptcy (the bankrupt does not have the right to deal with their assets after bankruptcy);
(b) the other party was unaware of the impending bankruptcy; and
(c) the transaction was in good faith and in the ordinary course of business.

Good faith and ordinary course of business are more difficult to explain and prove, consequently they are the areas of most contention. The other party must not have acted in any manner that would give the perception that they were not acting in good faith. Ordinary course of business has been held to be in the ordinary course of the relevant industry, not the ordinary course of that particular creditor.

The burden of proof rests with the party attempting to gain the protection of the section.

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Last Updated: 6.11.2008