Case Study: Bankruptcy and the Family Home
The prospect of losing the family home can be one of the most distressing consequences of bankruptcy.
One of the most common misconceptions I encounter is that the family home is automatically protected in bankruptcy.
It is not.
When a bankrupt person owns an interest in real property, that interest generally vests in the trustee and must be realised for the benefit of creditors.
How that occurs, however, can vary.
In a past matter, the non-bankrupt co-owner refinanced the property and purchased the trustee’s interest, enabling the trustee to realise the estate’s interest while allowing the family to remain in their home.
When a company problem became a personal problem
The bankrupt had been a director of a company that failed.
The company had significant unpaid tax and superannuation liabilities. Director Penalty Notices had been issued and allowed to expire, leaving the director personally liable for those amounts.
What began as a company problem had reached the director personally and ultimately placed their interest in the family home at risk.
The property was jointly owned with the bankrupt’s partner and if possible, they wanted to retain it.
This required consideration of how the bankrupt’s interest could be realised.
As bankruptcy trustee, I could not simply disregard the value of the bankrupt’s interest. That value was available for creditors and had to be properly assessed and realised.
At the same time, there was no reason to force a sale if the estate could receive an appropriate commercial outcome in another way.
The task was to work out whether that was possible.
The family home is not automatically protected
When a person becomes bankrupt, their divisible property generally vests in the bankruptcy trustee under sections 58 and 116 of the Bankruptcy Act 1966.
This will ordinarily include the bankrupt’s interest in a house, even when it is the family’s principal place of residence.
Where the home is jointly owned, the trustee generally becomes entitled to the bankrupt’s interest. The non-bankrupt co-owner retains their own interest.
The trustee must then determine whether there is equity and how the bankrupt’s share should be realised.
That may involve:
- selling the trustee’s interest to the co-owner;
- agreeing with the co-owner to sell the property; or
- where no agreement can be reached, applying to the court for orders that allow the property to be sold.
For a broader explanation of how property is treated in bankruptcy, see my article
Assessing the trustee’s interest
Determining the value is a relatively simple exercise.
It involved obtaining a current valuation, confirmed the mortgage payout and allowed for the reasonable costs that would have been incurred if the property were sold.
In simple terms:
Property value – mortgage – selling costs = estimated net equity
Once the figures were clear, I could give the co-owner an opportunity to purchase that interest.
Giving the co-owner an opportunity to keep the home
In this case, I gave the non-bankrupt co-owner the opportunity to purchase the trustee’s interest.
This was not about providing a special discount because the property was the family home. The bankruptcy estate still needed to receive an appropriate amount for the interest.
However, selling the interest directly to the co-owner could avoid the additional cost, delay and disruption of an open-market sale.
The co-owner was able to refinance the property and pay the agreed amount to the bankruptcy estate.
That meant the trustee’s interest was realised for creditors in a commercial manner, saving significant estate costs.
The outcome
The outcome worked for both the bankrupt estate and the family.
The estate received the amount required for the bankrupt’s interest.
The costs and uncertainty of an open-market sale were avoided.
Court proceedings to force a sale were not required.
Most importantly for the co-owner and the family, they were able to keep their home.
It was a positive outcome, although it is important to recognise why it was possible. There was enough equity to justify dealing with the property, and the co-owner had the financial capacity to refinance and purchase the trustee’s interest.
Not every matter will have the same outcome.
If a co-owner cannot fund an appropriate offer, or the parties cannot agree on value, a sale of the property may still be necessary.
A positive outcome and some lessons
This was a good outcome. The bankrupt estate received the appropriate value for the bankrupt’s interest, while the co-owner refinanced and the family kept their home.
There are, however, some lessons from how the problem arose.
First, company liabilities do not always stay with the company. Director Penalty Notices can make company tax and superannuation debts personal. A DPN should never be allowed to expire without obtaining advice. If you receive one, get advice immediately.
Second, asset protection should be considered when an asset is acquired. Placing significant assets in the name of someone exposed to business risk should generally be avoided unless there is a sound reason and appropriate advice has been obtained. Trying to change ownership after problems arise may be too late and could create a claim for a future trustee.
Finally, obtain advice early. The earlier the position is reviewed, the more options there may be to address the risk.
In this case, a practical solution was available.
That will not always be the position once company liabilities have reached the family home.
Need Advice About Bankruptcy?
Bankruptcy can have significant consequences for property, business interests and other assets. The outcome depends on the particular circumstances.
For more information about the process and how I can assist, see my Bankruptcy service page.
