Bankruptcy 101: Void transfers
One of the common misconceptions about bankruptcy is that assets can be protected simply by transferring them to someone else before bankruptcy.
In bankruptcy, a trustee does not only look at what a bankrupt owns on the day they become bankrupt, but also look back at transactions that occurred before.
That can include transfers of real property, money, shares, vehicles, businesses or other valuable assets.
In some cases, those transactions may be void against the trustee.
The starting point — what property vests in bankruptcy?
When a person becomes bankrupt, their divisible property vests in the bankruptcy trustee.
Section 58 of the Bankruptcy Act, deals with the vesting of property in the trustee and Section 116 deals with property that is divisible among creditors, subject to specific exclusions.
In practical terms, the trustee steps into control of property that is available for creditors, unless it is exempt under the Act.
If a person transfers an asset before bankruptcy, the asset may no longer be in their name when the bankruptcy starts, but that does not mean the sale or transfer won’t be reviewed.
The Act contains clawback provisions that allow certain transactions to be challenged.
What does “void against the trustee” mean?
It means the transaction may be ineffective against the bankruptcy trustee should the requirements of the relevant section be made out.
This may allow the trustee to recover the asset or value from the person who received the asset.
A transfer may have been signed, stamped, registered and completed years earlier, but if it falls within the relevant provisions of the Bankruptcy Act, it may be recovered.
Section 120 — undervalued transactions
Section 120 of the Bankruptcy Act deals with undervalued transactions.
This section can apply where a person who later becomes bankrupt transferred property within the relevant period before bankruptcy and the transferee gave no consideration, or consideration worth less than the market value of the property.
120 is not limited to houses or land and can apply to payments of money, business assets, shares, vehicles or other valuable property.
When a trustee reviews a transfer that has occurred prior to bankruptcy they will review the following:
- What was transferred?
- What was the market value at the time?
- What consideration was given?
- Was that consideration received by the bankrupt?
- Was the transfer to a related party?
- Was the bankrupt solvent at the time?
- When did it occur?
Section 120 can apply to transfers made in the period beginning five years before the commencement of bankruptcy and ending on the date of bankruptcy.
Solvency position and whether the transfer was to a related entity can affect the analysis and recoverability of the asset transferred.
As a trustee you might appreciate we pay particular attention to transfers to a spouse, family member, related company / trust that may raise concerns about value, purpose and timing.
It is worth noting that some things are not treated as valuable consideration for these purposes. For example, the fact that the transferee is related to the bankrupt or that the transfer was made out of love and affection.
Section 121 — transfers to defeat creditors
Section 121 deals with transfers made with the main purpose of preventing, hindering or delaying property from becoming available to creditors.
This is often the section people have in mind when they talk about “moving assets out of reach”.
Section 121 can apply where:
- the property would probably have become part of the bankrupt estate, or been available to creditors, if it had not been transferred; and
- the transferor’s main purpose was to prevent, hinder or delay the property becoming divisible among creditors.
That does not mean the trustee needs a written admission saying “I transferred this asset to defeat creditors”.
Purpose can be inferred from the circumstances and relevant facts:
- the timing of the transfer
- whether the transfer made commercial sense
- whether proper value was paid and received
- whether the transferor was insolvent or likely to become insolvent
- whether the transaction was with a related party
A transaction may look properly documented, but the surrounding circumstances can still create a problem.
Section 122 — preference payments
Section 122 deals with preference payments.
This is not usually what people mean when they talk about transferring assets to protect them before bankruptcy, but it is part of the same broader family of antecedent transaction claims.
Section 122 applies to transfers of property by an insolvent person in favour of a creditor, where the transfer has the effect of giving that creditor a preference, priority or advantage over other creditors and is made within the relevant statutory period.
Superannuation is not always immune
Superannuation is another area where people can get the wrong idea.
Super held in a regulated fund is protected in bankruptcy, but that does not mean every contribution made before bankruptcy is safe.
Sections 128B and 128C can apply to certain superannuation contributions made to defeat creditors.
These provisions are aimed at situations where money or property is contributed to superannuation in circumstances where the main purpose was to prevent, hinder or delay that property from becoming available to creditors.
This is relevant where unusual or large contributions are made after financial pressure has already emerged.
When might a transfer be protected?
Not every pre-bankruptcy transfer will be recoverable by a trustee.
There are specific exceptions and protections in the Bankruptcy Act.
For example, section 120 does not apply to certain transfers, including a payment of tax, a transfer to meet all or part of a liability under a maintenance agreement or maintenance order, a transfer under a debt agreement, or a prescribed transfer.
Section 121 does not contain the same general maintenance order exception. Instead, a transfer will not be void against the trustee if the transferee gave at least market value, did not know or could not reasonably infer that the transferor’s main purpose was to prevent, hinder or delay creditors, and could not reasonably infer that the transferor was, or was about to become, insolvent.
There are also broader protection provisions in sections 123 and 124. Those sections can protect certain market value transactions, payments and dealings made in good faith and in the ordinary course of business.
The practical point is that a trustee does not simply assume every transfer is void.
The trustee needs to look at the section relied upon, the timing, value, purpose, solvency, knowledge of the transferee, and whether any statutory protection applies.
Section 139ZQ notices
A trustee does not always have to start with ordinary court recovery proceedings.
In some cases, the trustee may apply for the Official Receiver to issue a notice under section 139ZQ.
A section 139ZQ notice may require a person who has received money or property as a result of a transaction that is void against the trustee to pay the trustee an amount equal to the money or value of the property received.
That does not mean every alleged void transaction is automatically established.
The trustee still needs evidence. If there is a dispute, the court may ultimately need to determine the matter.
Common examples
Types of transfer I have seen and recovered over the year have included:
- transferring an interest in the family home to a spouse for natural love and affection
- selling a property for less than market value
- gifting money to children or relatives
- transferring vehicles or shares for no consideration
- moving business assets to a related entity for less than their value
- directing sale proceeds to someone else and claiming it was received as cash
- making unusual superannuation contributions
- preference payments to relatives and other creditors
- documenting a transaction after the fact to try and give it validity
Not every transaction will be void.
But these transactions are often reviewed carefully where the person later becomes bankrupt.
The practical questions
When reviewing a pre-bankruptcy transfer, a trustee will usually ask practical questions.
- When did the transfer occur?
- What was transferred?
- Who received the asset or benefit?
- Was the recipient a related party?
- What was the market value at the time?
- What consideration was given and was it actually paid?
- Was the bankrupt solvent at the time and what were the surrounding circumstances?
- Does the transaction make commercial sense?
The answers to those questions usually determine whether the transaction is likely to be pursued.
Why this matters for directors and business owners
Void transfer issues are particularly important for directors and business owners.
Personal insolvency risk often builds over time.
It may come from such things as personal guarantees, director penalty notices, tax debts, failed business ventures and/or litigation.
By the time the risk is obvious, transferring assets at that time could possibly be challenged, if the relevant provisions apply.
That is why asset protection needs to be considered early.
There is a significant difference between proper asset protection planning and transferring assets after creditor problems have already emerged.
The first may be legitimate planning.
The second may simply create a recovery claim for a future trustee.
The practical takeaway
Transferring assets before bankruptcy does not necessarily protect them.
A bankruptcy trustee can look back at earlier transactions and consider whether they are void against the trustee.
The fact that an asset is no longer in the bankrupt’s name does not end the enquiry.
The key issues are usually timing, value, purpose, solvency and evidence.
Asset protection is not a last minute exercise.
Trying to move assets after creditor problems have already arrived is rarely a clean solution.
In many cases, it creates another problem.
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