• Bankruptcy and its effect on the distribution of family assets

    10.03.14

    The spectre of bankruptcy has lain heavy on many a divorce case in these harsh economic times, and  it is therefore apposite that legal practitioners and financial advisors are fully aware of the effects of bankruptcy on the distribution of family assets, including pensions

    Pensions

    Since the Welfare and Pensions Reform Act 1999, pension schemes have generally been excluded from a bankrupt’s estate, and therefore escaped being garnered by the Trustee in Bankruptcy for distribution among creditors. I say generally because if it is deemed that contributions to a pension scheme are excessive, the Trustee could argue that the inflated contributions were a device to put the bankrupt’s assets beyond the reach of creditors.

    But what if a bankrupt of pensionable age decides to draw down their pension during their bankruptcy? Unfortunately any lump sum paid out of the pension scheme will be regarded as after-acquired property and claimed by the Trustee for distribution among the creditors.

    Indeed any receipts from the pension scheme will be taken into consideration as part of the bankrupt’s income, as the Trustee is entitled to request contributions to the estate from any source of income for a period of up to three years.

    The Family Home

    Before the Enterprise Act 2002 came into being, when an individual became bankrupt, any interest they had in their family home automatically became an asset of the bankrupt’s estate.

    However, the Enterprise Act imposes time limits on a Trustee’s rights to seize and sell the family home. The current position in respect of bankruptcy petitions filed after 1st April 2004 is that if the Trustee fails to sell or secure their interest in a dwelling house (this definition includes the family home) within three years of the making of a bankruptcy order, the property reverts back to the former bankrupt. Note also that the term of bankruptcy has been reduced from three years to one year under the Act.

    It should also be noted that the definition of dwelling house is quite wide, as it includes any property in which the bankrupt had an interest, whether or not he or she actually lived in the property.

    Other Assets

    The husband or wife of a bankrupt has several problems to contend with if a court order distributing the marital assets has not been sealed prior to a bankruptcy order being made. The stark reality is that in the absence of such an order bankruptcy law prevails over matrimonial law, with the result that the solvent spouse will not be able to pursue a claim against the bankrupt’s assets, and gaining any financial settlement will be seriously hampered by the spectre of the bankruptcy.

    Love and fidelity in marriage often provokes acts of financial kindness. For example one party might have agreed to their share of the equity in a jointly owned property being used as security for the bankrupt.

    There used to be a principle called the equity of exoneration to protect such acts of kindness, trust and generosity, the lender being able to argue that they were simply providing security for their spouse, and thus entitled to an indemnity from them to the extent of the debt.

    However, a recent case, LEMON and ANOTHER v CHAWDA (2013), has overturned this principle. Family life has changed dramatically since the equity of exoneration first came into being. With both spouses often working and contributing both income and capital into the marriage, their finances are often so closely intermingled, that it can be difficult to distinguish who benefited from what. This is particularly the case where the party’s lifestyle was financed by a business. The court decided that even though a spouse was not directly involved with the business, they should nonetheless share not only in the fruits of the business, but also the consequences if the business failed. Maybe this is just another extension of the overriding principle of “fairness” enshrined in Section 25 Matrimonial Causes act 1973!

    So the former spouse, who previously funded her partner’s business, thinking themselves immune from the consequences if the business failed, must therefore beware. The long arm of bankruptcy might yet appear from the shadows and demand payment of the debt

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