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guide to bankruptcy voidable transactions

A voidable transaction under the Bankruptcy Act 1966 (Cth) can be very similar to those under the Corporations Act 2001 (Cth). A voidable transaction is a payment of money, transfer of property or other transaction from the Bankrupt’s assets to a related or unrelated third party that effectively causes a detriment to the Bankrupt.

The main distinction between the Bankruptcy Act 1966 (Cth) and the Corporations Act 2001 (Cth) is that in most circumstances you do not have to prove that the Bankrupt was insolvent at the time of the transaction. 

The responsibility of a Bankruptcy Trustee is to distribute a Bankrupt’s assets, fairly and evenly to all creditors. If a voidable transaction has taken place prior to the appointment of a Bankruptcy Trustee, then the Bankruptcy Trustee has the power to avoid these transactions under the Bankruptcy Act 1966 (Cth).

For all voidable transaction claims, the Bankruptcy Trustee has 6 years from the first act of Bankruptcy (as defined below) to commence proceedings for a voidable transaction under the Bankruptcy Act 1966 (Cth).

Uncommercial transactions

These are the most common type of voidable transactions in Bankruptcy’s and commonly take place when a debtor is aware that they will soon be declared bankrupt. They transfer their valuable assets or money to a related party at an undervalue in attempt to conceal it from becoming part of the Bankrupts’ estate. Examples of such transactions include purchasing assets for greater than market value in order to transfer money to a related party and selling valuable assets for less than market value.

SV Voidables are well experienced in recovering and defending these types of transactions. See the following article as an example.

Elements of uncommercial transactions

The transfer took place in the period beginning 5 years before the bankruptcy
Key terms

Transaction

A transaction is defined to include payments of money, transfer of property (which can include personal property, equipment, boats, cars and real property) or the entering into agreements. The most common type of transaction that gives rise to an uncommercial transaction is a transfer of land or real property to a spouse for “love and affection.”

Section 120(2) of the Bankruptcy Act 1966 (Cth) says that a transaction is taken not to include:

  • a payment of tax payable under a law of the Commonwealth or of a State or Territory; or
  • a transfer to meet all or part of a liability under a maintenance agreement or a maintenance order; or
  • a transfer of property under a debt agreement; or
  • a transfer of property if the transfer is of a kind described in the regulations.

Act of Bankruptcy 

An Act of Bankruptcy is defined in s 40 of the Bankruptcy Act 1966 (Cth), and includes a very long list of circumstances in which a Bankrupt is deemed to have committed an act of Bankruptcy. In summary and to give a very brief overview, an act of Bankruptcy arises where there is:

  • a Debtor’s Petition presented;
  • a transfer of property with intent to defraud creditors; or
  • the circumstance where a Bankrupt gives notice to its creditors that they will suspend payment of debts.
No consideration or less than market value was given for the transfer

The Bankruptcy Trustee needs to show that the consideration given by the third party for the transaction is less than market value.

For example, before the debtor goes into Bankruptcy, they decide to transfer their half share in their family home to their spouse and the consideration is said to be for “love and affection”. The Bankruptcy Trustee would hire an expert property valuer to assess the market value of the Bankrupt’s interest. If the market value is greater than the sum of any mortgage held over the property and the consideration paid, then the Bankruptcy Trustee would likely be able to void the transfer of the property.

Complications arise when family law and matrimonial issues need to be considered.

Is insolvency required to be proved?

In short no. However, if the transaction, that would otherwise meet the requirements of an undervalued transaction, occurs more than 2 years (for unrelated parties) and 4 years (for related parties) before the act of bankruptcy, then insolvency is required to be proven by the Bankruptcy Trustee. 

Avoidance of preferences

Preferences occur where a creditor has received an advantage over other creditors, by receiving payment (or other type of transaction) for their outstanding liabilities and does so in circumstances where they knew, or ought to have known, that the Bankrupt was insolvent.

Elements of unfair preferences:

A transaction was entered into between the Bankrupt and an unsecured creditor of the Bankrupt during the relation-back period

Key terms

  • Transaction – a transaction is defined to include payments of money, transfer of property (which can include personal property, equipment, boats, cars and real property) or the entering into agreements
  • Unsecured – a Bankruptcy Trustee cannot pursue a creditor for unfair preferences if they are a secured creditor, but only in proportion to the value of that security. This means that if a creditor validly registers on the Personal Property Securities Register (PPSR) and holds security over the Bankrupt’s assets that is greater than the sum of the purported preference payment, then the creditor would likely be safe from a Bankruptcy Trustee’s claim
  • Relation-back period – the relation-back period is the 6 month statutory time period during which a transaction must have occurred, in order for the Bankruptcy Trustee to be able to recover the transaction as an unfair preference. The relation-back period is calculated as the period from the earliest of (known as the relation-back day):
    • if the Bankruptcy arose by way of a Creditor’s Petition – it is the 6 month period beginning before the presentation of the Creditor’s Petition and extends to the date of the Bankruptcy
    • if the Debtor’s Petition is presented and at least 1 Creditor’s Petition is pending – it is the period beginning when the Creditor’s Petition was first presented to the date of the Bankruptcy; or
    • If only a Debtor’s Petition is presented – it is the 6 month period beginning before the presentation of the Debtor’s Petition and extends to the date of the Bankruptcy.  
The Bankrupt was insolvent at the time of the transaction 

The test of insolvency incorporates similar principles to that of a corporation. It applies the cash flow tests and balance sheets tests of insolvency. Basically, where a Bankrupt is unable to pay debts as and when they fall due and payable, then the Bankrupt is insolvent.

What is the balance sheet test?

  • Not the definitive test of insolvency
  • An assessment of the Bankrupt’s financial position (eg statement of assets and liabilities) to ascertain a snapshot of the Bankrupt’s financial position at the time of the transaction
  • A comparison of current assets to current liabilities is regularly used to measure the working capital of the Bankrupt (known as the liquidity ratio)
  • Requires an assessment of the financials, and potential adjustments, to ascertain the correct position or performance of the Bankrupt

What is the cash flow test?

  • Regarded as the best test of insolvency
  • Looks at all of the available assets of the Bankrupt, including those assets or funds it may otherwise be able to acquire (eg from bank loans, undrawn overdraft facilities, related parties, equity contributions), and assesses whether the Bankrupt could pay its due and payable debts now and into the immediate future
By receiving the transaction the creditor received more than what they otherwise would have received in the Bankruptcy, if the creditor was forced to repay the transaction and instead prove in the Bankruptcy
By way of example:
  • A Bankruptcy Trustee claims that a creditor received $200,000 in preference payments and demands repayment
  • The Bankruptcy Trustee has not realised any cash in the Bankruptcy (and does not expect to realise any other assets, except this preference claim)
  • The total creditors in the Bankruptcy are owed $400,000
  • The creditor is still owed $25,000 in the Bankruptcy
  • Simply put (assuming no fees are paid to the Bankruptcy Trustee and no priority creditors exist), if the creditor was ordered to repay the preference payments, then:
    • The $200,000 would be evenly distributed amongst all creditors totalling $600,000 (being $400,000 + $200,000), meaning a dividend of 33.33 cents in the dollar would be paid (ie $200,000/$600,000)
    • The creditor would receive approximately $75,000 (calculated as $225,000 (being the $200,000 repayment + $25,000 already owed) x 0.3333 cents in the dollar)
    • Accordingly, the creditor would have received $125,000 more than what they otherwise would have received in the Bankruptcy

It is important to note that different opinions exist as to the appropriate time to consider the preferential effect of transactions under the Bankruptcy regime. These different views are that the relevant date for testing this calculation is:

  1. during the actual Bankruptcy; or
  2. at the date of each transaction.

There are obviously practical implications for both views, however, it is likely that future courts will be more inclined to follow option (a), as opposed to option (b), so as to put the Bankruptcy regime in line with the Corporations Act. 

The creditor knew, suspected or ought to have known that the Bankrupt was insolvent when it received the transaction 

Creditors can defend themselves from unfair preference claims where they can prove that they did not know and ought not to have known that the company was insolvent. Being a defence, this means that it is the creditor that carries the burden of proof.

Any of the following characteristics may mean that a creditor is barred from arguing that they received the payments in good faith and without knowledge of the Bankrupt’s insolvency:

  • Excessive pressure by debt collection teams within companies;
  • Statutory demands and other informal demands;
  • Long outstanding debts;
  • Round payments; or
  • Dishonoured payments or post-dated cheques.

What can creditors do?

Call or contact SV Voidables. We specialise in assisting creditors defend unfair preference claims, by utilising different unique strategies and tactics to minimise the amount of money you have to pay to the Bankruptcy Trustee (if any) or fees to defend in court.

 

Transactions where consideration given to a third party

This is where a transfer of property has taken place between two parties (the Bankrupt and the transferee) and subsequently, the transferee gives some or all of the consideration for that transfer to a third party.

Under ss 120 and 121 of the Bankruptcy Act 1966, the third party can be the subject of recovery actions by a Bankruptcy Trustee where that consideration should have been paid to the Bankrupt.

Transfers to defeat creditors

This is where a person (who is subsequently declared bankrupt) transfers property to another person with an intention to protect that property from becoming a part of their Bankrupt Estate and subsequently being distributed to creditors or with an intention to defeat or delay the proper distribution of that property to creditors.

 

Contact our Voidables team

If you have any questions relating to our Voidables services, please contact one of our expert advisors.

 

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