Sydney Law Review
|
|
Home
| Databases
| WorldLII
| Search
| Feedback
Sydney Law Review |
|
LUCY ROBB[†]
In recent years, the number of high-income individuals who use bankruptcy to avoid their taxation obligations has steadily increased.[1] In a study conducted by the Australian National Audit Office in 1999, it was found that a small number of barristers, accountants and medical practitioners had tax debts amounting to five times the national average.[2] These cases of bankruptcy were remarkable in a number of respects. First, the sole or major creditor was the Australian Taxation Office (ATO). Second, the bankrupts were insolvent despite continuing to earn substantial incomes. Third, the trustee in bankruptcy was unable to recover sufficient assets to distribute to creditors because the bulk of the bankrupt’s property had been transferred to an ‘associated entity’,[3] prior to the commencement of bankruptcy. Fourth, while the bankrupt did not own the property, he or she used it as though it was his or her own.
The ATO estimates that it lost over 20 million dollars in revenue between 1996 and 1999 from 56 barristers alone.[4] In response to this situation, the Attorney General Daryl Williams and the then Assistant Treasurer Senator Rod Kemp commissioned a Joint Taskforce, comprised of members of the ATO, the Attorney-General’s Department, the Treasury and the Insolvency and Trustee Service Australia, to consider amendments to the existing law.
On 2 May 2003, the Taskforce published its Report.[5] It contains 12 recommendations, including a proposal to insert a provision which operates in a similar manner to s79 of the Family Law Act 1975 (Cth) into the avoidance provisions of the Bankruptcy Act 1966 (Cth).[6] Section 79 relates to the alteration of property interests between separating spouses. The purpose of the proposal is to extend the basis upon which a trustee in bankruptcy can recover property from third parties. This article will assess the necessity for and utility of that proposal.
On 20 November 1983, the Federal Attorney General asked the Australian Law Reform Commission to inquire into ‘the law and practice relating to the insolvency of both individuals and bodies corporate, in particular ... the provisions of the Bankruptcy Act, in its application to both business and non-business debtors’.[8] In 1988, the ALRC published its Report.[9] It made the following recommendation:
[W]hen a related person is involved [in an antecedent transaction] there should be a presumption of intent [to delay or defeat creditors]. With the shifting of the onus in this way, there is more control over transactions which, while clothed with apparent legal respectability, are repugnant in a commercial sense.[10]
The Commission’s recommendation was not adopted when the law was amended by the Bankruptcy Legislation Amendment Act 1996 (Cth).
In its report on the Use of Bankruptcy and Family Law Schemes to Avoid Payment of Tax, the Taskforce expressed the problem facing the ATO and other creditors in the following terms:
It is common for professional persons to own no significant assets. Typically, a spouse or a family trust or family company owns them. Where a bankrupt professional owns nothing and his or her spouse owns all the assets of the marriage, the question arises whether it is apt that legal ownership structures be regarded as inviolate. If they are, the bankrupt’s trustee — and creditors — get no access to assets registered as owned by the bankrupt’s spouse even if their acquisitions were solely funded by the bankrupt’s endeavours.[11]
Accordingly, the Taskforce made the following recommendation:
Courts having bankruptcy jurisdiction might be empowered to determine asset recovery applications by bankruptcy trustees where associated entities (including family members) of the bankrupt hold assets sourced from the bankrupt’s income flow or activities. This jurisdiction is to be additional to that conferred already under Division 4A of Part VI of the Bankruptcy Act.
The amount recovered could be determined by reference to family law principles relating to the contributions and needs of the parties to the marriage or, where applicable, by principles of property division under State domestic relationships law: in each instance the principles would be applied as if the relevant relationship between the bankrupt and another person had broken down.[12]
The Taskforce’s recommendation would therefore permit the trustee to recover assets from associated entities subject to two requirements. First, the trustee must be able to prove that property owned by an associated entity was ‘sourced’ from the bankrupt’s income or ‘activities’. Second, the trustee’s share of the property would be determined by applying the provisions applicable to the judicial division of property as between separating couples in s79 of the Family Law Act.
The recommendation was made by the Taskforce for the purpose of discussion, so no text of the proposed amendment is currently available. Accordingly, the proposal must be evaluated at a level of some generality. It is submitted, however, that the recommendation is sufficiently radical to warrant examination at this early stage.
It will be useful to commence by considering the principles which presently govern asset recovery in bankruptcy law.
There are two ways in which a trustee may gain access to a bankrupt’s property in order to distribute it amongst creditors. First, property owned by the bankrupt at the commencement of the bankruptcy will vest automatically in the trustee under s58 of the Bankruptcy Act. Second, property formerly owned by the bankrupt but transferred prior to the commencement of bankruptcy will be recoverable if the transactions were made in circumstances that would allow the court to declare the transfer void as against the trustee.[13]
Ownership is the foundation of asset recovery in bankruptcy law. It prescribes the limits of the trustee’s powers of recovery under the Bankruptcy Act. This is evident from the terms of ss 58 and 116. Section 58 states: ‘the property of the bankrupt ... vests forthwith’ in the trustee.[14] Property is defined as ‘real or personal property of every description, whether situate in Australia or elsewhere, and includes any estate, interest or profit, whether present or future, vested or contingent, arising out of or incident to any such real or personal property’.[15] Section 116(1) states, ‘all property that belonged to, or was vested in, a bankrupt at the commencement of the bankruptcy, or has been acquired or is acquired by him, or has devolved or devolves to him, after the commencement of the bankruptcy and before his discharge’ will be divisible among the creditors.[16] Section 116(2) enumerates the few exceptions to this rule.[17] It is clear that the principal difficulty faced by a trustee in recovery proceedings will usually be the need to establish the bankrupt’s title to the property.
The following examples illustrate the way in which a property transaction between a bankrupt and an associated entity, prior to the commencement of bankruptcy, can frustrate the asset recovery procedure under s58 of the Bankruptcy Act. The analysis assumes that the transfer complied with the rules for valid assignment of property in law and equity.[18]
Prior to bankruptcy, property may have been transferred to a company controlled by the bankrupt. Company law is founded on the principle that companies have separate legal personality to those who manage or are employed by them.[19] From this premise flows the principle of limited liability. A company cannot be required to satisfy the personal liabilities of an associated bankrupt, even if the bankrupt is the company’s founder and sole employee,[20] or the source of all its assets.[21]
Alternatively, the bankrupt may have transferred property to a trustee to be held on trust for the bankrupt or other associated persons. If the trust is discretionary, the beneficiaries will not have a proprietary interest in the trust property.[22] They will merely have a personal right against the trustee to compel due administration of the estate. Thus, the interest in a discretionary family trust which vests in a trustee in bankruptcy will be personal, not proprietary.
Dispositions of property within families are more complicated. A valid assignment of property prior to bankruptcy will ordinarily vest the bankrupt’s legal and equitable title in the transferee. However, in some cases, the circumstances surrounding the transaction may mean that the transferee holds the property on trust for the transferor. This may occur where the transferor has contributed all or some of the purchase price when the property was originally acquired. In these circumstances, a resulting trust may arise because the courts will infer that the parties intended the transferor to retain an equitable interest in the property.[23] The existence of a resulting trust may be displaced by evidence of the parties’ contrary intention, or by the presumption of advancement.[24] The presumption of advancement generally only applies to gifts made by husbands to wives, or parents to children.[25] Therefore, if a wife transferred property to her husband, he would hold it on trust for her, but a transfer by a husband to a wife will usually vest full beneficial ownership in the wife. In the context of recovery proceedings in bankruptcy, this means that the trustee may have access to property transferred by a bankrupt wife to her husband, but not property transferred by a bankrupt husband to his wife. All this is subject to the trustee being able to prove that the parties intended the transferor to retain an interest in the property. Given that the purpose of a disposition by a bankrupt to his or her spouse or child will usually be to alienate the full beneficial interest, it is unlikely that the courts will find a resulting trust. Consequently, no property will be available to distribute amongst creditors.
In circumstances like those illustrated above, the trustee will have to rely on the avoidance provisions of the Bankruptcy Act, which are contained in Division 4A of Part VI.
The first consolidated Bankruptcy Act was enacted in England in 1825. Before that time the antecedents of many provisions now found in the Bankruptcy Act 1966 (Cth) existed in separate statutes.[27]
The precursor to the modern s120, which concerns undervalued transactions, was the 1604 Statute of James I. According to Lewis’ Australian Bankruptcy Law:[28]
The Act of 1604 introduced a new principle. Hitherto property conveyed in good faith before bankruptcy was protected from seizure by the Commissioners. The 1604 Statute provided that all conveyances made by the bankrupt before bankruptcy, unless made in consideration of marriage or for value, should be treated as void and the property concerned recovered for distribution among creditors.
The consolidated Bankruptcy Act of 1825 enshrined these principles in section LXXIII. It stated that a transaction could be avoided if it was made at any time before bankruptcy, as long as the transferor was insolvent at the time of the transaction. Section LXXIII of the Bankruptcy Act 1825 was amended by s91 of the 1869 Act.[29] Section 91 provided that settlements were void against the trustee if made within two years of bankruptcy (irrespective of solvency) and, if made within 10 years, were void unless the transferee could prove solvency. Older settlements were not at risk of avoidance under s91.
The earliest New South Wales statute was the Insolvency Act of 1841.[30] It was in materially the same terms as the 1604 Statute of James I. Section 6 of that Act provided that transactions made by an insolvent transferor, at any time prior to bankruptcy, were liable to be set aside, if they were not made for valuable consideration. Subsequently, the NSW Parliament enacted the Bankruptcy Act of 1887,[31] which adopted the same time limits as s91 of the Bankruptcy Act 1869 (UK).[32]
In 1901, bankruptcy and insolvency became a federal matter under s51(xvii) of the Commonwealth Constitution. The first Commonwealth Bankruptcy Act was passed in 1924. Section 94 provided that voluntary settlements made within two years of the commencement of the bankruptcy were voidable and, if made within five years, were voidable unless the transferee could establish that the transferor was solvent.
Section 120 of the Bankruptcy Act 1966 (Cth), which replaced s94 of the 1924 Act, was in materially the same terms. Section 120 was then amended by the Bankruptcy Legislation Amendment Bill 1996 (Cth), which replaced the concept of a ‘voluntary settlement’ with that of an ‘undervalued transaction’.[33] The amendment did not disturb the two-tiered time regime under which transactions could be set aside under the 1966 Act.
This brief historical review shows that s120 has an ancient lineage. The balance it strikes between the rights of creditors and the bankrupt’s associates has been broadly accepted as fair and adequate for four hundred years. In fact, the provision has, if anything, been slanted in favour of the bankrupt’s associates by the gradual reduction of the period of time during which insolvent transactions were liable to be set aside. On the other hand, the interests of the creditors were protected by the introduction of the rule that all undervalued transactions made within two years of bankruptcy were voidable, irrespective of the transferor’s solvency.
The equivalent of s121 of the Bankruptcy Act 1966 (Cth) was not introduced into bankruptcy legislation until 1966.[34] Prior to that, fraudulent dispositions were governed by state and territory acts,[35] which were in turn based on the 1571 Statute of Elizabeth.[36] That legislation provided that transfers of property for the purpose of ‘delaying, hindering or defrauding creditors’ of their lawful debts were ‘to be cleanly and utterly void, frustrate and of none effect’.[37]
Section 121 was amended by the Bankruptcy Legislation Amendment Bill 1996 (Cth) to remove the emphasis on fraud. Under the old section, the trustee had to prove that the transferor intended to defraud his creditors. The new section requires the trustee to establish that the bankrupt’s main purpose was to delay or defeat creditors.[38] The amendment also introduced s121(2), which empowers the Court to infer that a transfer was made with the main purpose of defeating or delaying creditors if the transferor was insolvent at the time that the transfer was made.[39]
Given that the law has remained substantially unchanged for over four hundred years, it is submitted that it would be unwise to amend it further without good reason. The following section examines the scope of the avoidance provisions and their application to the transactions currently under review.
The avoidance provisions of the Bankruptcy Act 1966 (Cth) give a trustee in bankruptcy access to property transferred prior to the commencement of the bankruptcy. Unlike the recovery procedure available under s58 of the Act, avoidance provisions do not have the effect of automatically vesting the bankrupt’s (former) proprietary interest in the trustee. This is because these transactions are not void but voidable.[40] They are valid for all purposes and against all persons, unless and until the trustee applies to have them set aside by the Court.[41]
There are three circumstances in which a trustee may challenge an antecedent transaction: (i) where the transfer took place within five years of the commencement of bankruptcy and the consideration provided was less than market value;[42] (ii) where the intention of the transferor was to delay or defeat creditors;[43] and (iii) where the effect of the transaction was to prefer the interests of some creditors over others.[44] Preferential transactions have no application in the present circumstances because the relevant ‘associated entities’ are not creditors.[45] The following analysis will therefore focus on the effect of ss 120 and 121.
Before embarking upon a detailed examination of the scope of ss 120 and 121, it is important to understand the relationship between them. The purpose of the avoidance provisions is to enable trustees to recover assets where the transfer was prejudicial to the creditors’ interests because it reduced the size of the bankrupt’s estate.[46] Both ss 120 and 121 apply to transfers that were undervalued. However, s120 operates to invalidate ‘innocent’ transfers, while s121 applies to transfers made for the purpose of putting the property out of the reach of creditors, or hindering or delaying their access to it. The scope of the trustee’s power of recovery is limited under s120 to transfers taking place within five years of the commencement of the bankruptcy. This is in recognition of the fact that the transfers may not have been inherently wrongful. In contrast, a transfer that satisfies the criteria in s121 may be set aside whenever it took place. Section 121 is a reflection of the law’s enduring abhorrence of fraud or, what is now termed, a main purpose to delay or defeat creditors.
In Cook v Benson[47] the majority of the High Court commented:
The Court [in Barton v Official Receiver[48]] said that the purpose of the English [equivalent of s120] was to prevent properties from being put into the hands of relatives to the disadvantage of creditors.
Of course, it is not confined to dispositions to relatives ...
In order to invalidate a transaction under s120 of the Bankruptcy Act, the trustee has the onus[49] of proving that no consideration, or consideration that was not equivalent to the market value of the property, was provided. If the transfer took place within two years of the commencement of bankruptcy, it will be voidable. Similarly, if it took place within five years of the commencement of bankruptcy, and the bankrupt was insolvent at the time, the transaction will be voidable. If, however, the transfer took place within two to five years of bankruptcy, and the transferor was solvent, the transaction will be secure.[50] When a transaction is voidable, s120(4) requires the trustee to refund any consideration that was paid for the property.[51]
The time limits in s120 are the major obstacles preventing the trustee from being able to avoid an antecedent transaction. If a bankrupt has adopted a practice throughout his or her career of transferring assets to their spouse, the trustee may be unable to access them under this provision because of the effluxion of time.
If the trustee wishes to challenge a transaction which took place more than five years before the commencement of bankruptcy, he or she must bring a claim under s121. Section 121 requires the trustee to prove that the main purpose of the transfer was either ‘to prevent the transferred property from being divisible among the transferor’s creditors’,[52] or ‘to hinder or delay the process of making property available for division among the transferor’s creditors’.[53]
The principal difficulty faced by the trustee will be proving that the transferor’s main purpose was to defeat creditors. The High Court stated in relation to the old s121:
... it is clearly established that the party seeking to avoid disposition of property has the onus of proving an actual intent by the disponor at the time of the disposition to defraud creditors. The creditors ... need not be existing creditors; they may be future creditors ... [b]ut ... the intent must accompany the disposition.[54]
The new law has partially overcome the problem of proving ‘actual intent’ (or ‘main purpose’) by allowing the court to draw an inference where the transaction was made when the transferor was insolvent.[55] The trustee has less chance of succeeding if the transferor was solvent. In the context of transactions between family members, the courts have occasionally been reluctant to infer an intention to defeat creditors.[56] The case of Williams v Lloyd [57] is particularly apt. It involved a gift of property by a solvent husband to his wife and children. The gift was made because the husband was contemplating investing in a risky business venture. The bankrupt’s wife encouraged him to transfer the property to her and their children in order to protect it from being lost in the event that the husband became insolvent. Starke J, with whom the Chief Justice agreed, stated:
The fact that the dispositions in the present case were in favour of the [transferor’s] wife and children, and ... were made at a time when he was not embarrassed, is a circumstance entirely favourable to the bankrupt, for it is but natural and proper that a man should make provision for his wife and children without any intent whatsoever of defeating his creditors.[58]
This case illustrates the difficulty in proving the relevant purpose in cases relating to transfers between family members.[59] While on one view, the main purpose of the transfer was clearly to defeat creditors, the Court preferred to characterise the transfer as ‘protective’ rather than ‘fraudulent’. In cases which involve gifts within families, a trustee may have difficulty not only in proving that defeating creditors was the ‘main’ purpose of the transaction, but also in establishing that there was any purpose to defeat creditors at all.
Trustees may have difficulty recovering assets under the existing law in circumstances where the bankrupt has transferred property in an antecedent transaction for three principal reasons. First, although the property may be used by the bankrupt on a regular basis, he or she may not own it, so the property will not vest in the trustee under s58 of the Bankruptcy Act 1966. Second, if the property was transferred more than five years prior to the commencement of bankruptcy, s120 of the Act will not apply, and the trustee will fail in relation to transactions effected more than two years before the bankruptcy if the bankrupt was solvent at the time. Third, even if s120 does apply, proving that the ‘main’ purpose of a transaction was to defeat creditors may be difficult, especially in the context of gifts between family members.
Under s79(1) of the Family Law Act 1975 (Cth) (hereinafter Family Law Act), courts having jurisdiction under the Act are empowered to make declarations altering the existing property interests of the parties to a marriage.[60] Section 79(1) does not affect proprietary rights prior to the Court making an order, so until the order is made, the ordinary rules governing legal and equitable interests continue to apply.[61]
There are three stages in the process of reallocating property under s79 of the Family Law Act. First, the full extent of both parties’ property must be ascertained.[62] It is irrelevant how, when or by whom the property was acquired.[63] This includes property that was acquired before the marriage, after separation or even through an inheritance.[64] Second, the property must be valued. Third, the judge must exercise his statutory discretion to allocate property interests between the parties. The discretion given under s79 is wide. In De Winter v De Winter,[65] Gibbs J observed: ‘Few curial orders can have a greater effect on ordinary citizens of modest means. It needs hardly be said that such a discretion is to be exercised with scrupulous care.’[66]
The judge’s discretion is guided by the requirement under s79(2) that his or her order be ‘just and equitable’. Justice and equity are determined by reference to seven mandatory considerations enumerated in s79(4).[67] The first three considerations relate to the parties’ past contributions to the property and welfare of the marriage, and the subsequent four concern the parties’ present economic situation. Each case is considered on its own merits and there are no guidelines to influence the manner in which a judge should exercise his or her discretion, other than the provisions of s79 itself.[68]
Before considering the merits of the Taskforce’s proposal, it is worthwhile noting that the matter of tax evasion is properly the concern of taxation law, not bankruptcy. Under the Taxation Administration Act 1953 (Cth), the Commissioner of Taxation has certain powers with respect to the investigation and collection of tax debts. If the ATO had detected the practice of bankrupts who transfer assets to associated entities to defeat tax collection at an earlier stage, it might have been able to recover the debts while the debtor was still solvent. In cases where the debtor was already insolvent and bankruptcy had commenced, the trustee may have been able to recover the alienated property under s120 of the Bankruptcy Act. The Australian National Audit Office made a similar point in its 1999 Report.[69] It stated that the ATO’s practices in regard to the investigation of tax evaders could be more effective.[70] Ideally, flagrant disregard of tax should not go undetected for so long that it becomes a matter which cannot be remedied without a fundamental change to bankruptcy law.
Second, it is unclear how many instances of tax evasion will arise in the future because of the abuse of bankruptcy law. At this stage, there appears to be only a handful of barristers, accountants and medical practitioners who regularly use bankruptcy to avoid their debts.[71] This figure may decrease given that professionals now have to register with the ATO in order to be provided with an Australian Business Number (ABN) so as to receive credit for Goods and Services Tax (GST) paid as part of their business expenses. It will make it difficult, if not impossible, for high-income individuals to shield their incomes from the ATO for a prolonged period of time. It is therefore possible that the proposal, if implemented, will become law at a time when it is no longer necessary.
It is submitted that the law should not be amended until it has been thoroughly tested, and the existence and nature of any deficiencies established. There have been clear judicial statements to the effect that the recently amended s121 of the Bankruptcy Act will make it easier for trustees to recover property.[72] The ATO should be encouraged to fund a trustee to run appropriate test cases in order to establish that the existing law is incapable of addressing the problem. It is possible that, in many cases, s121 (as amended) is sufficiently flexible to provide a direct remedy to the specific problem. As discussed above, s121 is available when a transfer of property was made many years prior to the transferor becoming bankrupt. In cases where the transferor was insolvent, s121(2) allows the Court to infer that the transaction was made with the main purpose of delaying or defeating creditors. Problems only arise for the trustee in situations where the transferor was solvent.
However, it by no means follows that s121 will be unavailable because the transferor was solvent. Take, for example, the situation of a husband who transfers the family home into his wife’s name and shortly thereafter stops paying his tax. Although he was solvent when he made the transaction, the proximity between the transfer and the accumulation of the debt may be a basis upon which the transfer could be avoided.[73] The Court is not limited in the number and nature of considerations it may take into account in determining whether the circumstances surrounding a property transaction suggests an intention to defeat creditors.[74]
This being said, an intention to defraud creditors is notoriously difficult to prove.[75] There is one situation, in particular, in which the trustee will be unlikely to avoid a transfer under s121. Taking the example given above, if the family house is given to the bankrupt’s wife for the main purpose of providing her with financial security, and the actual decision to evade tax is formed later, s121 will be inapplicable. The temporal disjunction between the act and the formulation of intent defeats the avoidance mechanism.[76] Section 121 would only be available if the trustee could establish that the intention accompanied the disposition. It must be accepted that s121, even in its present form, will probably not avail the ATO in all cases of tax avoidance followed by bankruptcy of high-income individuals. It may, therefore, be necessary to introduce limited reform. However, until a test case is run, the practical utility of s121 will be uncertain, and there is a risk that the law will be amended unnecessarily.
If it is accepted that an amendment is necessary, the reform should be carefully tailored to address the specific vice. The vice in question relates to tax evasion. Accordingly, the reform should be available to the ATO and not to the general body of unsecured creditors. There are a number of factors which distinguish the position of the ATO from that of the ordinary unsecured creditor. First, the ATO is not in a position to detect all debts before they fall due. Unlike general creditors, it cannot choose whether or not to extend credit. Nor can it protect itself against the risk of loss. Ordinary unsecured creditors have a range of means at their disposal to protect themselves or reduce the risk of bad debts. For example, they can require security over the debtor’s property, demand guarantees or insist on cash on delivery. In contrast, the ATO must rely on individuals to faithfully declare their tax obligations before it knows how much it is owed. While the onus of investigating and collecting tax debts lies with the ATO, it cannot be expected to detect all misconduct as soon as it occurs. The resources of the ATO, although extensive, are not unlimited, and it is bound to ensure that it uses those resources efficiently and effectively. If the limits of the ATO’s power of investigation and collection are acknowledged, it follows that there may be a need to reform the law in order to provide the ATO with an additional mechanism to recover debts in cases where detection is extremely difficult.
Second, the ATO is more likely to be affected by long-term debt than general creditors. Most unsecured creditors suffer losses as a result of their clients’ short-term business difficulties. It would be rare for general creditors to allow a debt to exist for more than five years.[77] Thus, it is, in principle, more likely that a trustee acting on their behalf would be able to recover the bankrupt’s assets under s120 of the Bankruptcy Act.
If the Taskforce’s proposal is implemented, general creditors will have more rights against debtors than they currently enjoy under the Bankruptcy Act. It is submitted that this would be unwarranted. As a general principle,[78] the law does not require people to organise their affairs in order to ensure that they can always pay their debts. Furthermore, the law recognises that there are many situations in which undervalued property transfers are legitimate. Indeed, there are some circumstances in which gifts are positively encouraged.[79] The avoidance provisions of the Bankruptcy Act are a reflection of the principle that undervalued transactions are legitimate unless the law states otherwise because they enumerate the limited circumstances in which a transaction will not be legitimate. Arguably, the introduction of a bankruptcy equivalent of s79 of the Family Law Act will undermine this principle because it will not create a new exception but rather, will act as a catch-all provision, which trustees may fall back on when other remedies fail.
The first limb of the proposal requires the trustee to identify whether property owned by an associated entity was purchased, in whole or in part, by the bankrupt’s income. There may be cases where proof of this criterion is clear. The bankrupt may simply give property which he or she owns to an associate. In other cases, the bankrupt may be the only income earner, so that it is reasonably clear that the bankrupt is the sole source of the funds used to acquire the property. However, it is commonly the case that property is acquired by way of mortgage, and the mortgage debt repaid over a substantial period of time. In these, and perhaps other cases, it may not be easy to identify the extent to which the bankrupt has been the ‘source’ as contemplated by the Taskforce. Particularly in circumstances of rising property values, it may be difficult to relate the income diverted by the bankrupt from paying tax debts, to the provision of the original purchase price of the asset.
While the proposal would affect transactions between bankrupts and associated entities generally, its impact on marriages and families warrants separate consideration. The following analysis focuses on marriage but the position is the same with respect to de facto relationships and same-sex couples.
The law treats marriage as an unusual combination of a private union[80] and a commercial contract between two legally distinct personalities.[81] The dichotomy between unity and individuality must be remembered when assessing the Taskforce’s proposal. The basis of the proposal is the assumption that couples who receive the benefits of marriage should also be required to bear the burdens.[82] This accords with the view that marriage is a union. On one level, the argument has superficial appeal. However, it overlooks the fundamental legal principle that, in relation to property matters, spouses have separate legal personality. Separate ownership of property has existed for over one hundred years, since the Married Women’s Property Act was passed in 1882.[83] That Act abolished the doctrine of unity, according to which married couples were considered a single entity and gave wives the right to own property in their own names.[84] The abolition of the doctrine of unity meant that spouses could no longer be held responsible for their partner’s liabilities without express agreement to the contrary. The right to risk property is an incident of the right to own it. Accordingly, only the owner may engage in commercial transactions, or accumulate debts, which might result in the property being removed in the event of bankruptcy. The Taskforce’s proposal might have the effect of diminishing a wife’s right to separate legal ownership, since it would make full and uninterrupted enjoyment of her legal entitlements contingent upon her husband’s commercial liabilities. By enabling the trustee to treat the marriage as an economic unit, the proposal re-introduces certain aspects of a long defunct and socially unacceptable principle of property law.
A corollary of the right to own property is the right to freely alienate it. With very few exceptions, the law does not dictate how married couples must own property.[85] Even s79 of the Family Law Act might be seen as an example of a couple’s right to choose how to deal with property. One of the principal aims of that Act is to enable spouses to apply for an order altering their property interests at any time during their joint lives, whether during cohabitation or after separation.[86] The re-allocation of property interests between couples is therefore a matter of choice, not an imposition by the law. Freedom of property ownership and alienation within a marriage is tied to the notion that families are traditionally regarded as private and immune from intervention by the state.[87] It is submitted that the use of s79 principles outside family law will result in an unwarranted intrusion upon the private right of couples to allocate property as they see fit. It is not being suggested that the state does not already intrude upon family life in bankruptcy. Clearly, the vesting of property owned by a bankrupt spouse in the trustee in bankruptcy through the ordinary operation of s58 of the Bankruptcy Act can be devastating. It is submitted, however, that by interfering with the fundamental freedoms associated with property ownership, the proposal would extend the nature of the state’s current level of intervention in new and unacceptable ways.
It is also submitted that property orders like those made under s79 of the Family Law Act, if used in the context of bankruptcy, would place the family under unnecessary emotional strain and increase the risk of future discord. Section 79 is inherently divisive and intended to ensure that there is no further need for legal or financial interaction between the parties.[88] As the consequences of bankruptcy are already severe, it would be wholly undesirable to place further pressures on a family by imposing the equivalent of financial divorce.
Moreover, it will be very difficult to apply the principles of justice and equity, which presently guide the Court’s discretion under s79 of the Family Law Act, if the Court is required to treat the parties as though they were separating. The allocation of property interests within a continuing relationship must necessarily differ from the way such property would be distributed if the couple were to separate. This is particularly true of bankruptcy. If the couple continues to live together, the bankrupt spouse will, for a short time at least, become financially dependant on his or her partner. If the fiction of separation is applied without acknowledging the reality of the couple’s future life together, an artificial and unjust outcome may ensue.
In relation to other associated entities, it is not clear how the contributions method of assessing ownership will work. How is a judge to assess the relative contribution between a bankrupt and a trust? The factors that may be relevant under s79 of the Family Law Act in the context of a dispute between natural persons will not easily translate to proceedings involving trusts or companies. If the proposal is to have any effect, the legislature may have to establish a separate regime for transactions between natural persons and other legal entities.
It is submitted that, if the Government wishes to change the basis of asset recovery in bankruptcy law, it should do so consistently. If the proposal is enacted, asset recovery will be governed by two concepts of property ownership: legal title and contributions. This may lead to anomalous applications of the Bankruptcy Act. For example:
(a) Where one spouse owns property and becomes bankrupt, the whole property will vest in the trustee;
(b) Where the property is jointly owned, the property will be sold and the bankrupt’s interest will vest in the trustee;
(c) Where the non-bankrupt spouse owns the property, the trustee will be able to apply for a redistribution of ownership and the bankrupt spouse’s interest will vest in the trustee.
If examples (a) and (c) are compared, it is apparent that the proposal may lead to a certain level of injustice. In example (a), the non-bankrupt spouse’s rights are constrained by legal ownership. He or she will not be entitled to rely on his or her contributions to the marriage in order to retain an interest in the property, except in the special circumstances which give rise to a constructive trust in his or her favour.[89] In contrast, the trustee in example (c) will be able to recover part of the property on the basis of the bankrupt’s contribution. It is submitted that the law may become a motley combination of provisions in which the rights of the non-bankrupt spouse will be a matter of happenstance. If there is a genuine need to amend bankruptcy law by changing its reliance on the criterion of ownership, then it is arguable that the whole law of asset recovery should be reconsidered in order to promote consistency and justice between the parties.
It is submitted that the proposal is likely to make asset recovery more inefficient. Two important objectives of bankruptcy law are speed and simplicity. The complicated procedure of identifying and redistributing property under the principles embodied in s79 of the Family Law Act is anything but simple or swift. The costs associated with bringing an application would seem to be prohibitive for all but the most determined trustee. Except in a limited range of circumstances, the proposal is likely to have limited utility.
Finally, it is doubtful whether the proposal would truly eradicate tax evasion by wily bankrupts. Various loopholes would continue to exist. The most straightforward way of subverting the proposal would simply be to transfer assets to an offshore trust fund. Under private international law rules, domestic courts cannot enforce foreign revenue laws.[90] Given that high-income individuals often own significant assets overseas, there is a risk that the proposal will be ineffective against the very people whose conduct is arguably the most egregious. On this basis alone, there is a sound argument for abandoning the proposal in favour of a more reliable remedy.
Two fundamental questions must be considered in relation to the Taskforce’s recommendation. First, is it necessary or desirable to amend the existing law to increase creditors’ rights of asset recovery against debtors and their associates? Second, if it is necessary, is the introduction of principles of family law relating to the redistribution of property between separating spouses an appropriate basis for allocating property rights between a bankrupt and his or her associated entity? In answer to these questions, the following broad submissions were made. First, it has not been established that the existing law is incapable of applying a direct remedy to the apparent mischief. Second, it is arguable that the cases which do not fall within the scope of the current law should not, as a matter of public policy, be brought within its ambit. Third, the introduction of s79 principles of property distribution would fundamentally undermine the freedom to own and alienate property.
In the final analysis, however, a single fact must be emphasised. The Taskforce is proposing a radical and inefficient amendment to the Bankruptcy Act 1966 (Cth) in order to address a very specific problem of taxation law, caused by a relatively small number of people. If it is accepted that some form of amendment is required, it must surely be recognised that the benefits of the current proposal do not outweigh the detriments. It is difficult to avoid reaching the conclusion that the Government has rashly overlooked the fact that, in a liberal democracy, people are entitled to own or alienate property in any way they choose. There is nothing inherently wrong with transferring assets to a spouse or other associated entity, even if one of the purposes of the transfer is to protect the transferor against a future financial calamity. Indeed, it is arguable that such protection measures are prudent because the social costs of bankruptcy are immeasurable. There is a fundamental difference between these situations and cases where the bankrupt has wilfully frustrated tax collection by deliberately imposing a state of insolvency upon himself or herself. For these cases, the law already provides a remedy in the form of s121 of the Bankruptcy Act. Thus, to extend the circumstances in which a trustee may gain access to a bankrupt’s alienated property would not only be unnecessary, it would also be unjust.
[*]The Form of Solemnization of Matrimony’ in The Book of Common Prayer and Administration of the Sacrements, Church of England.
[**] Bankruptcy Act 1966 (Cth); Family Law Act 1975 (Cth).
[†] Final year student, Faculty of Law, University of Sydney.
[1] The problem has been identified in a number of reports by different government bodies, including the Australian National Audit Office, The Management of Tax Collection, No 23 1999/2000 (hereafter ‘ANAO Report No 23’): <http://www.anao.gov.au> Senate Economics References Committee, Operation of the Australian Taxation Office (Canberra, AGPS, 2000) and the Annual Report 1999/2000 of the Commissioner of Taxation: <http://ato.gov.au/content/asp?doc=/content/corporate/anrep2000.html> .
[2] ANAO Report No 23, id at para 50.
[3] Under the Bankruptcy Act 1966 (Cth) (hereinafter Bankruptcy Act), ‘associated entities’ refers to companies (s5B); natural persons, for example the bankrupt’s close relatives, agents, employees, trustees or solicitors (s5C); partnerships (s5D), and trusts (s5E).
[4] Joint Taskforce on The Use of Bankruptcy and Family Law Schemes to Avoid Payment of Tax (hereinafter ‘Report of the Taskforce’) (2 May 2003): <http://www.law.gov.au/www/legalservicesHome.nsf> .
[5] Ibid. The Taskforce also produced an issues paper which is available at <http://www.itsa.gov.au/dir288/itsaweb.nsf/docindex/reform->reviews->reviews?opendocument>.
[6] The term ‘avoidance provisions’ is used in this article to refer to ss120, 121 and 122 of the Bankruptcy Act.
[7] See Penelope Carruthers, ‘Bringing the High Flyers Back to Earth? Sections 120 and 121 of the Bankruptcy Act’ (1995) 25 Western Australian Law Review 88 at 100.
[8] Australian Law Reform Commission, General Insolvency Inquiry Report No 45, Vol 1 (1988) at para 1.
[9] Ibid.
[10] Id at para 282.
[11] Report of the Taskforce, above n5 at para 4.29.
[12] Report of the Taskforce, ‘Recommendation 3’, above n5 at para 4.37.
[13] See below for a discussion of the circumstances in which a transaction will be considered voidable.
[14] Emphasis added.
[16] Emphasis added.
[17] For example, the trustee will not have access to the bankrupt’s clothing, necessary household items or his or her main form of transportation.
[18] See R P Meagher, W M C Gummow & M J Leeming, Meagher, Gummow and Lehane’s Equity Doctrines and Remedies (4th ed, 2002) chapter 3, for an explanation of the rules.
[19] Salomon v Salomon & Co Ltd [1897] AC 22.
[20] Lee v Lee’s Air Farming Ltd [1960] 3 All ER 420.
[21] Although, if the bankrupt owns shares in the company those shares will vest in the trustee under s58 of the Bankruptcy Act and the trustee will gain access to the company’s property by that means.
[22] H Ford & W Lee, Principles of the Law of Trusts (3rd ed, 1996) at 47.
[23] Calverly v Green [1984] HCA 81; (1984) 155 CLR 242.
[24] Ibid.
[25] Ibid.
[26] Section 122 of the Bankruptcy Act relates to preferential transfers of property to creditors. The origins of s122 will not be considered here because the definition of ‘associated entities’ under s5 of the Bankruptcy Act does not include creditors. Consequently, s122 has no application to the transactions currently under review.
[27] For a general history of bankruptcy law, see Dennis Rose, Lewis’ Australian Bankruptcy Law (11th ed, 1999) chapter 2. Also, PT Garuda Indonesia Ltd v Grellman [1992] FCAFC 188; (1992) 35 FCR 515.
[28] Lewis’ Australian Bankruptcy Law, id at 14.
[29] 32 Vic, c 71.
[30] 5 Vic, c 19.
[32] Although the wording was copied verbatim from s47 of the Bankruptcy Act 1883 (UK), which was a re-enactment of the 1869 statute.
[33] As a consequence, property transfers now fall under the ambit of the Act, even if they were only intended to be temporary, or the property was intended to be dissipated. This differs from the position under the old section: see, for example, Barton v Official Receiver (1983) 52 ALR 95.
[34] It was inserted into the Commonwealth Act upon the recommendation of the Committee appointed by the Attorney General of the Commonwealth to review the bankruptcy laws of the Commonwealth (Clyne Committee).
[35] Conveyancing Act 1919 (NSW) s37A; Property Law Act 1958 (Vic) s172; Law of Property Act 1969 (WA) s86; Mercantile Act 1867 (Qld) s46; Conveyancing and Law of Property Act 1884 (Tas) s40.
[36] 13 Eliz 1, c 5.
[37] Quoted in Cannane v Cannane Pty Limited (1998) 192 CLR 557 at para 37 (Gummow J).
[38] For a more detailed comparison of the old and new law, see Prentice v Cummins (No 5) [2002] FCA 1503.
[39] This appears to be a codification of the common law position under the old s121. See, James Edelman, ‘The Meaning of Fraud in Insolvency and Bankruptcy Law: A 400 Year Old Riddle’ (2000) C&SLJ 97.
[40] Williams v Lloyd [1934] HCA 1; (1933) 50 CLR 341 at 374 (Dixon J).
[41] Brady v Stapleton [1952] HCA 62; (1952) 88 CLR 322 at 333 (Dixon CJ, McTiernan & Fullagar JJ).
[42] Bankruptcy Act s120.
[43] Bankruptcy Act s121.
[44] Bankruptcy Act s122.
[45] Above n27.
[46] PT Garuda Indonesia Ltd v Grellman, above n28.
[47] [2003] HCA 36 at 30.
[48] Above n34.
[49] Official Trustee in Bankruptcy v Alvaro (1996) 66 FCR 372 at 417.
[50] Bankruptcy Act s120(3).
[51] It is unclear to what extent a spouse’s unremunerated domestic work may amount to valuable consideration for the purposes of s120. Section 120(5) provides that factors such as the relationship between the parties, or their mutual love, shall not be taken into account. However, domestic labour, such as shopping, cooking and cleaning, which does have a market value, may be relevant: Mateo v Official Trustee in Bankruptcy [2002] FCA 344. If so, the trustee will be required to reimburse the non-bankrupt spouse for the full amount of his or her consideration. If the value of the work exceeds the market value of the asset, title will not vest in the trustee at all.
[52] Bankruptcy Act s121(1)(b)(i).
[53] Bankruptcy Act s121(1)(b)(ii).
[54] Cannane, above n38 at para 10.
[55] Bankruptcy Act s121(2).
[56] Carruthers, above n8 at 99.
[57] Above n41.
[58] Id at 361.
[59] Although contrast the case of Re Butterworth; ex parte Russell [1880] UKLawRpCh 156; (1882) 14 Ch D 588, in which the Court decided that the transaction was fraudulent in substantially the same circumstances.
[60] There are equivalent provisions in state and territory legislation. See, for example, Division 2 of the Property (Relationships) Act 1984 (NSW).
[61] In the Marriage of Fisher [1986] FamCA 35; (1986) 82 FLR 421 at 434.
[62] In the Marriage of Carter [1981] FamCA 18; [1981] FLC 91-061.
[63] Ibid.
[64] In the Marriage of Aroney [1979] FamCA 62; [1979] FLC 90-709 at 78-785.
[66] Ibid.
[67] In the Marriage of Hirst and Rosen [1982] FamCA 22; [1982] FLC 91-230 at 77, 251.
[68] Mallet v Mallet (1984) 156 CLR 605 (hereinafter Mallet).
[69] ANAO Report No 23, above n2.
[70] Id at chapter 3.
[71] Id at para 50.
[72] Ashton v Prentice (Federal Court of Australia, Hill J, 23 October 1998).
[73] Curruthers also suggests that the Court may have regard to factors such as the magnitude of the risk of the new venture, the total value of the disposed property and the extent to which the transferor continues to enjoy the disposed property. Above n8 at 99.
[74] Bankruptcy Act s121(3).
[75] Cannane, above n38 at para 30.
[76] Ex parte Mercer; In re Wise [1886] UKLawRpKQB 72; (1886) 17 QBD 290 at 299–300.
[77] Even if they did, their claim would be barred after six years: for example, Limitation Act 1969 (NSW) s6.
[78] There are some exceptions, for example banks and other lending institutions are required to fulfill prudential requirements.
[79] See, for example, the extract from Williams, above n59.
[80] Crabtree v Crabtree (No 2) [1964] ALR 820 at 821.
[81] W Blackstone, Commentaries on the Laws of England, Vol 1 (1965) at 421; Moss v Moss (orse. Archer) [1897] UKLawRpPro 23; [1897] P 263 at 267.
[82] ALRC, above n9 at paras 4.29–4.31.
[83] Separate ownership of property has always existed for de facto and same-sex couples.
[84] For a general history, see Lee Holcombe, Wives and Property (1983).
[85] For example, in NSW, a conveyance of land to two or more people now creates a tenancy in common: Conveyancing Act 1919 (NSW) s26.
[86] Henry A Finlay, Family Law in Australia (5th ed, 1997) chapter 32.
[87] Otto Kahn-Freund wrote, ‘the normal behaviour of husband and wife or parents and children towards each other is beyond the law — as long as the family is healthy. The law comes in when things go wrong.’ See Otto Kahn-Freund, preface to John Eekelaar, Family Security and Family Breakdown (1971) at 7, cited in Regina Graycar & Jenny Morgan, The Hidden Gender of Law (2nd ed, 2002). Contrast Kahn-Freund’s view with that of K O’Donovan, ‘Divisions and Dichotomie’ in Sexual Divisions in Law (1985), which argues that there are many direct and indirect invasions of family life by the law.
[88] Mallet, above n69 at para 2 (Gibbs CJ).
[89] Domestic labour alone does not create an interest in the family property: Burns v Burns [1984] Ch 317 at 330–331. See, for example, Baumgartner v Baumgartner [1987] HCA 59; (1987) 164 CLR 137, in which the material factor appeared to be the pooling of the couple’s financial resources.
[90] See, for example, Ayres v Evans (1981) 56 FLR 335.
AustLII:
Copyright Policy
|
Disclaimers
|
Privacy Policy
|
Feedback
URL: http://www.austlii.edu.au/au/journals/SydLawRw/2003/16.html