Senate

Revised Explanatory Memorandum

(Circulated by authority of the Attorney-General, the Honourable Philip Ruddock MP)

Schedule 1 - Amendments to the Bankruptcy Act 1966

(This schedule sets out all of the amendments proposed to be made to the Bankruptcy Act 1966 .)

Definition of examinable period

25. The term 'examinable period' is used in current Division 4A of Part VI of the Act. The Bill proposes amendments to that provision, including amendments to the meaning of 'examinable period'. For ease of reference, it is proposed that the new definition be contained in Division 4A of Part VI (see note to item 17), rather than in section 5. This change is reflected by the amendment proposed by item 1.

Section 77C

26. Section 77C of the Act allows the Official Receiver to issue a notice requiring a person to attend before the Official Receiver and give evidence and produce all books in the possession of the person relating to 'any matters connected with the performance of the functions of the Official Receiver or trustee' under the Act. Item 2 proposes to amend section 77C to clarify that notes and transcripts of proceedings carried out under this provision may be used in evidence in any proceedings under the Act, regardless of whether or not the person is a party to the proceedings; and made available for inspection by the person, the trustee or a creditor, without fee. Any other person wishing to inspect these documents will be required to pay a fee to be prescribed by the regulations.

27. The proposed amendment is consistent with the modern trend to allow relevant and probative material to be considered in proceedings, rather than having artificial limits on the evidence that may be adduced. In many cases, use of the transcript will be an efficient way to get straight to the major issues and evidence in the proceedings.

Section 81

28. Subsection 81(17) currently provides that notes and transcripts from an examination carried out under that provision may be used in evidence in any proceedings under the Act in which the person being examined is a party; and that these documents are open to inspection by the person being examined, the bankrupt, the trustee or a creditor without a fee. The effect of the amendment proposed by item 3 is that those documents will be able to be used in any proceedings under the Act whether or not the person is a party to the proceeding. This proposed amendment is in line with the amendment proposed by item 2.

Section 116

29. As noted, the Bill proposes to make amendments to Division 4A of Part VI of the Act. Those amendments propose to create new sections 139DA and 139EA (see notes on items 20 and 22). The effect of the amendments proposed by items 4 and 5 is to deem property vested in or money paid to the trustee pursuant to an order under those proposed new sections as property divisible amongst the creditors of the bankrupt.

Section 120

Consideration directed to a third party

30. An amendment in this Bill will allow for the application of the provisions in sections 120 and 121 to the movement of consideration from a transferee to a third party (see notes on item 15A). The amendment proposed to be made by item 6 directs the reader to this proposed new provision.

Time Periods

31. Item 7 proposes to create a different period of claw back for the purposes of section 120 where the transferee is a 'related entity' of the transferor. Subsection 120(3) currently provides that:

Despite subsection (1), a transfer is not void against the trustee if:

(g)

the transfer took place more than 2 years before the commencement of the bankruptcy and;

(h)

the transferee proves that, at the time of the transfer, the transferor was solvent.

32. The effect of proposed new subsection 120(3) is to extend this time period where the relevant transfer is to a 'related entity' (pursuant to current section 5 of the Act, a 'related entity' in relation to a person includes a relative; a body corporate of which the person, or a relative of the person, is a director; and a member of a partnership of which the person, or a relative of the person, is a member). The proposed change will mean that an under market value transfer of property to a related entity would be void as against the trustee in bankruptcy if it took place in the 4 years prior to the bankruptcy, regardless of whether the transferee was able to establish the transferor's solvency during that period.

Rebuttable Presumption of Insolvency

33. Item 8 proposes to create a rebuttable presumption of insolvency for the purposes of section 120. A presumption will arise that the transferor was insolvent at the time of the transfer if it is established that the transferor had not, in respect of that time, kept proper 'books, accounts and records'; or where, having kept the appropriate books, accounts and records in relation to that time, the transferor had failed to preserve them. The practical effect of this proposed change will be that the claw back period in section 120 could be extended to 5 years if a bankrupt had undertaken an undervalue transfer at a time during the first 3 years (and for related entities, the first year) of the 5 years prior to bankruptcy when he or she had not been keeping proper books and records (eg as required by taxation or business licensing laws). The presumption will also arise where the bankrupt had failed to preserve the appropriate books, accounts and records relating to the time of the transfer.

34. The policy underlying this proposed change is that if a bankrupt is unable to produce books and records explaining their financial position at a particular time, it would be reasonable to allow the trustee to presume they were insolvent at that time.

What is not consideration

34. Current subsection 120(5) sets out the actions and circumstances that are not to be regarded as consideration for the purposes of subsections 120(1) and 120(4) of the Act. The effect of the amendment proposed by item 10 is that a further circumstance is to be included in this provision. By virtue of new paragraph 120(5)(e), the grant by the transferee (if the transferee is the spouse of the transferor) of the transferor's right to live at the transferred property also does not constitute consideration for these purposes, unless that grant relates to a transfer or settlement of property, or an agreement, under the Family Law Act 1975.

Section 121

Consideration directed to a third party

36. An amendment in this Bill will allow for the application of the provisions in sections 120 and 121 to the movement of consideration from a transferee to a third party (see notes on item 15A). The amendment proposed to be made by item 11 directs the reader to this proposed new provision.

Notion of reasonableness

37. Current subsection 121(1) of the Act renders a transfer of property by the bankrupt prior to bankruptcy void as against the trustee if that transfer was made with the intention to defeat the interests of creditors.

38. Current subsection 121(4) provides that, despite subsection 121(1), a transfer of property is not void against the trustee if:

(a)

the consideration that the transferee gave for the transfer was at least as valuable as the market value of the property; and

(b)

the transferee did not know that the transferor's main purpose in making the transfer was the purpose described in paragraph (1)(b) (i.e. to defeat the interests of creditors);

and

(c)

the transferee could not reasonably have inferred that, at the time of the transfer, the transferor was, or was about to become, insolvent.

39. The amendment proposed by item 12 will mean that a person could only take advantage of subsection 121(4) if they both didn't know the transferor was seeking to defeat creditors (as at present) AND they could not have reasonably inferred that this was the transferor's main purpose. In other words, if the evidence objectively suggests the transferee (i.e. recipient) should have known that the transferor (i.e. pending bankrupt) was attempting to defeat creditors, the transfer would not be protected by subsection 121(4).

Rebuttable presumption of insolvency

40. Item 13 would create a rebuttable presumption of insolvency for the purposes of subsection 121. Pursuant to this proposed change, a rebuttable presumption arises that the transferor was, or was about to become, insolvent at the time of the transfer if it established that the transferor had failed to keep proper 'books, accounts and records' in respect of that time, or, having kept such books and records, the transferor had failed to preserve them. The Bill proposes to create the same presumption in relation to section 120 (see notes on item 8).

What is not consideration

41. Current subsection 121(6) sets out the actions and circumstances that are not to be regarded as consideration for the purposes of subsections 121(4) and 121(5) of the Act. The effect of the amendment proposed by item 15 is that a further circumstance is to be included in this provision. By virtue of new paragraph 121(6)(e), the grant by the transferee (if the transferee is the spouse of the transferor) of the transferor's right to live at the transferred property also does not constitute consideration for these purposes, unless that grant relates to a property settlement or agreement under the Family Law Act 1975 . A similar amendment is proposed in relation to the equivalent provision in section 120 (see notes on item 10).

Consideration directed to a third party

42. Item 15A proposes to insert new section 121A into the Act. This proposed new section would allow for the application of the provisions in sections 120 and 121 to the movement of consideration from a transferee to a third party. This is achieved by, firstly, creating a new provision (subsection 121A(1)) that applies if a person who later becomes bankrupt (the bankrupt) transfers property to a transferee who gives some or all of the consideration for the transfer to a third party. If the new provision applies, then by virtue of the proposed new subsection 121A(2), the movement of consideration is deemed to be 'transfer of property' (the 'property' being the consideration) by the bankrupt to the third party for the purposes of sections 120 and 121. This enables the existing rules in sections 120 and 121 to apply to that deemed transfer.

43. The third and final element of the provision (subsection 121A(3)), is that if a transfer is void against the trustee by virtue of these proposed changes, then the trustee has the same rights to recover the property (i.e. the consideration) as the trustee would have had if there has actually been a transfer of the consideration between the transferor and the third party.

44. This would mean that, in the situation where a transferee passes on market value consideration to a third party (instead of to the transferor who subsequently becomes the bankrupt), and the third party does not provide market value consideration to the transferor, the trustee would be able to utilise section 120 to recover for the bankrupt estate the consideration received by the third party.

45. Similarly, the effect of this proposed change on section 121 is that a transfer made to defeat creditors would not be protected from that provision where paragraph 121(4)(a) was not satisfied- i.e. where the third party did not give market value consideration for the property that constitutes the consideration.

Example 1

46. In the 18 months prior to his bankruptcy, John transfers a house property with a market value of $350 000 to Steven. The $350 000 consideration is forwarded by Steven to James (John's brother). As Steven paid market value consideration for the transfer (albeit to a third party), the transfer between John and Steven is not affected by the current provisions in section 120. Steven is able to retain the property. However, pursuant to these proposed changes, the transaction will be deemed to be a transfer between John and James for the purposes of sections 120 and 121.

47. The question will then be whether the current provision in sections 120 and 121 apply. If James had earlier lent $200 000 to John, and John had directed the payment be made in order to extinguish that debt, then James had not provided market value consideration to John for the payment of $350 000. That deemed transfer would be void against the trustee.

48. Current subsection 120(4) would also be relevant. By virtue of that provision, the trustee would be obliged to refund to James the $200 000 consideration he had earlier paid.

49. Had the transaction between John and James taken place in the months immediately prior to bankruptcy, it may have also been void as a preference under section 122 of the Act.

Example 2

50. Some 6 year prior to her bankruptcy, Alice's finance's are far from healthy. She decides to organise her affairs so as to remove the bulk of her estate from the reach of creditors. Alice transfers her luxury vehicle (worth $80 000) to Claire (an arms length transferee) and directs Claire to pay the $80 000 to her sister Sarah (as a gift). Pursuant to these changes, the transaction is deemed to be a transfer between Alice and Sarah for the purposes of sections 120 and 121. The transfer would be void under section 121 where Sarah was aware of Alice's intention in transferring the property, and had failed to provide market value consideration for the transfer.

Example 3

51. David transfers shares worth $50 000 to his brother Mark in the 12 months prior to bankruptcy. At David's direction, Mark gives $10 000 to Pat as consideration for the transfer. Pursuant to current section 120, the transfer between David and Mark would be void against the trustee because Mark did not pay market value consideration. The trustee could recover the shares from Mark. Further, under the proposed changes, the trustee could also recover the consideration paid to Pat.

52. Current subsection 120(4) would also be relevant. If Pat had paid $5 000 for that transfer then the trustee would be obliged under current subsection 120(4) to refund that amount to him. Similarly, the trustee would be obliged to refund the $10 000 paid by Mark. The net effect of this would be that the estate is returned to the position it would have been in had the transfer not occurred.

Division 4A of Part VI-Orders in relation to property of entity controlled by bankrupt or from which bankrupt derived a benefit

53. Current sections 139D and 139E empower the court to make an order transferring certain property from a company, trust, partnership or other third person ('the entity') to the trustee in bankruptcy. Before an order can be made under Division 4A, it must be demonstrated that:

(a)

during the 'examinable period' and before the end of the bankruptcy, the bankrupt supplied 'personal services' to, for or on behalf of the entity at a time when the bankrupt 'controlled' the entity (ss 139D(1)(a), 139E(1)(a)); and

(b)

the bankrupt received no remuneration or received inadequate remuneration for those services (ss 139D(1)(b), 139E(1)(b); and

(c)

either:

(i)

the entity acquired an estate in particular property as a direct or indirect result of, or of matter including, the bankrupt's supply of the services (and still has an estate in the property at the date of the order); and the bankrupt used the property, or derived a benefit from it, while controlling the entity in relation to the property (ss 139D(1)(c), (d), (e)); or

(ii)

at any time during the examinable period, the entity's 'net worth' was substantially more than it would have been if the bankrupt had not supplied the services (s 139E(1)(c)).

54. 'Examinable period' is currently defined to mean the period ending on the day of the trustee's application under the Division and beginning:

(d)

at the time or times when the bankrupt became insolvent during the period beginning four years before, and ending two years before, the commencement of the bankruptcy; or

(e)

in any other case - two years before the commencement of the bankruptcy (s 5).

55. By virtue of the amendments proposed by this Bill, Division 4A of Part VI will be amended to enable these provisions to apply to natural persons (see notes on items 20 and 22); and to align the 'examinable period' (i.e. the claw back period) with the changes proposed to the section 120 claw back periods (see notes on item 17).

56. Item 16 would repeal the heading of Division 4A of Part VI and replace it with a heading that reflects the proposed new provisions.

Definition of examinable period

57. Item 17 reflects these proposed changes by inserting a proposed new definition of the term 'examinable period'. Proposed new section 139CA provides that, for the purposes of Division 4A of Part VI, 'examinable period' is, in relation to a 'related entity', either 4 years prior to the commencement of the bankruptcy, or from the first point of insolvency in the year previous to that if the bankrupt became insolvent during that year. The proposed new definition also provides that, in any other case, the 'examinable period' is either 2 years prior the commencement of the bankruptcy, or from the first point of insolvency in the 3 years previous to that if the bankrupt became insolvent during that period.

58. Item 17 would also create a rebuttable presumption of insolvency for the purposes of proposed new section 139CA. Consistent with the proposed introduction of this presumption in relation to sections 120 and 121 (see notes on items 8 and 13), a presumption will arise that the bankrupt became insolvent during the first year of the 5 years prior to bankruptcy (or, for orders in relation to non-related entities, the first 3 of the 5 years prior to bankruptcy) if it is established that the transferor had not, in respect of that time, kept proper 'books, accounts and records'; or where, having kept the appropriate books, accounts and records in relation to that time, the transferor had failed to preserve them.

Current section 139D

Confined to entities other than natural persons

59. The change proposed in item 18 is necessary to make it clear that current section 139D is dealing only with orders in relation to entities other than a natural person. Proposed new section 139DA will apply specifically to natural persons (see notes on item 20).

Notion of benefit

60. As noted, in order for the court to transfer property to the trustee under current section 139D, the bankrupt must have used or derived a 'benefit' from that property during the examinable period. The effect of the change proposed by item 19 is that it is sufficient if the bankrupt benefited indirectly from the relevant property.

Orders relating to property of natural persons

61. Item 20 proposes to insert new section 139DA. This proposed new provision will allow the court to make orders in relation to property of natural persons where:

•

during the examinable period, the entity acquired an estate in particular property as a direct or indirect result of financial contributions made by the bankrupt during that period; and

•

the bankrupt used or derived (whether directly or indirectly) a benefit from, the property at a time or times during the examinable period; and

•

the entity still has an estate in the property.

62. These proposed changes will overcome the practical inapplicability of the current provisions in Division 4A of Part VI to natural persons. This has been achieved by removing criteria such as 'control', 'personal services', and remuneration and replacing these with provisions that allow the court to examine how the bankrupt's substantive contribution (his or her 'income flow or activities') has resulted in the acquisition of the property. The amended time period in Division 4A of Part VI will apply to these proposed changes (see notes on item 17). These proposed changes will address the situation where, for example, the bankrupt has diverted his income in order to fund the purchase a house property in his partner's name, and the bankrupt derives a benefit by living in that property.

Current section 139E

Confined to entities other than natural persons

63. The change proposed in item 21 is necessary to make it clear that current section 139E is dealing only with orders in relation to entities other than a natural person. Proposed new section 139EA will apply specifically to natural persons (see notes on item 22).

Order relating to increase in value of property of natural persons

64. By virtue if the changes proposed in item 22, the court will be able to make orders directing a natural person to pay the trustee a specified amount if the court is satisfied that:

•

during the examinable period, the value of the entity's interest in particular property increased as a direct or indirect result of financial contributions made by the bankrupt during that period; and

•

the bankrupt used or derived (whether directly or indirectly) a benefit from the property at a time or times during the examinable period.

65. The amount that the court can order the entity to pay under this proposed provision must not exceed the amount by which the value of the entity's interest in the property increased as a result of the bankrupt's financial contributions.

66. This proposed amendment will address the situation where, as a result of contributions supplied by the bankrupt, a person's net worth increases in the years immediately prior to bankruptcy, and the bankrupt derives a benefit from property directly connected to that increase in net worth. For example, in the 4 years prior to bankruptcy, a bankrupt may service the mortgage on a house property held in the name of his or her spouse, and the bankrupt may live in that property (thereby deriving a benefit from the property). Under these proposed provisions, the trustee may be able to recover the increase in the value of the property that can be attributed to the bankrupt's financial contributions.

Current section 139F

67. Current section 139F sets out the matters that the Court must take into account in considering whether to make orders under section 139D or 139E. These include matters such as hardship and, in relation to an order under section 139E, the respondent entity's current net worth. By virtue of the amendments proposed by items 23 and 24, the court must take these same matters into account when making an order under proposed new sections 139DA and 139EA.

Current section 139G

68. Current section 139G contains provisions which allow the court to give effect to orders under sections 139D and 139E, and which provide that, should laws of the Commonwealth, a State or Territory require the registration of the transfer of property subject to an order under section 139D, the property, estate or interest vests in equity in the person by virtue of equity but does not vest at law until the relevant registration requirements have been met. By virtue of the amendments proposed by items 25, 26 and 27, the provisions in section 139G will apply to orders under proposed new sections 139DA and 139EA.

Current section 139H

69. Current section 139H provides that, where orders have been made under sections 139D or 139E, the respondent entity may claim for a dividend in the bankruptcy to the value of the property or money subject to the order. However, such a claim must be postponed until all claims of other creditors (including claims for interest on interest-bearing debts in respect of a period after the date of the bankruptcy but not including claims under subsection 120(4)) have been satisfied. Items 28 and 29 propose to apply this provision to orders under proposed new sections 139DA and 139EA.

70. Item 30 sets out when the proposed amendments made by this Schedule apply.

71. The amendments made by items 2 and 3 apply to attendances under section 77C and examinations under section 81 that occur on or after commencement of these items.

72. The amendments made by items 6 to 15 apply to transfers of property made on or after the commencements of these items.

73. The amendments made by items 1, 4 and 5, and 16 to 29 apply in relation to an examinable period that commences on or after the commencement of these items.