Understanding Bankruptcy in a Family Law Context

Bankruptcy occurs when an individual is declared unable to pay their debts and their property vests in a bankruptcy trustee. The trustee's role is to realise assets and distribute them to creditors. However, bankruptcy doesn’t override the obligations and rights involved in a family law dispute.

In Australia, bankruptcy is governed by the Bankruptcy Act 1966 (Cth), but when it comes to family breakdowns, the Family Law Act 1975 (Cth) also plays a critical role.

What Happens When One Spouse Becomes Bankrupt?

If one party to a marriage or de facto relationship becomes bankrupt, their property becomes the responsibility of the bankruptcy trustee. This can complicate family law proceedings—particularly property settlements.

However, under the Family Law Act 1975 (Cth), the non-bankrupt spouse may still have a claim over assets vested in the trustee. Section 79 of the Act allows the Family Court to make orders adjusting property interests, even when bankruptcy is involved.

Can the Family Court Make Orders Against a Bankruptcy Trustee?

Yes. Section 79 of the Family Law Act 1975 (Cth) permits the Court to make property orders that bind third parties, including bankruptcy trustees. Section 90AE(2) specifically gives the Court the power to alter the rights and liabilities of third parties in relation to the property of a marriage【7】. This means the Court can order that certain property be transferred back to the non-bankrupt spouse if it is deemed just and equitable.

For de facto relationships, the equivalent provisions are found in section 90SM of the Act.

Important Legislative Provisions

• ‍Section 79: Grants the Court power to make property settlement orders, including those binding on third parties.‍
• Section 90AE(2): Allows the Court to alter third-party rights—including those of a bankruptcy trustee—if it is necessary to ensure a fair property division【7】.‍
• Section 75(2): Lists the matters the Court must consider when deciding what is just and equitable, including the financial needs and obligations of both parties.‍
• Section 90K: Allows financial agreements to be set aside if one party has become bankrupt and the agreement is found to be unjust.

Spousal Maintenance and Bankruptcy

Spousal maintenance is treated separately from property. A bankrupt spouse may still be required to pay maintenance under section 72 of the FamilyLaw Act 1975 (Cth), and bankruptcy does not extinguish this obligation.

However, if you're seeking spousal maintenance from a bankrupt party, it’s important to understand how their financial position is assessed and whether any payments are realistically enforceable.

Can Property Be Retrieved from a Trustee?

Yes, under certain circumstances. If the Family Court finds that an asset should form part of the property pool for settlement, it can order the bankruptcy trustee to transfer that asset to the non-bankrupt spouse. The Court must be satisfied that the order is:

• Just and equitable;
• Not unfairly prejudicial to the creditors; and
• Appropriate in all the circumstances.

These powers are outlined in sections 90AE and 90AF of the Family Law Act 1975 (Cth)【7】.

Bankruptcy and Financial Agreements

If a financial agreement (such as a prenup or binding financial agreement) exists and one party becomes bankrupt, the non-bankrupt spouse can apply to have the agreement set aside under section 90K. The Court may do so if the agreement was made to defraud creditors or if it results in an unjust outcome.

What About Superannuation?

Superannuation remains protected from bankruptcy in most cases and can still be included in the family law property pool for division under Part VIIIB of the Family Law Act. The Court can make orders to split superannuation interests, even if one party is bankrupt.

Why Early Legal Advice Matters

Bankruptcy can significantly delay or derail family law proceedings. The bankruptcy trustee, creditors, and the Court must all be considered when negotiating or litigating a settlement. If you're the non-bankrupt spouse, failing to act quickly may result in the loss of your entitlement to property. On the other hand, if you are the bankrupt party, it's important to know your rights and obligations.