In brief

A recent Federal Court case brings clarity to the treatment of protected money payments under Australia’s bankruptcy laws.

What you need to know

  • This case determines the law on how Trustees should deal with protected money payments used to pay mortgages under Australian bankruptcy laws.
  • Trustees for bankrupt estates can now confidently calculate the amount of the proceeds of sale which should be attributed to the Bankrupt.

Background

On 12 May 2016 the Federal Court of Australia handed down the judgment of Reaper v Vrsecky (Trustee) [2016] FCA 509. In this case, Madgwicks acted for the Trustee who was completely successful in his cross-appeal to the Federal Court.

This case is significant for insolvency practitioners because it settles the law on how Trustees should deal with protected money payments in circumstances where the bankrupt has used these funds to pay some of the mortgage on their house.

The Question for consideration by the Court

How much of the proceeds of realising the property should the Trustee attribute to protected money?

The Bankruptcy Act

Section 166(2)(g) of the Bankruptcy Act 1966 (Cth)(the Act) provides that any damages or compensation recovered by the bankrupt for personal injury is not divisible amongst his or her creditors.

In this case, the Court considered Section 116(4) which relates to where the outlay of a property is paid in part by the bankrupt by protected funds and the Trustee attempts to realise the property. It is relevant in this case that only part of the repayments (not substantially the whole of the acquisition) were paid from protected moneys.

The Facts

  • Madgwicks acted for the Trustee of the Bankrupt estate of Brett Reaper.
  • Mr Reaper owned a property as joint tenants with his wife, Sharron Fisher.
  • The Trustee applied in the Federal Circuit Court for partition and sale of the property.
  • Mr Reaper produced documents to the Court to show that some mortgage payments on the property were made with compensation funds received from a workplace injury. The Court found that these compensation funds were protected funds and not divisible property for the purpose of the Bankruptcy Act 1966 (the Act).
  • The Court held that the Trustees’ interest in the property was $96,000.
  • The Federal Circuit Court judgment was appealed.

The Figures

  • In 2004 Mr Reaper and his wife, Ms Fisher, entered into a loan for $285,000 to construct their house.
  • Between 2007 and February 2013, all the loan repayments were made by Mr Reaper’s compensation funds, totalling $188,462.
  • The principal on the loan during this time was reduced by $45,033.63 and the overall amount outstanding (including interest) was reduced from $317,649 to $275,000.

The Federal Court Findings

  • The Trustee is required to pay the bankrupt so much of the proceeds of the property as can fairly be attributed towards the protected funds.
  • The Court conducted a detailed review of the definitions of “exempt loan money” and “protected money” and how they related to Section 116(4) of the Act.
  • The Court held that only that part of the compensation moneys that repaid the loan principal constituted “protected money” and was therefore exempt loan money. The loan repayments reduced the principal by $45,033.63.
  • The Court also held that the protected money is to be treated as having been paid for the joint benefit of Mr Reaper and Ms Fisher (the other joint tenant).
  • The Court found that because Mr Reaper made payments incrementally, his percentage interest in the property should be averaged over the period of payment. The Court outlined these calculations in its judgment and held that the amount which can be fairly attributed to Mr Reaper’s protected money was $28,365.
  • The Court gave Ms Fisher the option to purchase the Trustees’ interest in the property for $221,635.

Important Lessons

For the purpose of Section 116(4) of the Act, if:

  •  a Trustee intends to realise a property which is jointly held by the bankrupt and another; and
  •  some of the repayments of the mortgage are made by the bankrupt with protected money;

the Trustee needs to pay the bankrupt so much of the proceeds of the property as can fairly be attributed towards the protected funds. In calculating this, the Court has held that:

  •  Only that part of the compensation moneys that repaid the loan principal in these circumstances constitutes protected money.
  •  Where the bankrupt is a joint tenant, the protected money may be treated as having been paid for the benefit of the bankrupt and the other joint tenant. This may have the result of halving the Bankrupt’s share of the protected money.

Conclusion

Trustees for bankrupt estates in these circumstances can now confidently calculate the amount of the proceeds of sale which should be attributed to the Bankrupt.

For further information about bankruptcy and insolvency issues, please contact Catherine Ballantyne, Senior Associate, Madgwicks Lawyers at catherine.ballantyne@madgwicks.com.au

Case reference: Reaper v Vrsecky (Trustee) [2016] FCA 509

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