BANKRUPTCY AND SELF MANAGED SUPERANNUATION FUNDS
21 10 2007
Prepared by Dean McVeigh, Timothy Holden and Michael Ennis.
Presented by Dean McVeigh at the Kaplan SMSF Conference
1. INTRODUCTION
Aims and Objectives
Aims: This presentation will provide you with knowledge of the legal requirements and implications for trustees of SMSF’s of the Bankruptcy Act 1966.
Objectives: After the completion of this presentation, you will:
1. Be able to outline the main concepts underpinning bankruptcy;
2. Understand the duties of a bankruptcy trustee;
3. Understand the concept of divisible property and differentiate property exempt from realisation by a bankruptcy trustee;
4. Understand the impact of recent (bankruptcy and superannuation) cases on legislative changes to the Bankruptcy Act 1966;
5. Be aware of the main aspects of the new (Superannuation Contributions) amendments to the Bankruptcy Act 1966 (Royal Assent received on 15 April 2007);
6. Understand the implications for SMSF trustees & how to operate once a bankruptcy has commenced.
This paper provides an explanation, albeit brief, of the world of bankruptcy which will necessarily include a foray into the Bankruptcy Act 1966, the governing legislation. In doing so it will also set out the main duties of trustees of bankrupt estates (bankruptcy trustees), the property available and the property exempt from realisation by a bankruptcy trustee.
It will also examine two of the leading cases that impact on SMSF’s and superannuation generally and more specifically on the bankruptcy legislation.
Then it will examine how the landscape has changed and taking that into account explore the implications for trustees of SMSF’s (SMSF trustees) and how to operate once an SMSF’s member’s bankruptcy has commenced.
Finally it will put and assess a case study scenario that deals with the actuality of a bankruptcy trustee seeking to recover property that may or may not be an asset of an SMSF and actions to be taken by the SMSF trustee.
2. WHAT IS BANKRUPTCY?
Bankruptcy is the state whereby a bankrupt’s divisible property is vested in the trustee of the estate (see below). The bankrupt is subject to the provisions of the Bankruptcy Act 1966 and has various duties and obligations placed upon him or her by the Act.
The provisions of Section 54 of the Bankruptcy Act 1966 (the Act) require a bankrupt to make out and file, in the office of the Official Receiver, a statement of their affairs, in the prescribed form within fourteen (14) days from the date on which they are notified of their bankruptcy.
Pursuant to Section 77, a bankrupt is also required to:
- give to the trustee all books (including books of an associated entity) that are in his or her possession and relate to his or her examinable affairs; and, if applicable, his or her passport;
- attend the trustee whenever the trustee reasonably requires;
- give such information about any of the bankrupt's conduct and examinable affairs as the trustee requires; etc.
A bankrupt may also be examined (as may other persons related to the bankrupt), have his or her income assessed and be required to make income contributions to the estate. The bankrupt will have restrictions placed on his or her ability to obtain credit, be required to disclose his or her address and telephone number and be required to obtain the trustee’s permission if he or she wishes to travel overseas.
These and other restrictions, duties and obligations are hanging over the bankrupt for the term of the bankruptcy, and in some cases may extend beyond.
The current term of bankruptcy is three years. If an objection is lodged then the bankruptcy is extended to either five or eight years depending on the nature of the objection.
An insolvent under administration is disqualified from managing a corporation without the leave of the court (Section 229 of the Corporations Act 2001).
The term "an insolvent under administration" includes an undischarged bankrupt.
3. DUTIES OF THE BANKRUPTCY TRUSTEE
Section 19 of the Bankruptcy Act 1966 lists various duties of the bankruptcy trustee including:
(a) notifying the bankrupt's creditors of the bankruptcy;
(b) determining whether realisable property forms part of the estate and whether it can be realised to pay a dividend to creditors;
(c) reporting to creditors within three months of the date of the bankruptcy on the likelihood of a dividend being paid to creditors prior to the end of the bankruptcy;
(d) giving information about the administration of the estate in response to the reasonable requests of a creditor;
(e) making a determination as to whether the bankrupt has made a transfer of property that is void against the bankruptcy trustee;
(f) taking appropriate steps to recover property for the benefit of the estate;
(g) taking whatever action is practicable to attempt to ensure that the bankrupt complies with and discharges all of the bankrupt's duties under this Act;
(h) considering whether the bankrupt has committed any offences;
(i) referring to the Inspector-General or relevant law enforcement authorities any evidence of an offences by the bankrupt;
(j) administering the estate as efficiently as possible by avoiding unnecessary expenses;
(k) exercising all the powers and performing functions of a bankruptcy trustee in a commercially sound way.
Whilst there are various other duties these are usually considered the primary duties of the bankruptcy trustee.
In carrying out their duties the bankruptcy trustee may utilise such powers as those provided by Sections 77A, 77C and / or 81 of the Bankruptcy Act 1966 to access books of persons and entities associated with the bankrupt, obtain information and evidence and /or to examine the bankrupt or persons and entities associated with the bankrupt.
The bankruptcy trustee is also required to comply with the Performance Standards in accordance with the Bankruptcy Regulations 1996 which include such obligations as acting honestly and impartially , avoiding conflicts of interest, being independent, etc.
4. DIVISIBLE PROPERTY / PROPERTY EXEMPT FROM REALISATION
Under the provisions of Section 58 of the Bankruptcy Act 1966 (the Act) the bankrupt’s property, including any property acquired during the term of the bankruptcy, vests in the trustee. Therefore, the bankrupt has no legal power or capacity to deal with that property. Only the trustee or a creditor holding security over the property can sell or otherwise deal with the property.
However, Section 116(2) and the Regulations specify the property which is exempt from realisation (i.e. will not be sold/claimed by the trustee) including:
Household property.
Tools of trade (current limit of $3,150).
Motor vehicles or other means of transport (aggregate value to a current limit of $6,300).
Some policies of life assurance or endowment assurance over the bankrupt’s life, an interest in a regulated superannuation fund, or Approved Deposit Fund, or payment from such a fund on or after the date of bankruptcy.
The right to recover damages or compensation for personal injury.
- A property acquired with a War Service Home loan.
For the sake of clarity ‘Household Property’ includes property (including recreational and sports equipment) that is reasonably necessary for the domestic use of the bankrupt's household, having regard to current social standards. The following lists items that are defined as ‘household property’ (the list is not exhaustive and other factors can be taken into account):
Kitchen equipment, cutlery, crockery, foodstuffs, heating equipment, cooling equipment, telephone equipment, fire detectors and extinguishers, anti‑burglar devices, bedding, linen, towels and other household effects, sufficient household furniture, sufficient beds for the members of the household, educational, sporting or recreational items (including books) that are wholly or mainly for the use of children or students in the household; 1 television set, 1 set of stereo equipment, 1 radio, either 1 washing machine and 1 clothes drier or 1 combined washing machine and clothes drier, either 1 refrigerator and 1 freezer or 1 combination refrigerator/freezer, 1 generator (if relied on to supply electrical power to the household), 1 telephone appliance, 1 video recorder.
Other factors to be taken into account include:
The number and ages of members of the bankrupt's household, any special health or medical needs, any special climatic or other factors (including geographical isolation) of the place where the household residence is located, whether the property is reasonably necessary for the functioning or servicing of the household as a viable and properly run household, whether the costs of seizure, storage and sale of the property would be likely to exceed the sale price of the property, etc.
5. THE CASES: TREVOR NEWTON SMALL & BENSON V COOK
Trevor Newton Small (an SMSF fund)
In the Official Trustee in Bankruptcy v Trevor Newton Small Superannuation Fund Pty Ltd (2001) 114 FCR 160; [2001] FCA 1267, Madgwick J determined that the potential for a payment to a superannuation fund to be caught by the relation back or avoidance provisions of the Act was not excluded by the protection provided to the bankrupt's interest in a superannuation fund even though such a payment might give rise to an interest in the fund.
It could be said that the protection operates in favour of any lawful interest in a regulated superannuation fund.
In this case one payment was made by the debtor after the deemed commencement of his bankruptcy and as such was recoverable. This is because the money had already vested in the hands of the bankruptcy trustee and accordingly the debtor did not have the authority to deal with it. The SMSF trustee (keeping in mind it was an SMSF and the bankrupt was a director of the SMSF trustee) was taken to be aware of that lack of authority and therefore did not derive title to the moneys paid.
Two earlier payments prior to the commencement of bankruptcy were voidable by reason of the operation of section 121 (transfers to defeat creditors). It assisted this recovery that at the time of both earlier transfers the debtor was or was about to become insolvent, and the superannuation fund trustee (the bankrupt being a director of the SMSF trustee) was also aware of this.
In summary an SMSF trustee is unlikely not to know the purposes or intent of the member (or third party) making the contributions. In addition the SMSF trustee is likely to know the solvency or otherwise of the relevant member.
Benson v Cook / Cook v Benson (arms length funds)
In Benson v Cook (2001) 114 FCR 542, the Full Federal Court applied section 120 (pre December 1996) which stated that "a purchaser or encumbrancer in good faith and for valuable consideration" was afforded protection by that section.
In short, the court found that there was valuable consideration when arms-length superannuation funds received, prior to bankruptcy, payments from a vested interest of the debtor in a company superannuation fund and, as such, the payments were not voidable as against the bankruptcy trustee.
In many respects the Bankruptcy Legislation Amendment (Superannuation Contributions) Act 2007 changed the law as a result of Benson v Cook.
The Explanatory Memorandum to the amending Bill stated that "the principal purpose of the amendments to be made by this Bill is to allow bankruptcy trustees to recover superannuation contributions made prior to bankruptcy with the intention to defeat creditors. These amendments address problems highlighted following the High Court's decision in Cook v Benson".
And now the scenery has changed …
6. THE NEW LEGISLATION
The Bankruptcy Legislation Amendment (Superannuation Contributions) Act 2007 received Royal Assent on 15 April 2007.
The headings for the new sections are as follows:
Subdivision B--Superannuation contributions
128B. Superannuation contributions made to defeat creditors - contributor is a person who later becomes a bankrupt
128C. Superannuation contributions made to defeat creditors - contributor is a third party
128D. Time for making claims by trustee
128E. Superannuation account-freezing notice
128F. Revocation of superannuation account-freezing notice
128G. Copy of superannuation account-freezing notice to be given to trustee etc.
128H. Consent of Official Receiver to the cashing etc. of a superannuation interest
128J. Power of Court to set aside superannuation account-freezing notice
128K. Judicial enforcement of superannuation account-freezing notices
128L. Protection of trustee of eligible superannuation plan
128M. References to a member of an eligible superannuation plan
128N. Definitions
The overall purpose of the amendments are to:
- allow a bankruptcy trustee to recover the value of contributions to an eligible superannuation plan made by the bankrupt to defeat creditors;
- allow the bankruptcy trustee to recover contributions by a person other than the bankrupt for the benefit of the bankrupt where the bankrupt’s main purpose in participating in the arrangement was to defeat creditors;
- ensure superannuation plans are not adversely affected by having to repay void contributions;
- facilitate recovery of void contributions by providing recovery mechanisms consistent with those applying to other void transfers of property; and
- to prevent the bankrupt dealing in a superannuation interest which includes a void contribution to the detriment of creditors.
- The amendments recognise that superannuation is significantly different to other assets dealt with by bankruptcy trustees. In particular, they strike a balance between the need to protect creditors from wilful avoidance behaviour by potential bankrupts and the need to encourage retirement savings. They also include features to protect trustees of superannuation plans and to deal with features peculiar to superannuation (such as rollovers of the initial investment).
Void Contributions
The amendments are designed to ensure that any superannuation contributions made by or on behalf of the bankrupt with the intention to defeat creditors are void against the bankruptcy trustee. They apply only in relation to contributions made after 27 July 2006 (which is the day on which the Attorney-General announced details of the amendments).
These provisions are based on section 121 of the Act which deals with transfers of property to defeat creditors.
Contributions made by the bankrupt
Subsection 128B(1) sets out the circumstances in which a superannuation contribution made by the bankrupt for his or her own benefit is void against the bankruptcy trustee. Such a contribution is void if:
(a) the contribution is made to an eligible superannuation plan; and
(b) the property contributed would probably have become part of the bankrupt estate; and
(c) the bankrupt’s main purpose in making the transfer was:
(i) to prevent the transferred property from becoming divisible among the bankrupt’s creditors; or
(ii) to hinder or delay the process of making property available for division among the transferor’s creditors; and
(d) the contribution was made on or after 28 July 2006.
An ‘eligible superannuation plan’ is defined in section 128N to mean any of the following:
(a) a regulated superannuation fund;
(b) an approved deposit fund;
(c) a retirement savings account;
(d) a public sector superannuation scheme.
Contributions made by a third party for the bankrupt’s benefit
Subsection 128C(1) sets out the circumstances in which a superannuation contribution made by a third party for the bankrupt’s benefit is void against the bankruptcy trustee. Such a contribution is void if:
(a) a person transfers property to another person; and
(b) the transfer is by way of a contribution to an eligible superannuation plan for the benefit of the bankrupt; and
(c) the transfer was made under a scheme to which the beneficiary was a party; and
(d) the property would probably have become part of the bankrupt estate; and
(e) the bankrupt’s main purpose in entering into the scheme was:
(i) to prevent the transferred property from becoming divisible among the bankrupt’s creditors; or
(ii) to hinder or delay the process of making property available for division among the transferor’s creditors; and
(f) the contribution was made on or after 28 July 2006.
The definition of ‘scheme’ for the purposes of section 128C is deliberately defined very broadly to capture any arrangement a person may make to defeat creditors which involves converting money or property, which would otherwise be available to pay creditors, into an interest in superannuation. A common example would be a salary sacrifice arrangement with an employer.
Determining the bankrupt’s main purpose
The sections provide that the transfer is taken to have been with the intention to defeat creditors if it can reasonably be inferred from all the circumstances that, at the time of the transfer or entering into the scheme, the transferor was, or was about to become insolvent.
The sections also provide for a rebuttable presumption of insolvency where, at the relevant time, the bankrupt had not kept or preserved proper books, accounts and records to explain his or her business transactions and financial position.
In determining the bankrupt’s main purpose, regard must be had to the bankrupt’s pattern of making superannuation contributions and whether the contribution in question was ‘out of character’ in light of that history.
The bankruptcy trustee is entitled to produce other evidence of the bankrupt’s main purpose in making the contribution even where the contribution was not ‘out of character’ and the bankrupt was solvent at the time the contribution was made.
Trustee to refund fees, charges and taxes
The superannuation fund trustee is entitled to receive fees for managing the bankrupt’s interest as well as the interest of all other members in the plan. The superannuation fund trustee is also obliged to meet taxation obligations associated with the interest (such as payment of superannuation contributions tax). As such, the sections provide that the superannuation plan generally not be exposed to any losses and that the superannuation fund trustee of the plan is able to retain any fees and charges paid.
Recovery of void contributions
A bankruptcy trustee is able to make an application to the Court directly under section 128B or 128C to recover a void superannuation contribution. In addition, a bankruptcy trustee can request the Official Receiver to issue a notice under section 139ZQ for the recovery of a void contribution on the same basis as these notices are available to recover other void transfers of property.
The Act also includes provisions enabling some tracing, by the Court, of superannuation contributions through the superannuation system. This is important particularly where the contribution may have been rolled-over and is no longer in the plan which originally received it.
Recovering contributions which have been rolled-over or otherwise transferred
It is possible that, after making a superannuation contribution which is void under section 128B or 128C, the bankrupt had rolled over or transferred that contribution before the bankruptcy trustee recovers it. Although the original contribution remains void, it would be inappropriate to require the trustee of that superannuation plan to repay money it no longer holds for the bankrupt’s benefit. Section 139ZU provides the Court with a broad discretion to make orders for payment out of other superannuation interests held by the bankrupt where the bankruptcy trustee can demonstrate a connection between those other interests and the original void contribution. It will not be necessary to trace the particular contribution and seek recovery only from its final destination – that would be problematic, particularly where there have been multiple rollovers or the contribution has been subsequently split into different interests and mixed with other contributions.
Subsection 139ZU(1) allows the Court to make an order for the payment of money by the trustee of an eligible superannuation plan to the bankruptcy trustee where certain conditions are met.
The maximum amount the trustee of the plan can be required to pay under section 139ZU is the bankrupt’s withdrawal benefit in relation to that plan. In addition, the Court should consider whether the trustee of that plan has debited any fees, charges or taxes against the bankrupt’s interest in determining the amount it orders the plan trustee to pay – this will ensure the interest of other members are protected.
Superannuation account-freezing notices
Section 128E allows the Official Receiver to issue a notice to the trustee of an eligible superannuation plan ‘freezing’ the interest of a member of the plan where the trustee of the bankrupt estate of the member demonstrates that a contribution or contributions made to that plan are void under section 128B or 128C or where the trustee has commenced action under section 139ZU..
The effect of a notice under section 128E is to prevent the member dealing in the superannuation interest and thereby preventing the trustee recovering it for the benefit of creditors. Its purpose is to allow a trustee who has evidence of a void contribution to prevent the bankrupt dissipating an interest in a superannuation plan while investigations are continuing.
Section 128F provides that a superannuation account-freezing notice is automatically revoked in the following circumstances:
(a) a section 139ZQ notice is issued within 180 days of the freezing notice being given to the trustee of the superannuation plan and that notice is complied with, revoked or set aside by the Court;
(b) a section 139ZU order is made within 180 days of the freezing notice being given to the trustee of the superannuation plan and that order is complied with or set aside on appeal;
(c) an application for a section 139ZU order is dismissed by the Court or withdrawn;
(d) no section 139ZQ notice is issued within 180 days of the freezing notice being given to the trustee of the superannuation plan; or
(e) no section 139ZU order is made within 180 days of the freezing notice being given to the trustee of the superannuation plan.
Where a superannuation account-freezing notice is in force, the Official Receiver’s consent is required for any dealings in that interest. Under section 128H, the member may apply in writing to the Official Receiver for consent to the cashing, debiting, roll-over, transfer or forfeiture, in whole or in part of the member’s interest.
The Official Receiver will normally give consent where:
(a) the consent is only in relation to an amount which exceeds the value of the void contributions;
(b) the member wishes to roll-over the interest for investment reasons and advises the Official Receiver of the details of the new fund (which will allow a fresh freezing notice to be issued in relation to that new fund); or
(c) it appears that the trustee will be able to pay all creditors’ claims without having recourse to the superannuation interest.
Section 128J provides that the trustee of the superannuation plan or another interested person (which would include the bankrupt) may apply to a Court to have the freezing notice set aside.
Protection of trustee of superannuation plan
Section 128L is designed to protect the trustee of an eligible superannuation plan who complies with their obligations under these amendments. A trustee who complies in good faith with a superannuation account-freezing notice, a section 139ZQ notice or a section 139ZU order cannot be exposed to any civil or criminal liability as a result of that compliance.
Abolition of the Reasonable Benefits Limit
The Superannuation Legislation Amendment (Simplification) Act 2007 has the effect of removing, as of 1 July 2007, the provisions that limit the extent to which a bankrupt’s interest in a superannuation or a life assurance policy is protected from seizure by their bankruptcy trustee.
After 1 July 2007, a bankrupt’s interest in a superannuation fund or life assurance policy in excess of an amount equivalent to the bankrupt’s pension Reasonable Benefit Limit will not vest in bankruptcy. This will be the case irrespective of whether the relevant bankruptcy commenced before or after 1 July 2007.
However, an interest in superannuation or a life assurance policy that has already vested in bankruptcy prior to 1 July 2007 will remain vested.
7. IMPLICATIONS FOR SMSF TRUSTEES & HOW TO OPERATE ONCE A BANKRUPTCY HAS COMMENCED.
Firstly and foremostly, Section 120 of the Superannuation Industry (Supervision) Act 1993 (SIS) specifically prohibits insolvents under administration (i.e. bankrupts) from acting as trustees of SMSF’s whether in person or through a corporate entity.
As such, it is my understanding that in the event of the bankruptcy of a member of an SMSF, that the member will no longer have the capacity to act as the trustee of the SMSF. Accordingly, the SMSF could convert to a Small APRA Fund (SAF) whereby an “approved trustee” takes over the running of the fund. That is the Fund continues with a new trustee until such time as the member is discharged from bankruptcy and the SMSF could convert (or is it revert) to an SMSF.
Alternatively, the member’s entitlement in the SMSF could be rolled over into an ‘industry’ arms length fund although this may bring with it certain taxation issues.
That said, SMSF and SAF and other superannuation fund trustees need to be aware of the changes to the Bankruptcy Act 1966 and the new provisions in Part VI, Division 3, Subdivision B and that any contributions on or after 27 July 2006 may be caught, whether a rollover contribution or not and whether contributed by the bankrupt or not.
In simple terms, the new provisions aim to allow a bankruptcy trustee to recover from a superannuation fund any contribution that was made with the purpose of defeating creditors of a bankrupt.
In particular, the superannuation fund trustee would be well advised to take notice of a Superannuation Account Freezing Notice. The superannuation fund trustee (or another interested party) may wish to utilise the option to seek an order setting aside the notice or they may simply wait out the 180 days and allow the notice to expire.
In the event that the superannuation fund trustee receives a Section 139ZQ Notice it (or another interested party) may wish to apply to the court to set aside the notice.
Similarly if an application is made to the court under Section 139ZU the superannuation fund trustee (or another interested party) may wish to defend the application or seek to have a Section 139ZU order set aside.
Bankruptcy law is a specialised area of law as is that of superannuation. An awareness of it, of Section 139ZQ Notices, of Section 139ZU applications and of Superannuation Account Freezing Notices is imperative.
8. CASE STUDIES
Prior to the conclusion of this paper it was requested that I consider the situation where an employer has become bankrupt (wound up?) and the court tries to link assets held in the name of the employer sponsored fund to the bankruptcy action (liquidation?).
In analysing this situation, it would appear that a couple of scenarios can exist:
1. Property is purchased by the employer sponsored fund but for whatever reason is held in the name of the employer; or
2. Property is purchased by the employer and is held in the name of the employer sponsored fund.
SOLUTION IN ANY AND ALL CASES: A Declaration of Trust (See attached example – NOT FOR ACTUAL USE) should be prepared contemporaneously with the purchase of the property.
In case 1. without such a declaration it may be difficult for the superannuation fund to assert legal title to the property given that the property is in the employer’s name. However, it could proffer an argument that at worst the employer holds the property in trust for it by virtue of a resulting or constructive trust. Alternatively, the fund could argue that a simple tracing of the purchase funds shows it has an equitable interest in the property irrespective of whose name it is held in.
In case 2. the converse holds true. Without a declaration of trust stating intent it may be difficult for the employer to assert legal title to the property given that the property is in the employer sponsored fund’s name. However, the employer could proffer an argument that at worst the fund holds the property in trust for it by virtue of a resulting or constructive trust. Alternatively, the employer could argue that a simple tracing of the purchase funds shows it has an equitable interest in the property irrespective of whose name it is held in.
Another situation that warrants discussion is as follows:
I am the sole member of an SMSF (the DRM Super Fund) and become a bankrupt. I used to have a corporate trustee (DRM Pty Ltd) of which I was the sole director and member. Let us assume for the sake of the exercise that I have $1 million assets in the fund and a $5 million judgment debt by virtue of which I became a bankrupt.
The questions to be asked include:
- Can my bankruptcy trustee take any of the assets of my fund … ?
- Is my fund still complying and if not what happens to the assets … ?
- What if I am of retiring age and not working anymore … ?
- ????????
DECLARATION OF TRUST
The person or persons described in the Schedule as Trustee, being registered as the holder of the property described in the Schedule ("the property") HEREBY DECLARE that:
The person described in the Schedule as the Beneficial Owner has provided all the money for the purchase of the property by the trustee.
The Beneficial Owner is and has at all times been entitled to the benefits of the property together with all income, distributions and profits accrued and to accrue in respect thereof.
The Beneficial Owner shall be entitled to hold the title for the property.
The Trustee or its successor or assignee will when called upon by the Beneficial Owner, execute a transfer of the property to the Beneficial Owner or to such other person or persons, company or corporation, as the Beneficial Owner shall direct.
The Beneficial Owner is hereby authorised to complete any transfer of the property executed by the trustee in blank by inserting the name of any transferee or otherwise completing such transfer to be duly registered.
The Trustee undertakes to deal with the property and exercise and perform all the rights, duties and powers attributable to the owner of the property as directed by the Beneficial Owner.
The Trustee’s of the Superannuation Fund have invested in this property via as a Tenant in common with The Trustee’s will ensure that they monitor all income and expenditure derived from this property investment to ensure the Fund will receive all entitlements in proportion to its ownership in this investment.
SIGNED:
TRUSTEE TRUSTEE
DATED:
Signed in accordance with the rules that govern the execution
of documents by the trust.
THE SCHEDULE
The Trustees:
Address of Trustees:
The Property:
The Beneficial Owner:
Address: