Bankruptcy

Unit Trusts can expose personal assets in bankruptcy

Most business people know that they should shelter their assets by keeping them out of their own name, so that if they go bankrupt, those assets are not available to the trustee in bankruptcy.

But it’s also important to make sure that the entities that control those assets are still under the individual’s direct or indirect control in the event of personal bankruptcy.

Recently a client* learned a hard lesson that was fortunately only a near miss.

He set up his interest in a business so a trustee company held it.  The company was trustee of a unit trust.  The only unit holders of the trustee company were he and his wife.  The only shareholders of the trustee company were he and his wife.  They were also the only directors.

The trustee company owned one third of a development site.

In the course of the business he and his wife had given personal guarantees over a business loan.  Eventually the lender made a call on the guarantee for an amount of over $10 million.  The guarantee had a very nasty clause in it (which he and his wife had not read) by which they agreed to give a mortgage over all of their real property to secure the loan.

When it became apparent that the loan may go bad, the lender placed caveats over all of the real property in the name of he and his wife which included 2 investment properties and a family home.

The client could not service the first mortgages on the family home and the investment properties, or service the business loan of which he was guarantor.

After a period the client and his wife each declared bankruptcy.

After they had declared bankruptcy, an opportunity arose to restructure the business and settle with the lender on favorable terms.   The restructure required the transfer of the trustee company’s interest in the development site to a Newco.

Problem?  The units in the unit trust vested in the trustee in bankruptcy of the client and his wife.  They had ceased to be directors of the trustee company because they were bankrupt.  And the shares in the trustee company vested in the trustee in bankruptcy.  Further, the trust deed reserved the power to change trustee to the unit holders alone. (Frequently, the appointor of the trust, usually a family member, has that power, but that was not so in this case)

So the client and his wife could not cause the trustee to execute a transfer or change trustee to a new entity who could. And the trustee (ITSA) would not assist.

In the end, the client had a near miss, more through luck than anything else.  It turned out that the units in the unit trust were held by he and his wife as trustees for another trust, their family trust, which fortunately was a discretionary trust.  The trustee of that trust was a different company with different directors.  The trustee of that trust was able to direct the trustee in bankruptcy to transfer the units to it.  Then it was able to change the trustee under the provisions of the trust deed, and the new trustee could execute the transfer.  Phew that was close!

So what are the lessons of this near miss?

1. Unit trusts are not very good at sheltering personal assets because the units will vest in the trustee in bankruptcy.  It is possible to use a hybrid unit trust/discretionary trust structure in their place.
2. If for tax reasons unit trusts structures are necessary, the unit themselves should not be held by the individual seeking to shelter assets beneficially.  They should be held by another entity that is sheltered.  The same goes for the shares in the trustee company.
3. Be careful to have directors of the trustee who are not likely to go bankrupt if the sheltered individual also goes bankrupt.  Preferably appoint another family member not involved in the business, or an accountant or lawyer (if one is willing).
4. Reserve a power to change the trustee to the appointor or to a family member in the trust deed.

Regards

Mark

*The facts have been changed slightly to protect the client

Warning to lawyers and creditors serving Bankruptcy Notices: No direct evidence of posting? No effective service.

This is a warning to creditors (and lawyers acting for them) who don’t have direct evidence that their bankruptcy notice was taken to the post office or post box and mailed. You will probably not have effectively served your bankruptcy notice.

Where direct evidence is lacking, the Court will not infer a bankruptcy notice was actually posted just because you had a system where mail placed in an out tray was usually or even always taken to the post office or post box.  There has to be direct evidence of posting.

That is the effect of a decision of Justice Collier of the Federal Court delivered last week in Mbuzi v Favell (No 2) [2012] FCA 311 (link).

Readers will be familiar with reg 16.01(e) of the Bankruptcy Regulations (link) from my earlier post on service by email (link).  That regulation allows a creditor to serve a bankruptcy notice by post.

Justice Collier’s decision is based on three simple points:

1. Although personal service is no longer required, strict proof of compliance with reg 16.01(e) is necessary;
2. The onus is on the creditor;
3. The Court will not infer that a mail item was posted just because it reached an in-tray:  given the penal nature of the bankruptcy system, there must be direct evidence of posting.

In Mbuzi the only evidence that the bankruptcy notice had been posted was oral evidence of the creditor as to his recollection of leaving the envelope containing the bankruptcy notice to be put in the mail by an unnamed secretary/receptionist in the ordinary course of business of his practice.

So what is sufficient direct evidence?

Notably, her Honour remarked that:

• there was no evidence of a record of the notice being sent by post, as might be expected if there was a system of postage pursuant to which the bankruptcy notice was posted;
• no evidence was tendered supporting the existence of any register of outgoing mail;
• no evidence, either oral or in affidavit form, was given by any third party who might have physically posted the bankruptcy notice that the notice had been posted.

These remarks suggest that a system for registering outgoing mail, evidence that the notice was on the register and affidavit evidence from the person who posted the mail on the day in question, may be sufficient.

Regards

Mark

Bankruptcy Notices can be served by email

One of the first posts on this blog dealt with establishing service of documents by email, tweet or facebook message (link).

Now, service of a bankruptcy notice by email has been held to be effective.  The relevant case is The Council of the New South Wales Bar Association v Archer (Federal Magistrates Court, Lloyd-Jones FM, 13 February 2012)(link).

It is surprising that an individual can be served with a bankruptcy notice by email, given that the recipient who fails to comply with the notice commits an act of bankruptcy.

The decision arises out of regulation 16.01(e) of the Bankruptcy Regulations 1996 (link) which permits a document to be “sent by facsimile transmission or another mode of electronic transmission”.  The Court surveyed the authorities and found none that permitted service by email.  Instead the Court relied on earlier authorities dealing with facsimile transmission.

The Court dealt with a number of issues raised by email service:

1. The requirement that the document be left “at the last known address of the debtor” imposed by r16.01(c) could be met when the address being used was an email address, and it did not matter that use of the email address was not tied to any fixed physical location as a street address or fax machine location might be;
2. If the email “bounced back” then service would not be effective;
3. Evidence on behalf of the debtor to the effect that he or she did not receive the document does not negate service, in the absence of the document being returned undelivered or other evidence of non-delivery:  being the same rule that applies to service by post.  Evidence of “non receipt” is not relevant;
4. The email account need not belong to the debtor provided there is evidence that the debtor checks the account.  In the Archer decision, the account belonged to the debtor’s spouse and was checked about once a week by the debtor.

The decision is consistent with Austin J’s judgment in Austar Finance Group Pty Ltd v Campbell which is referred to in my earlier post, and it will be interesting to see if superior courts follow the Archer decision.

Regards

Mark

What can creditors do if the “Official Receiver” is the trustee in bankruptcy?

I’ve recently had a number of clients ask me questions about the Official Receiver as a bankruptcy trustee in relation to debtors they are chasing.

The Official Receiver is a statutory appointee who acts as trustee in bankruptcy for debtors where there is no private appointment of an insolvency practitioner.

In effect, the Official Receiver is the default option in those bankruptcies where nobody (be it creditor or debtor) appoints a private trustee.  The Official Receiver has many thousands of current bankruptcies.  The staff of ITSA, the Insolvency and Trustee Service of Australia, manage them from day to day.

This default option most frequently gets used in consumer level matters where the bankrupt has little or no assets.  For example, debtors made bankrupt over small credit card debts, personal loans and the like.

You will hear anecdotally, and it has been my experience as well, that ITSA has more work than it can cope with and it does not provide the level of service that a privately appointed trustee would.  You can expect as a creditor that ITSA will attempt to identify any easily identifiable assets (land or vehicles)  but not much else.  This can be frustrating to you as a creditor if you believe that transfers of assets that are recoverable by a trustee are not being investigated.

If as a creditor you are not happy with the handling of a bankruptcy by ITSA, you are not helpless.  If a particular estate requires recovery of property the file is usually referred out to a private practitioner  appointed in the place of the Official Receiver.

Further, as I understand it, ITSA are usually quite willing to refer a matter to a private trustee if asked to do so by a creditor.  You may well be able to find a private trustee who will take the referral even without a fee arrangement, if you make sufficient enquiries.

Thanks to Stephen Michell of HLB Mann Judd (contact) and Kylie Wright (contact) of VInce and Associates  for assistance with this post.

Regards

Mark

Bankruptcy pitfall – joint judgment creditors must enforce together

The recent decision in Rookharp Pty Ltd v Webb & Anor [2011] FMCA 801 (at paragraphs [27] to [83]) is a reminder that a joint judgment debt must be enforced by all of the judgment creditors, not just one of them.  The issue commonly comes up in relation to orders for costs, which are joint, not joint and several, debts.  Costs orders are final orders which can be the subject of a bankruptcy notice.

In Rookharp, only one of the joint judgment creditors was named as a creditor on the bankruptcy notice and was, in turn,  a petitioning creditor.  The other judgment creditor was not named as a joint petitioner or as a respondent.

The petition was set aside on the basis that one of a number of joint creditors has no title to issue a bankruptcy notice or otherwise deal with the judgment debt alone:  since it is a joint debt, all such actions must be taken jointly.

The petitioning creditor unsuccessfully argued that the other joint creditors had authorised them to act for all petitioning creditors.  The court found that all of them had to be named.

Regards

Mark