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Divorcing a bankrupt, Part II: where insolvency law meets financial remedies

Henry Clayton of 4 Paper Buildings outlines the consequences where a party to financial remedy proceedings becomes bankrupt after the making of a final order

















Henry Clayton, Barrister, 4 Paper Buildings

This is the sequel to my article "Divorcing a bankrupt: where insolvency law meets ancillary relief" published by Family Law Week. That article focused on what happens where a party becomes bankrupt during proceedings and covered the following:

• How bankruptcy works;
• What financial remedies can be ordered against a bankrupt;
• Grounds for setting aside a bankruptcy order.

This article addresses what happens if the party who is to pay money or transfer property becomes bankrupt after the making of a final order. It will cover:

• Bankruptcy between final order and implementation;
• Applications by the trustee in bankruptcy to set aside the final ancillary relief order;
• The impact on deferred interests in property of a bankruptcy arising subsequent to an ancillary relief order

Bankruptcy between final order and its implementation
Let us suppose you have conduct of a matrimonial finance case where the husband is carrying significant personal debt but there are other assets from which to meet your client, the wife's, housing needs. You arrive at a consent order before the husband or his creditors petition for his bankruptcy. Is your client's award safe? Not necessarily. It really depends upon the type of asset which was the subject of the order:

Property adjustment orders confer an equitable interest from the time the order takes effect (making of Decree Absolute) – this is a manifestation of the maxim 'equity treats that as done which ought to be done' – which means the transferee is not affected by the transferor's bankruptcy after this time whether or not the order has actually been implemented: Hill v Haines [2008] 1 FLR 1192 (CA) at [7]-[8] (although, interestingly, it was suggested in Independent Trustee Services v GP Noble [2012] EWCA Civ 195 [2012] 3 FCR 1 by Patten LJ at [43] that setting aside a final order does not automatically re-vest assets previously transferred by a party pursuant to that order, which appears not to be consistent with Hill v Haines).

Lump sums work differently. The beneficial interest in the money which one party is ordered to pay does not pass at the moment the order takes effect (Burton v Burton [1986] 2 FLR 419 per Butler-Sloss J (as she then was) at 425). Although in Re Mordant; Mordant v Halls [1996] 1 FLR 334 (Ch D) money which had been paid to the husband's solicitors to satisfy a consent order, but not yet paid to the wife, did not vest in the trustee in bankruptcy.

As explained in Part I of this article, pension rights do not vest in the trustee in bankruptcy and therefore the implementation of pension sharing orders is unaffected by the making of bankruptcy orders. Also previously addressed were periodical payments: these remain payable by a bankrupt, but the assessment of quantum is not binding on the bankruptcy court which will make an income payments order leaving the bankrupt with such amount as it considers he reasonably needs to provide for himself and his family.

Applications by the trustee in bankruptcy to set aside final orders
Even if your final order is made and implemented prior to the paying/transferring party becoming bankrupt that does not necessarily mean that the disposition is completely protected. The trustee in bankruptcy has two means of clawing back money for the benefit of the creditors:

(a) Transactions at an undervalue (Insolvency Act 1986 s.339);
(b) Preferences (IA 1986 s.340).

S.339 states that "where an individual is adjudged bankrupt and he has, at a relevant time, entered into a transaction with any person at an undervalue, the trustee of the bankrupt's estate may apply to the court for an order under this section."

The "relevant time" is 5 years prior to the presentation of the bankruptcy petition, if at the time of the transaction the person was insolvent or became insolvent as a result of the transaction. "Insolvency" means unable to pay one's debts as they fall due (commercial insolvency) or liabilities exceeding assets (balance sheet insolvency) - these requirements are presumed to be met in the case of a transaction at an undervalue if entered into with an associate (s.341(2)); this includes a spouse or civil partner (s.435). In other cases, where the bankrupt was not insolvent prior to or as a result of the disposition, the relevant time will be 2 years.

The definition of 'an undervalue' is (s.339(3)):

(a) "...a gift ……. on terms that provide for him to receive no consideration;
(b) ... a transaction …. for consideration the value of which, in money or money's worth, is significantly less than the value of… the consideration provided..."

S.340 applies to preferences: "where an individual is adjudged bankrupt and he has at a relevant time given a preference to any person". Where the transferee is an associate the relevant time is 2 years. Where the transferee is not an associate the relevant time is 6 months (s.341(1)(b)(c)). It is also a requirement that the transferor was at that time insolvent or made insolvent as a result of the transaction.

If the trustee is successful in demonstrating the undervalue or preference then the court shall 'make such order as it thinks fit for restoring the position to what it would have been' (s.339(2); s.340(2)).

The court therefore has a discretion. Although not a divorce case, Trustee in bankruptcy of Claridge v Claridge [2011] EWHC 2047 (Ch) is an example of a court finding that there was a transaction at an undervalue but deciding to make no order. Another is Singla v Brown [2008] 2 FLR 125 in which the bankrupt had accepted a notice from his partner reducing his beneficial interest in the couple's home, but in circumstances where he made no capital contribution or mortgage payments and had only been legal co-owner because the mortgagee required it.

An example of a divorce settlement being set aside as a transaction at an undervalue is Segal v Pasram and another [2008] 1 FLR 271 (Ch D). The husband and wife executed a deed purporting to transfer his half share in the matrimonial home to her for consideration of £1,000 and her giving up her ancillary relief claims (though divorce proceedings were not issued until years later). He was made bankrupt 8 months later. After a delay of 6 years the trustee in bankruptcy sought to have the transfer set aside. It was held that the limitation period for a recovery of real property by a trustee in bankruptcy is 12 years.

In Hill v Haines (above), it was clear at the time of the final hearing that the husband would become bankrupt. The District Judge made an order that the husband's share in the matrimonial home should be transferred to the wife within 7 days of Decree Absolute. He did not execute the transfer but he was made bankrupt shortly thereafter. The District Judge subsequently executed the transfer documents. The trustee in bankruptcy applied the following year for the transaction to be set aside as a transaction at an undervalue. The trustee succeeded in the Chancery Division but the decision was overturned by the Court of Appeal who was held that:

(a) The disposition was made at the time the court order took effect (at [7]-[8]);

(b) The compromise of ancillary relief claims does amount to consideration (at [29]-[30]);

(c) Absent the usual vitiating factors of fraud, mistake or misrepresentation the compromise of a party's statutory rights would be balanced by the payment of money or transfer of property – i.e. This is not an undervalue (at [35]);

(d) If the ancillary relief order was the product of collusion between the spouses designed to adversely affect creditors then the order would be set aside (at [46]; (for what may amount to collusion see Re Jones (A Bankrupt); Ball v Jones [2008] 2 FLR 1969 – in which the argument that such a disposition would amount to a preference was also rejected);

(e) An agreement to compromise ancillary relief proceedings cannot constitute a transaction for the purposes of s.339 (at [31]).

The last point demonstrates how important it is, in cases where bankruptcy is a risk, to get an agreement approved by the court as soon as possible.

Risk of future bankruptcy
Family practitioners are used to drafting orders which provide for a party to have a deferred interest in real property – whether by chargeback, Mesher or Martin order – usually when a primary carer needs the use of additional capital during the minority of children of the family. Where there is a risk of bankruptcy this may be inadvisable.

The case of Avis v Turner and  another [2007] EWCA Civ 748 established that, where a party has a deferred interest in property and is subsequently made bankrupt, the trustee in bankruptcy is entitled to apply for an order for sale before any of the trigger events in the order/charge have occurred. What is worse, s.335A Insolvency Act 1986 applies, so that after one year the interests of the creditors outweigh all other considerations unless the circumstances of the case are exceptional. Clearly, this could completely invalidate the basis upon which an order was made (but not likely to be in such a way as to amount to a Barder event).

The risk of bankruptcy may arise out of facts such as one party carrying a lot of debt which they will struggle to pay out of income, or perhaps a gambling addiction. I suggest it does not necessarily mean balance sheet insolvency. It may be better in that sort of case to accept a lower capital settlement, without the Mesher or chargeback, and strive for an immediate capital clean break.