Insolvency vs family financial proceedings

In the current economic climate of the covid pandemic and the inevitable rise in bankruptcies and divorce petitions being presented, it is imperative solicitors and clients know what they are facing when insolvency and divorce proceedings meet.

The impact on an individual being made bankrupt whilst divorce proceedings are in existence can cause some confusion over the assets of the individuals involved. This article will deal with some of the considerations a family lawyer will need to think about when a divorcing party goes bankrupt, or there are concerns over the financial stability of one of the parties.

When an individual is made bankrupt, a Trustee in Bankruptcy is appointed to deal with and distribute any assets within the bankruptcy estate for the benefit of the bankruptcy creditors. Any assets that belonged to the bankrupt at the date of the bankruptcy order, vests in a Trustee in Bankruptcy upon their appointment pursuant to section 306 of the Insolvency Act 1986. This will mean that the bankrupt’s interest in property will no longer belong to them; and will belong to the Trustee in Bankruptcy to realise for the bankruptcy estate.

If an individual is made bankrupt whilst divorce proceedings are still on-going, then any agreement over a financial settlement will be at risk. One must be clear when the bankruptcy proceedings were commenced and whether a property adjustment order has been made within the family proceedings before commencing with the distribution of assets.

The general starting position is that if a Property Adjustment Order is made within the family proceedings before a bankruptcy petition is presented, then it will bind a Trustee in Bankruptcy. See the case of Mountney V Treharne (2002) EWA Civ 1174. If however, the Property Adjustment Order within the family proceedings is made after the presentation of the bankruptcy petition but before the bankruptcy order is made, then the family solicitor would need to make an application to the bankruptcy court to validate the Property Adjustment Order, otherwise it will be seen as a voidable disposition under section 284 of the Insolvency Act 1986 (“IA 1986”). That said, such an application is unlikely to succeed given the judgment held in Treharne V Forrester (2003) EWHC 2784 (CH). In this case a bankruptcy petition had been presented but the bankruptcy order had yet to be made; and the family courts had not yet validated a Property Adjustment Order. The family court did not have jurisdiction to make a Property Adjustment Order, as it could be challenged by the bankruptcy court if subsequently the bankruptcy order was made. If the bankruptcy order has been made, then only the Trustee in Bankruptcy has the power to deal with the bankrupt’s assets under sections 306 and 363 of the IA 1986.

There are exceptions and challenges to the above, for example, if it can be shown that the divorcing party made themselves bankrupt to defeat ongoing divorce proceedings. In some circumstances, challenges can be made to overturn the bankruptcy order where it can be shown that the bankruptcy proceedings were an abuse of process. This will require substantial evidence to be shown that the bankrupt was solvent at the time the bankruptcy petition was presented through disclosure in the family proceedings.

Further challenges by a Trustee in Bankruptcy to unwind auxiliary relief orders within family proceedings can be made under section 339 and 340 of the IA 1986. In relation to section 339 IA 1986, this relates to transactions at under value and the leading case on these transactions is Hill V Haines 2007 EWCA Civ 1284, where a Trustee in Bankruptcy could challenge a Property Adjustment Order in circumstances where there is evidence of collusion or misrepresentation between the parties.

Where a lump sum has been paid over in family proceedings to comply with a Consent Order but not yet paid to the receiving party, the monies cannot be claimed by a Trustee in Bankruptcy. As with pensions, these do not vest in a Trustee in Bankruptcy, and therefore any implementation of pension sharing orders is not affected by the making of a bankruptcy order. Periodical payments remain payable by a bankrupt but the assessment of quantum is not binding on a bankruptcy court, as a Trustee in Bankruptcy can make an income payments order application leaving the bankrupt with an amount a Trustee in Bankruptcy considers suitable for the bankrupt’s reasonable needs to provide for themselves and their family.

If there is any suggestion that a divorcing party may be at risk of bankruptcy in the future as they are either carrying a lot of debt or have had some form of gambling addiction in the past, then it would not be advisable to agree to a Mesher order on the basis that if the divorcing party was to be made bankrupt, then a Trustee in Bankruptcy would be entitled to an order for sale of the family home before the terms of the Mesher order had been triggered. In this situation, it would be imperative to strive for a clean break in the family proceedings where there is a suggestion that bankruptcy proceedings may be commenced.

This all demonstrates how important it is where there is a risk of bankruptcy of one of the divorcing parties, to finalise an agreement to be approved by the family court as soon as possible; and prior to the presentation of a bankruptcy petition. If a divorcing party is made bankrupt prior to finalising the financial consent order in family proceedings, then the assets that belonged to the bankrupt would vest in a Trustee in Bankruptcy, and cannot form part of the financial assets within the divorce proceedings until the bankruptcy has been concluded.

It is always advisable to seek expert advice when there is a potential cross over between the family and bankruptcy proceedings. At Turner Nicholson, we have a wide range of expertise to deal not only with the complexities of divorce proceedings but also with the impact of any financial constraints and insolvency.

Please do contact us if you have any of the above concerns before commencing either divorce or bankruptcy proceedings; or if you have already commenced proceedings and need advice over any of the above issues.

By Emma Easton, Partner