Understanding Voidable Transactions in Bankruptcy

This is the tenth topic in a series of articles aimed at informing directors of their duties and options for small to medium enterprises if faced with insolvency.

One of the most severe consequences of being a bankrupt (now called a regulated debtor) is the divisible property of the debtor vests in their Trustee. This article outlines a key aspect of investigations a Trustee may undertake, in their efforts to recover funds for creditors during an appointment, specifically transactions entered by the debtor prior to bankruptcy.

What are voidable transactions in Bankruptcy?

A voidable transaction is a transfer of property or assets owned by the debtor to a third party that causes detriment to creditors. By voiding these transactions, a Trustee can recover assets that would otherwise have been available to creditors, ensuring an equitable distribution of assets to all creditors.

Under the Bankruptcy Act 1966, there are five primary transactions which may be voided by the Trustee. These include:

• Section 120: Undervalued transactions
• Section 121: Transactions to defeat creditors
• Section 121A: Transactions with consideration to third parties
• Section 122: Unfair Preferences
• Section 128B and C: Superannuation contributions made to defeat creditors

Section 120: Undervalued transactions

An undervalued transaction occurs when a debtor either gives away or sells their assets for less than their market value to another party before entering bankruptcy. Section 120 of the Act empowers the trustee to set aside such transactions if they occurred within the five years before the bankruptcy commenced. This provision is aimed at preventing debtors from disposing of their assets at less than their true value to the detriment of creditors.

Examples of undervalued transactions include a debtor selling an interest in the family home to their spouse for a nominal amount or “natural love and affection”.

Potential Defence

A possible defence against such claims involves demonstrating market value consideration was given. Thus, obtaining a market value assessment by a legitimate valuer prior to the transfer, followed by the transfer of consideration, equal to the market value, may serve as a complete defence to a claim. Section 120(3) also provides a possible defence if the transfer happened within two to five years prior to the commencement of bankruptcy, or between four and five years in the situations involving transfers to related parties and the transferee can prove that, at the time of the transfer, the transferor was solvent.

Section 121: Transactions to defeat creditors

A transfer to defeat creditors occurs when an individual transfers an asset to another party with the intention of preventing it from becoming available for distribution to creditors, or to hinder or delay the process of making that property available.

A “transfer of property” is a similar kind of transaction that is void under Section 120. The distinction lies in Section 121, which focuses on the “main purpose” of the transfer. To establish a claim under Section 121, the Trustee must prove that the transferor’s “main purpose” in making the transfer was to prevent or hinder or delay the creditors getting a share of the property transferred. For example, Tom knew that he was going to become bankrupt soon. He did not want his creditors to get their hands on his real property. Therefore, to protect his real property from creditors, he transferred its title and ownership to his mother for a token amount of consideration well under market value. Under Section 121, this would render the transaction voidable, requiring the property to be returned to the Trustee.

Potential Defence

A transferee may seek protection under Section 121(4) to defend such claims, provided they acted in good faith. To successfully rely on this defence, the transferee must establish:

• That the consideration given for the transfer was at least as valuable as the market value of the property received; and
• The transferee did not know and could not reasonably have inferred that the transferor’s “main purpose” was to prevent or hinder property being available to creditors; and
• It was not reasonable for the transferee, at the time of the transfer, to infer that the transferor was, or was about to become insolvent.

Section 121A: Transactions with consideration to third parties

The introduction of Section 121A was designed to strengthen the trustee’s ability to claw back transactions under Sections 120 and 121, where the consideration for the transfer of property is paid to a third party.

An example of this might be a husband and wife, where the husband, Tom is insolvent and prior to bankruptcy, Tom transferred a property valued at $550,000 to his wife, Angie. Subsequently, Angie paid the full value of $550,000 to Tom’s mother, Jenny. As Angie paid market value consideration for the transfer (albeit to a third party), the transfer between Tom and Angie is not affected by the provision in Section 120. Angie likely can retain the family home.

However, the key is whether Jenny has provided market value consideration to the Bankrupt, for the receipt of the payment of $550,000. If Jenny had earlier lent $350,000 to Tom, and Tom directed the $550,000 be made to Jenny in order to extinguish the debt, then Jenny had not provided market value consideration to Tom for the receipt of $550,000. Payment received by Jenny would be void against the Trustee under Section 121A. The Trustee is allowed to recover the difference of $200,000 from Jenny.

Section 122: Unfair preference

A preferential payment occurs when a debtor pays one particular creditor in preference to other creditors. For example, if a debtor pays a debt owed to a creditor pressuring them, intending to favour that creditor or over his/her other unsecured creditors, such transaction may be deemed as preferential payment.

Section 122 of the Act provides a trustee with the power to seek repayment of any debt paid by an insolvent debtor before they became bankrupt, if that payment had the effect of giving that creditor “a preference, priority or advantage over other creditors”. This section ensures that assets of a person who is insolvent are distributed equally among his or her creditors.

Under Section 122(1), to have a transaction set aside as preference, the trustee is required to establish:

• A transfer of property occurred;
• The debtor was insolvent at the time of the transfer;
• The transfer was made by the debtor in favour of a specific creditor;
• The effect of the transaction was to give the creditor, who was a party to the transaction, a preference priority or advantage over other creditors; and
• The transfer took place within the requisite timeframe mentioned in Section 122(1)(b).

All five elements must be proved by a trustee who seeks to challenge a preference. Potential Defence Potential defences that creditors may employ to defend a preference claim include:-

• The creditor who received the property or payment did so in the ordinary course of business, acted in good faith and gave consideration at least as valuable as the property transferred;
• The debtor was solvent at the time of the transfer;
• Provide evidence indicating that the transaction subject to the preference claim does not affect the remaining creditors.

Section 128B and C: Superannuation contributions made to defeat creditors

As is widely known, the interest of a debtor in a regulated superannuation fund is not divisible property amongst creditors in bankruptcy pursuant to Section 116(2)(d) of the Act. However, such protection is explicitly subject to Section 128B and 128C of the Act.

Section 128B and 128C operates in a similar way of Section 121 providing transfers made by a debtor (S128B) or a third party (S128C) are void against a Trustee if the “main purpose” of the superannuation contribution made is to defeat or delay creditors, particularly if there is a reasonable inference that the debtor was insolvent at the time of the contribution.

If you find yourself navigating the complexities of bankruptcy law or require assistance in clarifying your position concerning voidable transactions, our experienced team at WCT Advisory is here to help. Contact our office for expert guidance and support tailored to your specific situation.