September 2009

Purchasing assets with post-bankruptcy income - do these vest in the trustee?

Rodway v White [2009] WASC

The Supreme Court of Western Australia has partly clarified a previously uncertain area of Bankruptcy Law relating to income earned by bankrupts.  The decision should make it easier for trustees to recover additional assets during bankruptcy, for the benefit of creditors. For bankrupts in receipt of income, the case highlights the real danger not only of losing valuable assets, but also facing prosecution for offences under the Bankruptcy Act.

The issue

Upon bankruptcy, a bankrupt's assets vest in the trustee in bankruptcy.  Any assets acquired during bankruptcy also belong to the trustee.

During bankruptcy, the bankrupt is entitled to continue to earn income.  Above the statutory thresholds, the bankrupt is required to contribute ? of any income to the trustee for the benefit of creditors.  Income below the threshold is the bankrupt's to spend however it is thought best.

But when this income is used to purchase an asset, does the asset belong to the bankrupt or is it nonetheless after-acquired property vesting in the trustee in bankruptcy?

The facts

In Rodway the bankrupt earned $155,440 income over two years during his bankruptcy.  It is understood that he paid income contributions on this amount.  With the income he was entitled to keep, the bankrupt purchased shares.  He was subsequently charged and convicted with 21 offences under s265(1)(a) of the Bankruptcy Act for failing to disclose an interest in property, the shares, to his trustee in bankruptcy.

On appeal to the Supreme Court of Western Australia, the bankrupt argued that the assets  were acquired with protected income, and should not be available to his trustee and creditors.

It was accepted on the appeal before Justice Heenan that the shares constituted \"property\" within the meaning of the Bankruptcy Act.  The issue the Court was required to consider was whether the property was divisible amongst creditors of the bankrupt.  The parties accepted that income earned by the bankrupt after bankruptcy and before discharge did not of itself constitute \"after-acquired property\" and was not divisible amongst creditors.

This issue had been previously considered by the Federal Court in Re Gilles; Ex Parte The Official Trustee in Bankruptcy v Gilles (1993) 42 FCR 571.  French J in that case speculated that assets purchased by a bankrupt with after-acquired income would, unless otherwise excluded from being divisible property under the Bankruptcy Act, constitute divisible property amongst creditors and vest in the trustee.  However His Honour expressly declined to make any final decision on the matter. 

Justice Heenan in Rodway pointed out the \"incongruity\" in treating after-acquired property as belonging to the trustee, yet maintaining that after-acquired income does not.  There is not such a clear distinction between income and property.  In general terms, income is received as money, which is itself property.  Where income is paid into a bank account, this represents a different form of property, being the chose in action against the bank for repayment of the monies deposited.  His Honour raised for consideration circumstances where income is received, paid into an account, and transferred to a second, third or subsequent bank or deposit account.  His Honour noted that each transfer was itself the acquisition of property.

His Honour then considered the effect of the \"exempt money\" provisions of section 116 of the Bankruptcy Act, which provides for certain types of money received by a bankrupt to be protected, even when converted into property.  For instance, where a bankrupt receives an award of damages in respect of a personal injury, and acquires a house with this money, both the damages payment and also the house are protected.  However there is no general protection for assets acquired with ordinary income. 

In the end, His Honour agreed with Justice French in Gilles:

\"that the conversion of that income (or specie) into a distinctly different form of property, as for example by the purchase of shares in the present case, will result in the acquisition of after-acquired property divisible among creditors and so vest in the trustee, unless within any of the categories excluded by s 116(2).\" (at [66])

In the circumstances of Mr Rodway's circumstances, the failure by him to disclose the acquisition of shares with his post-bankruptcy income meant that he was guilty of an offence under section 265 of the Bankruptcy Act.  Had he used the money to purchase non-divisible property under s 116(2) (for instance superannuation or property held on trust for someone else), the property would not have belonged to his trustee and he would not have committed an offence under the Bankruptcy Act.

Conclusions

There is now some authority behind the general practice (which seems to be adopted by most trustees) to treat assets acquired with post-bankruptcy income as vesting in the trustee.  Trustees may need to take heed of the advice of Justice Heenan that:

\"a trustee can, and in appropriate cases perhaps should, conduct an examination of a bankrupt or require the bankrupt to answer certain questions before discharge which include questions regarding whether or not the bankrupt has received after-acquired property within the meaning of s 116 since his first examination or asset disclosure or statement or [sic] affairs.\" (at [69])

For those advising debtors and those experiencing bankruptcy, there can be a fundamental trap in dealing with post-bankruptcy income.  Unless the income is used to acquire non divisible property, the asset purchased will become available to the bankrupt's creditors.  The bankrupt is triple penalised in having already had to pay income contributions on the income earned, as well as losing the benefit of the property acquired, and potentially committing an offence under the Bankruptcy Act.  Sensible advice is required to ensure a bankrupt is not caught out in this regard.

As Mr Rodway found out, the consequences can be worse even than the loss of the asset.  Convicted of a number of offences six years after his discharge from bankruptcy, Mr Rodway was fined $5,700 and ordered to pay costs of $4,000.

There still remains some uncertain ground in relation to when income deposited to a bank account, for instance, will become property for the purposes of the Bankruptcy Act ? that is, what constitutes a \"distinctly different\" form of property so that income loses its character as income and is converted to after-acquired property?

This publication is intended as a source of information only. No reader should act on any matter without first obtaining professional advice.

Stephen Mullette