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How does personal bankruptcy impact the family home?
If an individual is made bankrupt, it is not necessarily the case that their house will be sold from under them.
Given that in most bankruptcy cases we are dealing with the family home, it pays to have knowledge in this field to provide the best outcome for your client and hopefully “save the house”.
Bankrupts have several options for retaining their family home during bankruptcy; however it will depend on variables such as ownership structure, amount of equity in the property and the cooperation of the mortgagee.
This article explores the impact that personal bankruptcy can have on the family home and provides answers to questions your clients may have when exploring bankruptcy as an option.
Is a bankrupt’s house protected from bankruptcy?
Under the Bankruptcy Act, a bankrupt’s home is not a protected asset. Upon an individual becoming bankrupt the property immediately vests in the trustee.
The trustee is required to realise any equity in the property after payment of the mortgage and selling costs.
I own my property outright with no mortgage.
If the property is unencumbered the trustee will sell the property. The trustee will work with the bankrupt to realise the property. The property must be sold at market value.
The bankrupts house is jointly owned. How will bankruptcy impact the co-owner’s share in the house?
As the property vests in the trustee at the commencement of bankruptcy, joint tenancy is automatically severed. Following this severance, the interests in the property are held as ‘tenants in common.’
Although the property is jointly owned the trustee must still realise the bankrupt’s share of the property. A trustee can insist on selling the house so that the bankrupt’s share may be realised, however the trustee will attempt to work with any co-owners to come to a mutually beneficial agreement on the sale of the property.
There are a number of scenarios as to how jointly owned property is treated during in bankruptcy. These scenarios are in most cases determined by the value of the equity in the property.
Jointly owned property with no mortgage
Firstly, the trustee will most likely give the co-owner a chance to buy the bankrupt’s share of the property. If the co-owner cannot or chooses not to take up this opportunity, the trustee will attempt to reach an agreement on how they can jointly place the property on the market. If they cannot reach such an agreement, the court may grant a ‘statutory trustee for sale’ over the co-owner’s share in the property to allow the sale. The proceeds of the sale will be shared between the trustee and co-owner.
Jointly owned property with minimal equity
Upon the appointment of a trustee, the property will be valued and the amount owing under the mortgage and or any other security will be determined. A trustee would then determine the amount of equity remaining in the property. This equity is then split 50/50 (assuming this is the ownership structure) to determine the amount of equity that belongs to the bankrupt. The trustee would then offer the co-owner the opportunity to purchase the bankrupt’s share of the equity in the property. In this situation, the co-owner would be required to continue maintaining the mortgage.
Example:
Jack and Jill are married. Jack becomes bankrupt due to a failed business venture. Jack and Jill jointly own a property 50/50 valued at $500,000. The mortgage over the property is $450,000. Accordingly, the joint equity in the property is $50,000 ($500,000 – $450,000). As Jack and Jill each have a 50% share in the property, they each have $25,000 in equity. The bankrupt’s $25,000 share will vest in the bankrupt estate.
The trustee approaches Jill and offers her to purchase the bankrupt’s equity in the property for $25,000. Jill accepts the trustee’s offer and the trustee transfers all right and title in the property to Jill. Jack and Jill continue to live in the property with Jill as the as the sole owner.
This strategy allows the bankrupt to remain in the family home and minimises the impact bankruptcy may have on the family.
Property owned but with nil equity
Sometimes, the value of the property is outweighed by the loans secured against it. This means that there is nil equity in the property.
In this situation, the trustee would offer the co-owner to purchase the future rights in the property for a nominal fee. This allows the co-owner to protect the asset from being realised by the trustee in the future.
In this scenario the co-owner must continue to service the mortgage. There is a small risk that the mortgagee would take possession of the property, however, generally if the mortgage can be maintained it would be unlikely that the mortgagee would take recovery action.
Example:
Following a valuation of the property, Jack and Jill are shocked to discover that their house is now only worth $350,000. Accordingly, they do not have any equity in the in the property ($350,000 – $450,000).
The trustee offers to sell all future right in any equity interest in the property that the bankrupt may have for a nominal fee.
Jill accepts this offer and is assigned all equity interest in the property. Jill continues to service the mortgage and Jack and Jill remain in the family home.
This strategy ensures that the bankrupt and the bankrupt’s family can remain in the property and also protects the property from any future claims from the bankrupt’s creditors or the trustee.
The house is jointly owned, is it a 50/50 split? The doctrine of exoneration
In some situations the home may be owned in equal shares on the title, however, one of the joint owners has used the property as security for a business venture for their sole benefit. This loan must not have any connection with the co-owner.
The doctrine of exoneration states that the co-owner who received the benefit of the loan should have to pay the loan that is secured by the jointly owned property from their portion of the jointly owned property in the first instance. The following example outlines how the doctrine would apply.
Example:
Using the jointly owned property as security, Jack took out a $100,000 loan for his business Jack Pty Limited. Jill did not receive any benefit from this loan whatsoever. The property was sold by the trustee and $200,000 proceeds were made available to the co-owners, trustee (Jack’s share) and Jill.
In normal circumstances the proceeds would be split 50/50. However due to the fact that the funds available under the mortgage were only used by Jack and Jill did not receive any benefit from this loan the doctrine of exoneration can be applied. Accordingly, the amount due under the mortgage ($100,000) is taken from Jack’s equity and added back to Jill’s equity.
The split of equity is calculated as follows:
Equity realised – $200,000
Bankrupt’s Share – $100,000
Less Mortgage – ($100,000)
Bankrupt’s Share – Nil
Co-owner’s Share – $200,000
The doctrine is not applied automatically and would require to be proven to trustee that the claim and application of the doctrine is valid.
Conclusion
When your clients are facing bankruptcy there are a number of considerations when determining how to “save the house”. The best option to make the process less daunting than it may already be for your clients, contact the team at Rapsey Griffiths for a consultation.