How does a trustee deal with assets of a bankrupt?

A practical approach

Understandably, how a bankruptcy trustee deals with assets owned, or income earned by someone that goes bankrupt, is confusing – as every situation is unique. This case study provides some clarity on exactly how a trustee deals with the more common assets of a bankrupt.

Background

At the commencement of a bankruptcy, a bankrupt will complete a Statement of Affairs that discloses their assets, income, creditors and other information. The following is a summary of a typical bankruptcy.

Assets

Real Property (the bankrupt’s home) jointly owned with spouse   $450,000

(mortgage $400K)

Lexus IS250 $55,000

under finance (payout $59K)

Ford Falcon XR6 $10,000

Business assets $2,500

(laptop and office equipment)

Superannuation $103,000

Income from consulting business $91,000

Liabilities

ATO – Income tax $15,000

ATO – GST $90,000

Trade creditors $20,000

Credit Cards $25,000

What does the bankruptcy trustee do?

The trustee reviews the Statement of Affairs disclosing the assets as set out above. The trustee then explores the possible recoveries in the following manner.

Real property

When a trustee identifies real property owned by a bankrupt, they will undertake the following tasks:

  1. Obtain a property valuation.
  2. Confirm the amount of the debt owing under the mortgage.
  3. Confirm the ownership status (i.e. owned individually or jointly).

This information allows a trustee to determine the property’s equity that may be recoverable for the benefit of the bankrupt estate. In this case, the bankrupt is a joint owner of the property and therefore has a 50% interest in any equity. The equity is calculated as follows:

Value $450,000

Mortgage $400,000

Gross equity   $50,000

Bankrupt’s interest @ 50%   $25,000

The above shows the trustee has identified potentially $25,000 equity in the property. To realise the equity, the trustee can take one of the following steps.

  1. Agree with the joint owner to sell the property with 50% of net proceeds going to the bankrupt estate and the other 50% being paid to the other joint owner.
  2. Sell the bankrupt’s share of the equity to the other joint owner.
  3. If the other owner disagrees to either of the above, the trustee can apply to appoint a statutory trustee over the property for the purposes of selling the property and distributing the funds to the two owners. A statutory trustee is an independent party of both the joint owners and the bankruptcy trustees.

Commonly, a joint owner will elect option two so they can keep the property. Negotiations then commence between the trustee and joint owner regarding a suitable sale price, usually after considering any likely selling costs that would be incurred of the property was sold on the open market. Importantly, stamp duty implications and the mortgage’s consent must be considered.

Once a sale price is agreed upon, a sale agreement is executed and the bankrupt’s property interest is transferred to the new owner. The trustee receives the funds, which can be a lump payment, or a payment over time, and has no further interest in the property.

This arrangement benefits all parties as the trustee realises the asset in a timely manner with minimal costs and the joint owner keeps the asset (usually their home).

Of course, if option two is not possible, typically option one is undertaken with both the bankrupt estate and the other joint owner receiving the net proceeds from the sale.

Motor vehicles

To determine the value of a motor vehicle, the trustee must take in to account the threshold amounts for calculating the estate’s interest. In this instance, the bankrupt has two motor vehicles. We will deal with them separately.

Lexus Is250

This vehicle is subject to finance, so the trustee will calculate the equity position in relation to the financed debt, and then will reduce any equity by the motor vehicle threshold. In this instance, the payout figure is in excess of the vehicle’s value, therefore there is no equity in the vehicle, so the motor vehicle threshold is not applicable.

Value $55,000

Payout   $59,000

Equity nil

The trustee has no interest in this motor vehicle and will issue a formal disclaimer to the finance company, whereby the trustee disclaims an interest in the vehicle. The bankrupt can deal with the financier directly in respect of the vehicle. Typically, if a bankrupt maintains their finance repayments, the financier allows them to retain the vehicle. However, if the bankrupt falls into arrears, a financier will take action to repossess and sell the vehicle.

Ford Falcon XR6

This vehicle has a value of $10,000 with no debt owing against it. On this basis, the trustee calculates the bankrupt’s interest by deducting the motor vehicle threshold allowance, as follows:

Value of vehicle $10,000

Motor Vehicle Threshold   $7,600

Equity $2,400

In this case, there is $2,400 in equity (above the threshold amount), the trustee is required to realise this equity in one of the following ways:

  1. Take possession of the vehicle and sell it. The first $7,600 is paid to the bankrupt and the trustee retains any surplus funds.
  2. Agree to sell the equity ($2,400) to another party.

Typically, when the equity a small amount, the trustee will enter into an arrangement to sell the equity to another party. In this case, the bankrupt’s spouse may wish to buy it for $2,400. This would mean the bankrupt and spouse keep their vehicle.

Business assets

A bankruptcy trustee is required to realise any business assets held by a bankrupt. In this case, the bankrupt ran a consultancy business with assets (laptop, printer, modem etc.) valued at $2,500. These assets must be determined as either “tools of trade”, or divisible property. In this case, these assets were determined as being tools of trade and the bankrupt is entitled to a threshold of $3,700. As the total asset’s value is less than the threshold, the bankrupt retains ownership of these assets and the trustee has no right to them.

Ongoing trading of business

There is often some confusion as to whether as bankrupt can continue to operate a business. As long as the trustee realises any divisible assets (i.e. not tools of trade) the bankrupt can continue to operate a business with any remaining assets. However, the bankrupt is required to trade in their name and not a business name – i.e. cannot trade as “East Coast Consultants”, must be “Fred Smith Consultant”. The bankrupt should obtain the trustee’s consent to continue trade, but the trustee has no basis to stop the bankrupt trading while they comply with their obligations under the Bankruptcy Act 1966.

Income contributions

A common question asked is whether a bankrupt has to pay income contributions to their trustee. The simple position is, if they earn income above their relevant threshold, they have to pay 50% of the amount over the threshold (after income tax) to their trustee.

In this case, the bankrupt earns a gross income of $91,000. The bankrupt earns a gross income of $91,000. The bankrupt’s spouse is working and they have a 12 year old child (that lives with them), which allows an income threshold of $63,311.25 after tax. The bankrupt’s income contribution liability is calculated as follows:

Income $91,000

Tax payable $23,508

Net income $67,492

Less threshold amount   $63,311.25

Income over threshold   $4,180.75

Income liability @ 50% $2,090.38

In this case, the bankrupt is liable to pay their trustee $2,090.38 for an annual income contribution. Typically they are paid monthly (e.g. $174.20 - $2,090.38/12).

Superannuation

Superannuation is specifically excluded from bankruptcy as a divisible asset. In this case, the trustees cannot recover any funds held in superannuation. The trustee will look for any recent, large contributions to ensure they are not recoverable under section 128B or 128C of the Bankruptcy Act.

Summary

The above analysis gives the bankrupt the following outcome:

  • Home – bankrupt’s Interest is solid to the spouse and they retain their home.
  • Lexus IS250 – the bankrupt has to decide whether to maintain repayments or have the financier sell the vehicle at a loss of $4,000.
  • Ford Falcon XR6 – spouse purchases equity in vehicle and retains ownership.
  • Consultancy business – business continues as long as trading is in bankrupt’s name.
  • Income – bankrupt is liable for a small amount of income contributions.
  • Superannuation – unaffected, securing the bankrupt’s retirement provision.

In conclusion, it can be seen that while the Bankruptcy Act clearly outlines what assets are recoverable, a trustee can apply the law to achieve an outcome that works for all parties. Recoveries are still made for the benefit of creditors while the bankrupt can still earn an income and retain some assets (as long as they are paid for).

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