Convergent Divergence: When bankruptcy and the family courts collide

11 June 2021

The suggestion that the financially stronger party is at risk of bankruptcy is not a novel argument in financial proceedings following a divorce.  In many cases, the threat of bankruptcy does not materialise and therefore has no bearing on the final outcome.  In some, however, the risk of bankruptcy is used as an excuse for a breach of orders made in the family court and in the worst case scenario, the threat of bankruptcy can become a reality. 

Where orders have been made in the family courts, the effect of a later bankruptcy order will depend on the timing of the orders and can be effected by how the family order was made (i.e. whether it was by agreement or imposed by the family court at a final hearing).  Using a fictional case study, this blog will consider the potential effect a bankruptcy order can have on a financial order made in the family court, and the different tests of each court.

Case study

Mr and Mrs Andrews have divorced after 20 years of marriage.  The assets in the case comprised of the family home (jointly owned by the parties as joint tenants and where Mrs Andrews continued to reside); Mr Andrew’s new property, which was on the market for sale; Mr Andrews’ business, owned with his business partner and in which Mrs Andrews held shares (Mr Andrews’ shares were valued at £1million and Mrs Andrews’ at £500,000); and some pensions.  At an interim hearing on 15 March 2019, the court awarded Mrs Andrew “maintenance pending suit” at the rate of £10,000 per month, to provide for her interim needs pending the conclusion of the case.  These payments were not secured.  Mr Andrews had complied with this order, and at the time of the final hearing, there were no arrears. 

Unfortunately, the parties were unable to agree the terms of a financial settlement and a final trial was necessary which took place on 29 June 2019.  After hearing evidence from both parties, and expert evidence in respect of the business valuation, the family court imposed an order on the parties on the following terms:

  • The family home was to be sold and Mrs Andrews would receive 90% of the net proceeds of sale;
  • Mr Andrews was to pay a further lump sum to Mrs Andrews of £200,000 within five years;
  • Mr Andrews would retain his shares in his business;
  • Mrs Andrews would transfer her shares in the business to Mr Andrews;
  • Mr Andrews would continue to pay to Mrs Andrews maintenance pending suit at the rate of £10,000 per month until Decree Absolute, and thereafter spousal maintenance at the same rate until the earlier of either party’s death, Mrs Andrews’ remarriage or a further order of the court (a maintenance order for life).  The maintenance payments would be secured against Mr Andrews’ new home, and in the event it was sold, the net proceeds of sale of that property;
  • Each party would retain their pension assets;
  • The order would take effect on Decree Absolute, which is the court’s decree that formally ends the marriage.

The effect of the order was to see Mr Andrews receive (or retain) 65% of the total assets, but the departure from equality was justified on the basis that Mrs Andrews was receiving liquid assets and maintenance for life.  Unfortunately, throughout the proceedings, Mr Andrews made threats to bankrupt himself to ensure Mrs Andrews received nothing.  Within days of the family court’s final order, Mr Andrews announced he would rather make himself bankrupt than pay Mrs Andrews a penny, and that his business partner would take everything.  Mrs Andrews believed, and there was evidence to support, that Mr Andrews’ decline in financial circumstances was self-induced.  Mr Andrews failed to pay any further maintenance under the terms of the order.

In the months that followed, Mrs Andrews started enforcement proceedings and the following events then happened:

  1. On 10 March 2020 the court awarded Mrs Andrews an interim charging order in her favour, securing her outstanding maintenance pending suit from Mr Andrews’ net proceeds of sale of the family home and the costs order made in her favour for her costs of that hearing.  The interim charging order was made final by the family court at a further hearing on 1 May 2020.  At that point, Mr Andrews owed £80,000 in unpaid maintenance and costs of £15,000.
  2. At a further enforcement hearing on 16 July 2020, Mrs Andrews obtained another interim charging order, securing her further maintenance pending suit arrears of £40,000 against Mr Andrews’ share of the net proceeds of sale of the family home and Mrs Andrews’ costs of £8,000 for that hearing.  This interim charging order was made final on 29 September 2020.
  3. On 10 September 2020, Mr Andrews transferred all of his shares in his business to his business partner.
  4. The court granted Decree Absolute on 18 September 2020, which formally ended the marriage.
  5. On 28 September 2020 Mr Andrews petitioned for his own bankruptcy.  A bankruptcy order was made on 29 October 2020.
  6. A trustee in bankruptcy was appointed on 20 November 2020.
  7. The sale of the family home completed on 1 December 2020.  The property solicitor dealing with the sale transferred Mrs Andrew’s her 90% in accordance with the family court’s final order. Aware of the bankruptcy order, the solicitors dealing with the sale transferred the balance of the funds to the solicitors acting for the trustee in bankruptcy, who hold them to order.
  8. On 11 January 2021, Mr Andrews applied to the family court to have the maintenance order terminated with immediate effect.

At the time of Mr Andrews’ bankruptcy petition, he had total debts of £600,000, made up of an unpaid bank loan, unpaid credit cards and unpaid costs to his solicitors. He had no assets in his name, the family home and his property having been sold and his shares in his business transferred to his business partner. He was no longer earning an income and claims he is unable to work because of his health and because he does not want to pay spousal maintenance. He says he will be able to work again if and when the maintenance order is terminated.

 

The view of the insolvency court v the view of the family court

Unfortunately for Mrs Andrews, her prospects of having the bankruptcy order annulled are low.  In order to persuade the insolvency Court to annul Mr Andrews’ bankruptcy under s 282(1)(a) IA 1986, she would need to show that the bankruptcy order ought not to have been made.  For this purpose, it will not be enough for Mrs Andrews to prove that her ex-husband petitioned for his bankruptcy in order to frustrate performance of the family court’s final order.  A bankruptcy petition is not an abuse of process merely because the debtor wishes to frustrate his wife’s matrimonial claims. Instead, the issue for the insolvency court will be whether Mr Andrews was in fact unable to pay his debts as they fell due and notwithstanding suspicions that he has engineered his financial demise to defeat Mrs Andrews’ claims, he satisfies this test. 

The family court, however, is likely to take a different approach when considering Mr Andrews’ application to terminate the maintenance order, against his bankruptcy petition.  In AW v AH [2020] 2 FLR 519 Roberts J confirmed that, for the purposes of determining what are described as "financial resources" under s25 of the Matrimonial Causes Act 1973, the Family Court is engaged in a different exercise in considering the underlying reality of beneficial entitlement which is a more nuanced approach to the black-letter of insolvency law.  Mr Andrews’ motives would be a relevant consideration for the court when dealing with a) enforcement efforts by Mrs Andrews; and b) Mr Andrews’ application to terminate the maintenance order.  Of course, the effectiveness of any court orders will depend on what assets Mrs Andrews can enforce against.

 

The effect of the bankruptcy on the family court orders – what provisions will survive and what will fall into the bankrupt’s estate?

The timing of the family orders against the date of Mr Andrews’ bankruptcy petition is key here.

The property adjustment order

The order awarding Mrs Andrews 90% of the net equity of the family home was made and took effect before the bankruptcy petition was presented. A property adjustment order made before the presentation of the bankruptcy petition will be valid and will bind the trustee.  There are limited circumstances where the trustee may challenge this, although these are rare.  Whilst a property adjustment order is considered a disposal of assets, there is not necessarily a lack of consideration for that disposal; the consideration for that disposal is the matrimonial claims, which will be dismissed on the order. 

Had the property adjustment order taken effect after the date the bankruptcy petition was presented, the property adjustment order would be void as a disposition of the bankrupt's property under section 284(1) of the Insolvency Act 1986, s 284(1).  Had Mrs Andrews found herself in that scenario, she would need to make an application to the bankruptcy court seeking an order to validate the property adjustment order, the prospects of success of which are likely to be very low.

The charging orders

The family court made two charging orders in Mrs Andrews’ favour; one of those was made final on 1 May 2020, before Mr Andrews petitioned for bankruptcy on 28 September 2020.  In respect of this first charge, Mrs Andrews is considered a secured creditor and can enforce the maintenance arrears and costs secured by that charge against the balance of the net proceeds of sale of the family home, being held by the trustee.  In respect of the second, whilst the interim charge was granted before the bankruptcy petition, it was not made a final charge until 29 September 2020, one day later.  Accordingly, the security could be susceptible to challenge by the Trustee in Bankruptcy as a void disposition pursuant to s.284 IA 1986.  Should the Trustee successfully challenge it, Mrs Andrews would not be considered a secured creditor, and therefore would not be able to take steps to enforce the further arrears of £40,000 and £8,000 costs order against the held funds.  In those circumstances, the balance of these funds, after her secured payments, would fall into the bankrupt’s estate and Mrs Andrews would have to make a claim with the other creditors.

The lump sum

The lump sum owed to Mrs Andrews remains payable.  Whilst Mr Andrews has sought to vary the maintenance order awarded to Mrs Andrews, he cannot, as a matter of law, vary the lump sum order (save by way of an appeal).  However as Mr Andrews is not required to pay the lump sum for five years, this debt has yet to crystallise.  As a result, Mrs Andrews cannot claim this in the bankruptcy.  The lump sum order will survive, but Mrs Andrews will have to wait the full five years before she can start enforcement proceedings, and the prospects of recovering anything will depend on Mr Andrews’ financial position at the time.

The maintenance

Notwithstanding the bankruptcy order, Mr Andrews remains liable to pay maintenance to Mrs Andrews unless he successfully varies that order. As stated above, the family court will consider his motives, and will take a more nuanced approach when considering his resources. Any maintenance arrears that were due at the time of the bankruptcy petition will fall into the bankruptcy estate, either as secured debts or unsecured debts, depending on the timing of the relevant orders granting security, as considered above.

 

Will Mrs Andrews have to repay anything?

At the time of the bankruptcy petition, Mrs Andrews had been granted security for her maintenance payments with the creation of a charge over Mr Andrews’ home, and the net proceeds of sale in the event that property was sold.  One possible concern Mrs Andrews may have is that the trustee in bankruptcy could argue that this charge conferred a preference on her for the purposes of s340 IA86.  It is arguable that the charge created by the order had the effect of preferring Mrs Andrews in Mr Andrews’ bankruptcy by turning her into a secured creditor.   In this case study, however, the charge was imposed by the court, and Mr Andrews vehemently opposed it in the family court proceedings. Accordingly, in the event that Mrs Andrews faced such a challenge from the trustee, she ought to be able to demonstrate that Mr Andrews was not motivated by any intention to prefer her at all.  The preference was one granted by the Court against Mr Andrews’ wishes.  The remaining net proceeds of sale from Mr Andrews’ property would form part of the bankruptcy estate, but subject to Mrs Andrews’ charge.  Mrs Andrews ought to therefore have an argument that, as a secured creditor, there will be no diminution in the bankruptcy estate if she exercises that security. 

The timing of Decree Absolute is key here.  The final order made by the family court was stated to be effective “on Decree Absolute”. In this scenario, Mrs Andrews obtained Decree Absolute before the bankruptcy petition, so the order granting the security was effective, as was the property adjustment order made in her favour. Had Mrs Andrew waited and obtained Decree Absolute after the bankruptcy petition was presented, the order would have taken effect after this date.  As a consequence,  Mrs Andrews would have been an unsecured creditor at the time of the bankruptcy petition and any payment for maintenance under the final order (i.e from 29 June 2020) would not have been secured.  Further, the property adjustment order would be subject to a challenge by the trustee, and likely to be considered a disposition of the bankrupt’s estate. 

Applying for Decree Absolute promptly can be very important in family cases where there have been threats of bankruptcy.

 

Mr Andrews’ shares

In this scenario, Mr Andrews transferred his shares in his business to his friend and business partner just two weeks before he petitioned for his own bankruptcy and four months before his application to vary maintenance.   The trustee in bankruptcy will no doubt need to consider if they should take steps to set this transfer of shares aside, and the bankruptcy court would have powers to do so.  Similarly, Mrs Andrews could ask the family court to set this share transfer aside under section 37 of the Matrimonial Causes Act 1973, if the court was persuaded that it took place with the intention of defeating her claims.  Given the timing of the transfer, and the high valuation of the shares that Mr Andrews had disposed of, the family court would be very interested in this if an application was made.  Unfortunately for Mrs Andrews, if the court did set aside the share transfer, the shares would fall into the bankrupt’s estate.  However, as she is an unsecured creditor for a significant amount of money, this may benefit her and she would need to carry out a cost benefit analysis of this exercise, in the event the trustee in bankruptcy failed to take action.

 

Sharing information with the trustee

Parties in family proceedings need the family court’s express permission to share documents from the family court proceedings with a third party, such as the trustee in bankruptcy. In this scenario, sharing the business valuation, transcripts of court hearings and the orders made may prove helpful to both Mrs Andrews and the trustee.  Where bankruptcy threats have been made, or where a petition has been filed and there are concerns as to the legitimacy of the bankruptcy, it is sensible to seek the permission from the court that documents can be shared with the Trustee in Bankruptcy as soon as possible.

Bankruptcy orders can have a devastating effect on the intention behind orders that have been legitimately made in the family court, and for the non-bankrupt spouse, it can feel like the bankruptcy court rides roughshod over the order they have worked hard to obtain.  If bankruptcy is a concern, security should be sought (and effected and made final as soon as possible), and Decree Absolute obtained promptly where appropriate. Failure to do so could see a beneficiary to a financial order fighting with other creditors, as an unsecured creditor in the bankruptcy.   Obtaining advice from an insolvency specialist in tandem with family law advice can be valuable.

 

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