When a bankruptcy trustee investigates transactions made prior to bankruptcy and identifies that assets have been improperly transferred, these assets may be recoverable under the Bankruptcy Act 1966 (Cth) (Act). Voidable transactions were introduced to the Act to create a more equitable distribution of rights between debtors and creditors.1 Voiding these transactions enables trustees to recover assets that would otherwise have been available to creditors, and to ensure that these assets are equitably distributed for the benefit of all creditors.
When Will Transactions Be Void?
There are 4 main circumstances in which transactions may be void, all of which involve the transfer of property from a person who later becomes bankrupt (Transferor) to another person (Transferee).
1. Section 120: Is the Transaction Undervalued?
The two key factors here are timing and consideration. The transfer must have occurred 5 years before the period of bankruptcy. Section 120(1) of the Act also identifies that a transaction is undervalued if the person who buys the property did not give any consideration or if the consideration was less than market value. Consideration may come in various forms but typically involves the payment of money.
Section 120(2) highlights circumstances where undervalued transactions may not be voidable such as if the transfer occurred under certain types of agreements. It is also important to look at the transferee’s solvency at the time of the transfer and whether the transfer was to a related entity as this could affect which time limits apply under section 120(3).
2. Section 121: Did the Transferor Intend to Defeat Creditors?
Under section 121 of the Act, a transfer of property is void if the transferor’s main purpose was to prevent, hinder or delay property being available to creditors. The trustee must also demonstrate that if the transfer had not occurred, the property would probably have become part of the transferor’s estate or have been available to creditors. The easiest way to demonstrate this intention to defeat creditors is to prove that the transferor was, or was about to become, insolvent at the time of transfer.2
Section 121(4) provides protection for innocent parties who receive the property. For example, a transfer of property is not void if the consideration given was at market value of the property, the transferee didn’t know and couldn’t have inferred the transferor’s main purpose, or that they were about to become insolvent.
3. Section 121A: Has Consideration Been Transferred to a Third Party?
Section 121A enables a trustee to recover property from third parties where consideration should have been paid to the bankrupt. The section applies if the transferee gives some or all of the consideration for a transfer to a third party other than the transferor.
4. Section 122: Has the Debtor Transferred Property in Preference Over Other Creditors?
Section 122(1) arises in situations where the bankrupt transfers property to a creditor with the effect of giving the creditor priority, preference or an advantage over other creditors. Once again, timing is crucial. To be voidable, the transaction must have occurred in a specific time period depending on when the petition leading to bankruptcy was presented.
Similar to previous provisions, section 122(2) of the Act protects the rights of purchasers that acted in good faith and gave consideration that was at least equal to the market value of the property.
Pros and Cons of Voidable Transactions
Although voidable transactions provide an important mechanism for trustees to recover assets for the benefit of creditors, the advantages of voidable transactions claims in bankruptcy must be balanced against the costs of these actions. For example, the trustee must factor in that if consideration was paid for undervalued transactions or transfers to defeat creditors, then the trustee must pay the transferee an amount equal to this consideration, which may reduce the overall recovery.
1 Explanatory Memorandum, Bankruptcy Amendment Bill 1979, cl 6.
2 Bankruptcy Act 1966 (Cth), s 121(2).
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