What are Voidable Transactions in Bankruptcy?

Voidable transactions in bankruptcy are transactions made before the bankruptcy which can be recovered by the bankruptcy trustee.

If the bankrupt transferred assets, which the bankruptcy trustee judges to be property that would have formed part of the estate available to creditors, then these transactions can be voided, or reversed / undone by bankruptcy lawyers.

This is sometimes known in liquidation and bankruptcy as “claw-back provisions” or “voidable transactions”.

The Bankruptcy Act 1966 (Cth) (“Bankruptcy Act”) allows the bankruptcy trustee to void these transactions, or claw back the asset, meaning that the other party will have to transfer the asset back to the bankrupt’s estate, or pay money back to the bankrupt’s estate.

Our insolvency lawyers explain in more detail below.

What are Voidable Transactions in bankruptcy?

In the Bankruptcy Act, there are four (4) transactions which can be voided by the bankruptcy trustee, these are:

1. Undervalued transactions – section 120 of the Bankruptcy Act; and/or
2. Transfers to defeat creditors – section 121 of the Bankruptcy Act; and/or
3. Transactions where consideration given to a third party – section 121A of the Bankruptcy Act; and/or
4. Transactions giving preference to one creditor over other creditors – section 122 of the Bankruptcy Act.

The trustee is able to void the transactions above if he/she is able to do the following:

1. Identify the transaction and identify the transaction as a voidable transaction in bankruptcy;
2. Identify the other party to the transaction in order to get the property or money from them;
3. Identify when the transaction occurred to prove it falls within the legislative time limits; and
4. Ensure that the transaction was not protected property under the Bankruptcy Act.

These are similar to voidable company transactions in liquidation and winding up proceedings.

Undervalue Transactions

Section 120 of the Bankruptcy Act says:

(1)  A transfer of property by a person who later becomes a bankrupt (the transferor) to another person (the transferee) is void against the trustee in the transferor’s bankruptcy if:

(a)  the transfer took place in the period beginning 5 years before the commencement of the bankruptcy and ending on the date of the bankruptcy; and

(b)  the transferee gave no consideration for the transfer or gave consideration of less value than the market value of the property.

Classically, this voidable transaction in bankruptcy would be the bankrupt’s share of the family home, transferred to their partner, for no consideration, or consideration less than the market value of the property at the time of the transfer.

The full court of the Federal Court of Australia in Official Trustee in Bankruptcy v Lopatinsky [2003] FCAFC 109 said that:

… it would be inconsistent with the observations of Wilcox J and Branson J in Mateo to proceed upon the basis that “consideration” could be something less than the ordinary legal and commercial understanding of that term. Indeed, it would be inconsistent with the statutory purpose of the section which is designed to protect creditors to hold that the Parliament intended to enable a transferee to provide something less than the well-established legal definition of “consideration“.

So, consideration under this section must adhere to the legal definition of consideration, and cannot be past consideration – Official Trustee in Bankruptcy v Mateo [2003] FCAFC 26.

In Sutherland v Brien [1999] NSWSC 155 the Court said:

It seems to me obvious that … the Court’s task is twofold: first, to identify as precisely as one can, the consideration (if any) which was in fact given … and secondly, if consideration was given, to determine whether the value of the consideration at the time of the transfers was less than the market value of the property transferred.

So, in determining if a transaction was an undervalue transaction pursuant to section 120 of the Bankruptcy Act, and therefore a voidable transaction in bankruptcy, firstly there needs to be a determination as to whether legal consideration was given; and if so, whether the value of that consideration was equal to the market value of the property transferred.

This is similar to uncommercial transactions in liquidation in company insolvency.

Transfers to Defeat Creditors

Section 121 of the Bankruptcy Act says:

(1)  A transfer of property by a person who later becomes a bankrupt (the transferor) to another person (the transferee) is void against the trustee in the transferor’s bankruptcy if:

(a)  the property would probably have become part of the transferor’s estate or would probably have been available to creditors if the property had not been transferred; and

(b)  the transferor’s main purpose in making the transfer was:

(i)  to prevent the transferred property from becoming divisible among the transferor’s creditors; or

(ii)  to hinder or delay the process of making property available for division among the transferor’s creditors.

The main point to consider in relation to section 121 of the Bankruptcy Act is the intention of the debtor.  This section states that a transaction can be void if the main purpose of the transfer was to attempt to defeat creditors.

The main purpose is determined by reasonable inference from all the circumstances surrounding the transfer, at the time of the transfer.

Section 121(2) of the Bankruptcy Act says:

The transferor’s main purpose in making the transfer is taken to be the purpose described in paragraph (1)(b) if it can reasonably be inferred from all the circumstances that, at the time of the transfer, the transferor was, or was about to become, insolvent.

So, if the bankrupt was just about to become insolvent, then the transfer of property is taken to be caught by section 121.  The trustee in bankruptcy can raise the legal presumption of insolvency if they can establish that the transferor:

1. Had not, in respect of that time, kept such books, accounts and records as are usual and proper in relation to the business carried on by the transferor and as sufficiently disclose the transferor’s business transactions and financial position; or
2. Having kept such books, accounts and records, has not preserved them.

However, some transactions are not able to be voided by the bankruptcy trustee, these are outlined at section 121(4) of the Bankruptcy Act and are “good faith” provisions, including:

1. The consideration is as valuable as the market value of the property; and
2. The transferee did not know, and could not reasonably have inferred, that the transferor’s main purpose was trying to defeat creditors; and
3. The transferee could not reasonably have inferred that, at the time of the transfer, the transferor was, or was about to become, insolvent.

Examples of transfer of property are:

1. The transfer of monies held in the bankrupts bank account to a spouse or family member; and/or
2. The transfer of the bankrupt’s interest in real property to a spouse, friend or family member; and/or
3. The transfer of other property such as shares, motor vehicles etc.

Transactions where Consideration Given to a Third Party

Section 121A of the Bankruptcy Act says:

This section applies if:

(a)  a person who later becomes a bankrupt (the transferor) transfers property to another person (the transferee); and

(b)  the transferee gives some or all of the consideration for the transfer to a person (a third party) other than the transferor.

An example of this might be a husband and wife, where the wife is insolvent and likely to become bankrupt, transfers her interest in the matrimonial home for market value consideration to the husband; and the husband then pays that market value consideration to the wife’s sister instead of to the wife.

Section 121A allows the same right of recovery as against the third party as against the bankrupt, if they trigger sections 120 and 121 of the Bankruptcy Act.

Voidable Transactions in Bankruptcy

Section 122 of the Bankruptcy Act says:

(1)  A transfer of property by a person who is insolvent (the debtor) in favour of a creditor is void against the trustee in the debtor’s bankruptcy if the transfer:

(a)  had the effect of giving the creditor a preference, priority or advantage over other creditors; and

(b)  was made in the period that relates to the debtor, as indicated in the following table.

A preference payment is the payment of monies from a debtor to a creditor in preference to other creditors of the debtor.

An example might be where the debtor makes the payment of a debt to a business owned by a family member, in an attempt to favour that family member over his/her other unsecured creditors.

In James v Commonwealth Bank of Australia [2015] FCA 582 the Court said:

Although there appears to be a dearth of authority on the point, section 122(1) is directed at a situation of the pool of assets being available to creditors generally, being detrimentally affected by a transaction in favour of one creditor. Accordingly, in my view, what one has to do is to consider the situation of the creditors generally before the transaction, and then look at the situation afterwards and see whether the other creditors, that is the general creditors, have been disadvantaged.

The main point to consider is that the transaction must have a detrimental effect on the other creditors, in favour of one creditor.

In Sheahan v Carrier Air Conditioning Pty Ltd [1997] HCA 37 the High Court of Australia said:

To my mind, cases such as Richardson v The Commercial Banking Company of Sydney Ltd do focus consideration on the ultimate effect of the transaction with respect to the general creditors over and against the relevant creditor. Accordingly, in my view, if one can see that the position of the general creditors after the transaction was no worse than it was before the transaction then the transaction does not have the effect of giving a preference to one creditor over the others.

The above voidable transactions in bankruptcy give a brief understanding of how a bankruptcy trustee can attempt to void a transaction.

This is similar to unfair preferences in liquidation in company insolvency.

However, there are defences to those claims that the transaction contravened the Bankruptcy Act, and is therefore voidable.

Defences to Voidable Transactions in Bankruptcy

The defences to claims that transfers of property can be void, and voidable transactions are contained in the provisions themselves.

Defences to Undervalued Transactions

As mentioned, a trustee in bankruptcy would need to prove that there was no legal consideration paid, or if it was paid that it was not equal to market value.

Therefore, a market value appraisal by a legitimate valuer prior to the transfer, followed by the transfer of consideration, equal to the market value, may be a complete defence to a claim pursuant to section 120 of the Bankruptcy Act.

Or, if the transfer happened outside of the legislative timeframes allowable, either four (4), five (5), or six (6) years, depending on the circumstances of the bankrupt.

Defences to Transfers to Defeat Creditors

The main defence to a claim that a transfer of property was in an attempt to defeat creditors is by establishing that the intention of the transfer to defeat creditors was not the main purpose of the transfer.

Further, if it can be shown that the transferee acted in good faith and transferred market value legal consideration at the time of purchase, then any increase in the value of the property is protected.

Defences to Transactions Giving Preference to one Creditor over other Creditors

As previously mentioned, giving evidence that the transaction pursuant to the claim does not affect the remaining creditors, may be a defence to the claim for unfair preferences.

What Property Vests in the Bankruptcy Trustee?

Almost all of the bankrupt’s’ property will vest in the trustee, and is able to be realised to satisfy the creditors.  This includes:

1. Property of bankrupt as at the date of commencement;
2. All after acquired property;
3. Relation back assets;
4. After acquired income; and
5. Proceeds from Court action;

Further, all of the assets from successful voidable transactions in bankruptcy claims can be realised to satisfy creditors, including:

1. Undervalued transactions;
2. Transactions to defeat creditors;
3. Transactions with consideration to third parties; and
4. Unfair Preferences.

FAQ on Voidable Transactions in Bankruptcy

This FAQ section addresses common questions about voidable transactions in bankruptcy, providing clear explanations and practical information.

Understanding these concepts is essential for both debtors and creditors involved in bankruptcy proceedings.

What are voidable transactions in bankruptcy?

Voidable transactions are transfers of property or payments made before a person becomes bankrupt that can be reversed by the bankruptcy trustee. These transactions are scrutinised because they may unfairly favour certain parties or reduce the assets available to creditors.

Why are some transactions voidable in bankruptcy?

Transactions are voidable to ensure that all creditors are treated fairly and equitably. The bankruptcy trustee can recover assets that were transferred improperly to maximise the estate available for distribution among creditors.

What is an undervalued transaction?

An undervalued transaction occurs when property is transferred for less than its market value within five years before bankruptcy. This type of transaction can be voided by the trustee if it is deemed to have been done to disadvantage creditors.

What does it mean to transfer property to defeat creditors?

Transferring property to defeat creditors means moving assets with the intent to prevent them from becoming part of the bankrupt estate. Such transfers can be voided if it is shown that the main purpose was to hinder or delay creditors.

Can transactions where consideration is given to a third party be voided?

Yes, if a bankrupt person transfers property to someone, and the consideration is paid to a third party, this transaction can be voided. This prevents the bankrupt from circumventing the intent of the Bankruptcy Act by funnelling assets indirectly.

What are preference payments?

Preference payments are transactions where a debtor pays one creditor over others shortly before becoming bankrupt, giving that creditor an unfair advantage. These payments can be voided to ensure all creditors are treated equally.

How does the bankruptcy trustee identify voidable transactions?

The trustee identifies voidable transactions by examining the bankrupt’s financial records and transactions leading up to the bankruptcy. They look for transfers that fall within the defined categories and time frames set out in the Bankruptcy Act.

What is the time frame for voidable transactions?

The time frame varies depending on the type of transaction. For example, undervalued transactions can be voided if they occurred within five years before the bankruptcy, while preference payments are typically scrutinised within six months before bankruptcy.

What is the significance of ‘market value’ in these transactions?

Market value is the fair value of the property at the time of transfer. Transactions made for less than market value can be voided because they potentially deprive creditors of the full value of the assets that should be available in the bankruptcy estate.

What defences can be used against claims of voidable transactions?

Defences include proving that market value consideration was given, the transfer was made in good faith, or the transaction occurred outside the statutory time limits. Evidence supporting these claims can protect the transaction from being voided.

How does intention affect the voidability of a transaction?

The intention of the debtor at the time of the transaction is crucial. If the main purpose of the transfer was to defeat creditors or hinder their claims, the transaction is likely to be voided.

What happens if a transaction is voided?

If a transaction is voided, the transferred property or its value is returned to the bankruptcy estate. The trustee can then distribute these assets among the creditors according to the priorities set out in the Bankruptcy Act.

Are there any transactions that are protected from being voided?

Certain transactions are protected, such as those made for fair market value in good faith, or those that occurred outside the relevant time periods. Additionally, payments for necessary living expenses or ordinary business transactions may also be protected.

Can a voidable transaction involve personal property?

Yes, voidable transactions can involve personal property such as money, shares, or vehicles. Any transfer that meets the criteria set out in the Bankruptcy Act can potentially be voided, regardless of the type of property involved.

Why is it important to understand voidable transactions?

Understanding voidable transactions helps debtors avoid making transfers that could be reversed and helps creditors identify transactions that might unfairly deplete the bankruptcy estate. This knowledge ensures fair treatment and maximises the assets available for distribution among creditors.