Bankruptcy and the Family Home Part 2 – The Doctrine of Exoneration

In the February 2015 newsletter I wrote about bankruptcy and the family home and typically what happens when an individual enters into bankruptcy and has an ownership interest in the family home. In such situations, it is a very emotional and real practical consideration when contemplating voluntary bankruptcy. This follow on article considers the position of the co-owner (i.e. the spouse in most instances) and aspects they should consider when taking into account what offer they may put forward (if any) to the bankruptcy trustee regarding the bankrupt’s interest in the family home.
I typically find as a Bankruptcy Trustee that the Doctrine of Exoneration is a concept that can be quite critical from the co-owners perspective when considering what the bankrupt’s true net equity position may be in the family home (or indeed another property owned jointly). Put simply, the Doctrine adjusts the interest of owners in the equity of the property when monies are borrowed and secured against a jointly owned property, but NOT used for the benefit of all co-owners. As such it can often result in a significant difference in the bankrupt’s true net equity position and make the offer for such interest more achievable. Such aspect generally is more common in situations where the family home has been used as security for the business operated by one of the co-owners – i.e. family businesses.


A 2004 case, Dickson vs Reidy [2004] NSWSC 1200 provides a typical example of what I see occurs. Importantly, it also cites that case of Parsons vs McBain [2002] 192 ALR 772 which provides an excellent insight on the Doctrine of Exoneration and its principles.

In Dickson vs Reidy, the husband and wife were joint owners of a property in East Gardens, NSW. A Sequestration Order (i.e. involuntary bankruptcy) was made against the wife declaring her bankrupt in early 2003. As a result of the wife being made bankrupt, and in accordance with Sections 58 and 116 of the Bankruptcy Act (“the Act”), the joint ownership was severed and her interest in such property now belonged to her bankruptcy trustee. Around mid 2003, the property was sold by the husband and the wife’s bankruptcy trustee for $747,000. At the time of the sale, there was a mortgage over the property ($470,000) which after payment of same / other sale costs resulted in surplus proceeds of approximately $230,000. These were then split on a 50/50 basis being approximately $115,000 to the husband and $115,000 to the wife’s bankruptcy trustee. The husband commenced action against the wife’s bankruptcy trustee for an adjustment to the net proceeds.

Specifically the husband contended that the jointly owned property was mortgaged to secure a loan which was wholly and only used for the benefit for the wife and in such circumstances the Doctrine of Exoneration applied such that her interest in the property was subject to a charge to secure his right of exoneration from liability for the loan. As a result, the husband claimed that her interest in the property which passed to the bankruptcy trustee was subject to that charge, and thus he should have received the whole of the net proceeds (being approximately $230,000) rather than one half.

At paragraphs 20 and 21 of the Parsons vs McBain the Court provided the following explanation:

“20” The equity of exoneration is an incident of the relationship between surety and principal debtor. It usually arises where a person has mortgaged his property to secure the debt of another whether or not that other has covenanted to pay the debt. However it will also arise on a case where, although not an actual suretyship, the relationship is treated as one of the suretyship.

“21”An equity of exoneration operates in the nature of “a charge upon the estate of the principal debtor by way of indemnity for the purpose of enforcing against the estate the right to which (“the beneficiary”) has, as between (the beneficiary) and the principal debtor to have that estate resorted to first for the payment of the debt”.

Therefore where co-owners mortgage their property so that the money can be borrowed for one mortgagor, the other has an interest in the property of the co-mortgagor whose property is to be regarded as primarily liable to pay the debt.

Relevantly, in the Official Trustee in Bankruptcy vs Citibank Savings Limited [1995] 38 NSWLR 116 the judge indicated that the Doctrine of Exoneration depends on the presumed intention of the parties. Thus it is important to remember that the Doctrine is based on an inference with reference to all the facts of the particular case in question.

Whilst contemporaneous agreements or other documented expressions of intention are sources of evidence about what the intentions of the parties were, equally there is no reason as to why their intentions may not be inferred from the circumstance in which they acted.

In Dickson vs Reidy, the bankruptcy trustee submitted that the equity of exoneration did not apply to any of the loans in that case because it had not been shown that they were for the substantial benefit of the wife (“the Bankrupt”) and it was not sufficient to show that she did receive some incidental benefit. Additionally it was indicated that for the husband to succeed it was necessary to show his intention to act as if the surety for his wife in respect of each loan and the evidence did not prove such intention. Ultimately the Court determined that funds were raised and applied for the use of the wife without the benefit to the husband and thus it was sufficient to attract the Doctrine of Exoneration. As a consequence, the husband had established a charge on his wife’s (“the Bankrupt Estate’s”) interest in the property to secure that right which was passed to the bankruptcy trustee subject to the charge. Accordingly the husband was successful in obtaining Orders that the bankruptcy trustee pay him the sum of approximately $115,000 and thus the husband received effectively the entirety of the net proceeds from the sale after the mortgage was discharged.

This case and other authorities should be considered when there is a co-owned property and borrowings regarding it may have been for the benefit of only one of the co-owners, ie for use in the business that they operate. Additionally the factual evidence, including the intentions of the parties will be critical in determining whether the Doctrine of Exoneration can be sufficiently made out.

As evident above, the outcome ultimately has a substantial benefit to the non-bankrupt co-owner to the detriment of the unsecured creditors of the Bankrupt Estate.

With the manner in which new start businesses get off the ground, it is not uncommon for family home to be used (particularly where there is sufficient equity in it) as a means by which the business has working capital from the start. However if the business is only operated by one of the co-owners and ultimately fails whereby the business operator may themselves be presented with having to declare bankruptcy, then careful consideration as to whether or not the Doctrine of Exoneration could potentially be applicable is important because it is quite often in my view overlooked. Having sufficient records that attempt to properly record and explain such borrowings will be vital when raising same with the bankruptcy trustee of the co-owner.

As a Bankruptcy Trustee I am regularly involved in matters where this issue comes up and I am happy to take any inquiry in relation to this aspect.

BEWARE: ATO flags tougher stance on small business tax debt

Recent media coverage about the ATO tougher stance on small business tax debt [Daniel Meers from Herald-Sun on 21 May 2015] should serve as a timely reminder to company directors (owners) that find themselves unable to pay GST / PAYG or SGC to get the right professional advice, rather than ignoring the problem with the hope that they will be able to deal with it later. The recent article titled “No More Mr Nice Tax Guy” was also published in the Daily Telegraph.
The article in short indicated that the ATO has begun a crackdown on unpaid small business tax debt. This should come as no surprise as it tends to be these types of companies (ie mainly family businesses) that more frequently have significantly aged debt with the ATO either though non-lodgement and non-payment of returns and GST / PAYG / SGC or alternatively just do not pay such taxes on time. Sometimes there are legitimate reasons as to why it’s occurred, ie ill-health etc. However, the position still needs to be dealt with. In other circumstances, it may not be possible to negotiate a payment plan or some other arrangement with the ATO and thus some company directors (owners) will need to consider the financial position and future of their company, ie voluntary administration or voluntary liquidation.

Of particular interest was the ATO’s position, where Ms Cheryl-Lea Field revealed:

“There are a small number of people that won’t engage with us, and they may be trading insolvent or deliberately not paying.”

Ms Field confirmed that the ATO would not close businesses that genuinely wanted to arrive at a payment plan. However there was a clear message, that being if you are having difficulty, contact (either yourself or your advisor)  the ATO and see what can be worked out.

Ms Field also touched on a point I have raised previously, that being it is important for industry competitiveness that all businesses try and pay on time their tax debts (as well as lodge returns), as otherwise those that do not for a sustained period of time have an unfair advantage over those that do. Specifically, she revealed “it wasn’t fair for the ATO to overlook businesses refusing to pay taxes. If someone up the road is not paying their [PAYG] withholding or their superannuation, then that is simply not fair.”

It is critical not just with the ATO’s recent focus, but importantly with the Director Penalty Notice (“DPN”) regime in place for unpaid PAYG and SGC that company directors (owners) realise they can be personally liable for certain tax debts. In previous blogs I have covered the DPN regime in detail.

Whilst one can understand that family businesses at times have the ATO significantly down the payment queue, the ATO did say recently in a paper that it wanted to reduce the level of its “aged debt”. So this tougher stance should not come as much of a surprise.

As a Registered Liquidator with significant insolvency experience in dealing with family businesses, as well as having a detailed working knowledge of the DPN regime, I am happy to discuss with any company director that may be feeling under a little pressure regarding their company’s tax debt with the ATO and their potential personal exposure. However, as with many things in life, the sooner you get the right professional advice, the sooner financial independence can be regained. So don’t leave it any later than you need to.

Anecdotal evidence I have seen over the past few weeks reveals that the ATO does appear to be issuing more statutory demands on companies, as well as initiating winding up applications.

Repeal of the Loss-Carry Back Tax Offset: Why companies may now be liable? Can the Liquidation regime be utilised?

The Minerals Resource Rent Tax Repeal and other Measures Bill 2014 (“the Bill”) received Royal Assent on 5 September 2014 and became law. IMPORTANTLY, the Bill included the repeal of the loss carry-back tax offset provisions, with an effective date of 30 September 2014. The loss carry-back tax offset was originally enacted through the Tax and Superannuation Laws Amendment (2013 Measures No.1) Act 2013, which received Royal Assent on 28 June 2013 and was seen to be good chance for businesses to “smooth out” their income tax liabilities over a period of years rather than just rely on the carry forward loss provisions. So much for a good idea. It was squashed before it got going!!

What are the Loss-Carry Back Tax Offset Provisions?

Essentially, the loss carry-back tax offset provisions permitted a company to apply current year tax losses to recover tax paid in prior years. The provisions enabled a company to ‘carry back’ up to $1m of tax losses incurred in the 2012/13 year to recoup tax paid for the 2011/12 year. The provisions commenced for the 2012/13 year.

What does the Repeal mean for a Company?

The repeal of the loss-carry back tax offset provisions applies from the start of the 2013/14 year but the operation of the provisions for the 2012/13 income year is preserved. For example, a choice to carry back a loss for the 2012/13 income year can still be made or changed to the extent that it could have been made or changed had the provisions not be repealed.

However, companies that claimed the loss carry-back tax offset before the repeal took effect and that are now no longer eligible have been or are likely to be contacted by the Australian Taxation Office (“ATO”) about their circumstances. The ATO may remove the claimed offset from the affected assessment and send the company a Notice of Amended Assessment. In many instances, the amount now claimed by the ATO may be significant, particularly for a company in the SME space, and may have a significant impact on the financial health of the company. In some instances, the company may not have sufficient assets to pay the assessed amount and may then be insolvent!

A Recent Example which lead to Voluntary Liquidation!

We were recently contacted by an a professional whereby their SME client had claimed the loss carry-back tax offset under the old law and subsequently received a Notice of Amended Assessment from the ATO as a result of the repeal. In this particular instance, in the period between the company lodging its income tax return and receiving the Notice of Amended Assessment, the company wound down its operations and ceased to trade. At that time, it had no other creditors.

Upon receiving the Notice of Amended Assessment, and given that the company had ceased trading, it did not have sufficient funds in which to pay the amount of the Notice of Amended Assessment now owing to the ATO. The advisor subsequently contacted us and the director of the company ultimately placed the company into a creditor’s voluntary liquidation in order to deal with the amount owed to the ATO.

Such examples may be limited, but are out there and it is important that directors get the right advice.

What should you do if you receive a Notice of Amended Assessment?

If you have received a Notice of Amended Assessment due to the repeal of the loss carry-back tax offset provisions, you may wish to contact Jones Partners to obtain the appropriate advice from a Registered Liquidator regarding the company’s options, irrespective of whether the company is continuing to trade or has ceased to trade.

Want to Know More?

Please go to the following ATO link where you can find more information including worked examples

Bankruptcy – gambling, excessive use of credit cards and blowing proceeds from sale of property – a dangerous cocktail!!

A recent Media Release by AFSA see link highlights the addiction of gambling and additionally that if forced into bankruptcy as a result of such gambling, then, in certain circumstances the individual may have committed an offence under Section 271 of the Bankruptcy Act. In this case, the individual went into bankruptcy voluntarily owing her creditors almost $440,000 using 22 credit cards. In the 12 months prior to her bankruptcy she sold property owned by her and claims to have blown almost $100,000 on gambling.
The individual was found guilty and placed on a 9 month good behaviour bond, as well as having other restrictions imposed.

As a Bankruptcy Trustee I have administered estates where gambling has been a cause of the bankruptcy. Whilst it has an impact of unsecured creditors via the high chance of there being no return to them, the other critical issue is discussing and establishing whether the individual (and possibly family members) has sought proper counselling. Otherwise the cycle may repeat itself in time. Whilst there are many organisations that do offer assistance and counselling, one service is the NSW Government Gambling Help Service or . It is a free gambling help counselling services for gamblers, family members and friends. It includes face-to-face counselling, financial counselling, a 24-hour Gambling Helpline (1800 858 858) and a 24-hour online Gambling Help service. Counselling and help are available in five community languages as well as English and there are also specialist Aboriginal programs.

Gambling can not only cause or result in significant financial hardship for the individual and their family, but critically it can lead to other extensions or behaviours as the financial crisis worsens. It is absolutely vital that if you are aware that a family member, friend or colleague may have such a problem you actively encourage them to get proper help.

As a Bankruptcy Trustee I am cognisant that individuals may find themselves in this precarious position and I believe that apart from assisting the individual in dealing with the financial crisis, they need to be pointed in the right direction to get help.