Individuals facing financial difficulties may think that making lump sum payments into their superannuation fund means that those funds will be “protected”’ in the event of the individual subsequently declaring bankruptcy. This misguided belief is because in the personal insolvency world, a bankrupt’s interest in a regulated superannuation fund is generally regarded as “non-divisible” property and is generally not available to creditors. However, payments to a superannuation fund will not always be protected.
Similarly, some individuals may access superannuation early in an effort to pay creditors or use as working capital in their business. This may not achieve anything particularly where the individual ends up in bankruptcy anyway and those funds (if left in the superannuation fund) would have been protected.
- What happens when an individual facing financial difficulty makes large lumps sum contributions into their superannuation fund? For example they realise an investment in their name (ie shares) and then make a lump sum contribution into their superannuation fund.
There are provisions within the Bankruptcy Act (“the Act”) that deal with a bankrupt’s interest in a regulated superannuation fund. Section 116(2)(d) of the Act says that an interest in a regulated superannuation fund is not divisible property. However, Section 128B of the Act provides that a transfer (ie a payment) made by way of a contribution to a superannuation fund is void against a Bankruptcy Trustee if:
- the transfer is made by way of a contribution to an eligible superannuation plan; and
- 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
- the transferor’s main purpose in making the transfer was:
- to prevent the transferred property from becoming divisible among the transferor’s creditors; or
- to hinder or delay the process of making property available for division among the transferor’s creditors; and
- the transfer occurs on or after 28 July 2006.
In determining whether the person had the requisite purpose in making the contribution, the Bankruptcy Trustee will typically consider the individual’s pattern of contributions and whether the contribution in question is “out of character”. It is not always the case that an out of character contribution will automatically be void, rather, an out of character contribution may indicate that the transferor was aware of their financial problems and as a result would be required to explain the purpose of the contribution to a Bankruptcy Trustee.
In addition to the above, Section 128C of the Act deals with contributions into a superannuation fund made by a third party for the benefit of an individual who subsequently becomes bankrupt. This section applies to situations in which a person agrees that monies that would normally be paid to the individual should instead be paid to the individual’s superannuation fund. For example, if a payment is made by an individual’s employer under a salary sacrifice arrangement. Section 128C(1) of the Act says that transfers that are void if:
- a person (the transferor) transfers property to another person, (the transferee); and
- the transfer is by way of a contribution to an eligible superannuation plan for the benefit of a person who later becomes a bankrupt (the beneficiary); and
- the transferor did so under a scheme to which the beneficiary was a party; and
- the property would probably have become part of the beneficiary’s estate or would probably have been available to creditors if the property had not been transferred; and
- the beneficiary’s main purpose in entering into the scheme was:
- to prevent the transferred property from becoming divisible among the beneficiary’s creditors; or
- to hinder or delay the process of making property available for division among the beneficiary’s creditors; and
- the transfer occurred on or after 28 July 2006;
Importantly, for Section 128C of the Act to apply, the bankrupt needs to be a party to the “scheme” which resulted in the transfer and the transferred property would have been available to creditors in a bankruptcy. A scheme means:
- any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and
- any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.
The beneficiary’s main purpose in entering into the scheme is taken to be the purpose described in paragraph (1)(e) above if it can reasonably be inferred from all the circumstances that, at the time when the beneficiary entered into the scheme, the beneficiary was, or was about to become, insolvent. In determining whether the individual’s main purpose in entering into the scheme, regard must be had to:
- whether, during any period ending before the scheme was entered into, the transferor had established a pattern of making contributions to one or more eligible superannuation plans for the benefit of the bankrupt; and
- if so, whether the transfer, when considered in the light of that pattern, is out of character.
If the payment is considered to be void under Section 128B or 128C of the Act, a Bankruptcy Trustee may be able to recover the payment by requesting the Official Receiver issue a superannuation account freezing notice pursuant to Section 128E of the Act. This effectively prevents the superannuation fund from cashing, rolling over, debiting or transferring any part of the fund. The Trustee can then:
- request the Official Receiver issue a notice pursuant to Section 139ZQ of the Act which may require the superannuation fund to pay to the Bankruptcy Trustee the lessor of the withdrawal benefit or the value of the property received as a result of the void transaction; or
- obtain a Court Order pursuant to Section 139ZU of the Act which deals with rolled over superannuation funds and may direct a superannuation fund to pay to the Bankruptcy Trustee a specified amount where a void contribution has been paid to another superannuation fund.
Accordingly, it is not simply a case of an individual making large lump sum payments into a superannuation fund on the assumption that such superannuation fund will be protected when that individual enters into bankruptcy.
- So what happens when an individual withdraws superannuation early and ultimately ends up in bankruptcy?
Many individuals may consider it appropriate to access their superannuation early (assuming they meet the grounds for early release) to pay creditors or to fund working capital for a business interest in an effort to avoid bankruptcy. This may not ultimately achieve anything particularly where the individual ends up declaring bankruptcy anyway and those funds (if left in the superannuation fund) would have been protected.
Lump sum withdrawals from superannuation funds prior to bankruptcy lose their protection from bankruptcy and are fully exposed to creditors the same as any other property the individual may own. In other words, let’s assume an individual withdraws $25,000 to repay mortgage arrears on a family home that he has a joint interest in, and then sometime after that declares bankruptcy. Although the $25,000 contributed towards the mortgage was made using money from the superannuation fund, the payments have had the effect of increasing the equity in the family home (which is a divisible asset) and the Bankruptcy Trustee will be able to realise such asset for the benefit of creditors. In this instance, had the individual not obtained the withdrawal from the superannuation fund, then the amount would likely have been protected and not available to creditors.
Balances in superannuation funds are generally the result of many years of work. It is therefore important that individuals facing financial difficulties get the right professional advice prior to considering the above types of transactions. This is particularly important because if the right advice is obtained then it is likely that the individual’s superannuation will be protected and will be an available financial resource for when they ultimately retire.
In our next edition, we consider the effects of bankruptcy on Self Managed Super Funds!