Myth or Fact - Your Client Will Lose Their House if They Go Bankrupt?
Updated: Jul 22, 2020
Often one of our client’s biggest fears is losing the family home in a bankruptcy scenario. This situation is exacerbated when one partner in a relationship is going bankrupt and the other not, especially where children are involved.
Thankfully in the first instance, whilst a bankrupt’s share in a property vests in their bankruptcy trustee upon appointment, the trustee would only look to sell the property in the event equity exists. In most cases where there are joint tenants, a bankruptcy trustee, will give the first right to purchase the equity to the non-bankrupt party. Provided the mortgage is kept up to date and market value paid for the bankrupts share of equity, the family home is preserved.
But what happens where there is significant equity, or the non-bankrupt party has insufficient resources to purchase the equity. This happened with clients of ours recently and we were able to utilise a principle called the Doctrine of Exoneration (“DOE”) to alter the implied marital 50-50 split.
The facts are simple, our clients were husband and wife who had been referred to us by their accountant due to the husband’s company being placed into Liquidation. They jointly owned the family home, registered as tenants in common on the title. The mortgage for the purchase of the home was in joint names. The husband has subsequently borrowed money, secured against the property, for working capital for his company as financial difficulties began to arise. The husband’s company ultimately failed and he was facing bankruptcy due to personal guarantees. Upon review we determined their property was valued at $1,000,000.
There were two separate loans;
One being the balance of the original mortgage loan ($200,000)
The second being the husband’s subsequent borrowings ($400,000)
At face value there is $400,000 (ignoring costs of sale etc) in equity to be split 50-50 ($200,000) between each party. On this basis bankruptcy trustee would seek to realise the husband’s share of this equity upon appointment, being $200,000. His wife had no means to secure these funds, which would have left little option but to sell the property in bankruptcy.
In its simplest form applied to this situation, the equitable principles of the DOE dictate that any borrowings against jointly held property which are applied for the use of one party (the bankrupt) without benefit to the other (non-bankrupt spouse), should be satisfied from the benefiting party’s (bankrupt’s) share of the relevant property first.
In this situation, de Jonge Read identified that the successful application of the DOE would materially alter the actual equitable interests in the property as depicted below:
50-50 split Value: $1,000,000 Loan - purchase: $200,000 Loan - Working Capital: $400,000 Equity: $400,000 Equity - Bankrupt: $200,000
Equity - Non-Bankrupt Spouse: $200,000
Loan - purchase: $100,000
Loan - Working Capital: $400,000 Equity: $0 Equity - Bankrupt: $0
DOE - Non-Bankrupt Spouse
Value: $500,000 Loan - purchase: $100,000 Loan - Working Capital: $0 Equity: $400,000 Equity - Non-Bankrupt Spouse: $400,000
As you can see, both the husband and wife remain entitled to 50% of the property value and 1st Mortgage in applying the DOE. However, because the wife had no interest in the second mortgage and did not receive any benefit from the loan, we were able to deduct the full amount from the bankrupt’s share.
This reduced the husband’s interest to nil, preserving the family home and increased wife’s share of the equity. When the husband entered into bankruptcy de Jonge Read worked closely with the trustee to confirm the application of the DOE and then communicated with the bank on behalf of our clients and had them agreed to allow the loan facilities to continue.
Relatively straightforward right? In this example yes, however, applying the DOE can be contingent on several other factors. If you have Clients facing a similar situation, or looking at implementing an asset protection strategy, please do not hesitate to give any of the strategists at de Jonge Read a call for an obligation free consultation.