Bankruptcy and other insolvency activities are on the rise, increasing 11 per cent in the 2008-09 year, compared to the 2007-08 year. An important question now is how superannuation is treated upon bankruptcy. Historically a bankrupt’s interest in a superannuation fund was protected, but only up to a certain limit. That limit was the pension reasonable benefit limit (RBL). This meant that if a person became a bankrupt, only his or her first $1.2 million or so of interests in superannuation funds were protected from creditors. Everything in excess of that amount would form property available to creditors. However, from July 1, 2007, the reasonable benefit limit regime was abolished.
This abolition left many wondering what would replace the pension reasonable benefit limit as being the limit on superannuation protection during bankruptcy. The very good news is that no new limit was introduced. This means the default position is now that a bankrupt can have an unlimited amount in superannuation funds, and that amount is fully protected. The Government described the change as follows: “The amendments remove references to RBLs from the Bankruptcy Act 1966 to ensure consistency with the new Simplified Superannuation rules, which abolish RBLs with effect from July 1, 2007. This means that, from July 1, 2007, a bankrupt’s entire interest in a superannuation fund is protected from being divisible amongst creditors.” Of course, at the same time, the Government introduced various contribution caps. But for those who already have sizeable amounts in superannuation funds, the change is welcome news.
TRANSFERS TO DEFEAT CREDITORS
The Bankruptcy Act seeks to void “undervalued transactions”. Section 120 considers people who transfer property for less than market value, and then within five years of the transfer become bankrupt. It essentially provides that such transfers are “void” and that creditors can claw back that property from whoever has the property. A tricky question used to be whether a contribution to a superannuation fund constituted a transfer of property for less than market value. Some argued that it was a transfer for less than market value because, for example, superannuation funds do not pay members in consideration of their contributions. Under this argument, section 120 would allow contributions to be clawed back from superannuation funds. The opposing view is that market value is received by the contributor. That market value is said to be the various duties and obligations that superannuation fund trustees owe and are subject to in respect of the members.
The debate was settled in the High Court decision of Cook v Benson (2003) 214 CLR 370. There, a 4:1 majority held that a contribution to a superannuation fund is for market value consideration. Naturally, this caused concern: a person facing imminent bankruptcy could transfer their assets to a superannuation fund where it would be protected. New provisions were inserted into the Bankruptcy Act to overcome this situation. The new provisions consider the situation where a transferor’s main purpose in making a transfer to a superannuation fund was to prevent, hinder or delay the property from becoming divisible among creditors. If the main purpose is said to be to prevent, hinder or delay, then the transfer may be clawed back. These new provisions have no time limits. This means that if a transfer is made to a superannuation fund today for the main purpose of preventing, hindering or delaying, but the person does not become a bankrupt for another 20 years, the transfer may still be clawed back. The legislation also provides that – unless a person can prove otherwise – a person has the main purpose of preventing, hindering or delaying if he or she has failed to make or keep books, accounts and records as are usual in whatever business that person carried on. Accordingly, it is vital to make and keep such records.
Once someone has become a bankrupt, he or she might want to receive benefits from his or her superannuation fund. How that benefit is structured can make a significant difference. If the benefit is paid as a lump sum, although the recipient is bankrupt, it cannot be divided among creditors. Rather, it can be retained and enjoyed by the bankrupt. However, the situation is very different if the benefit is paid as a pension. Superannuation pension payments count as regular income and only a relatively modest amount is protected: any excess amount received is available to creditors.
No superannuation fund – including a self-managed super fund (SMSF) – may have a trustee or a director of a trustee who is a bankrupt. The penalties for contravention of this rule are strict and can include imprisonment. This is vitally important for the approximately 800,000 Australians with SMSFs. If someone has an SMSF and is facing bankruptcy, he or she must act promptly. The most popular option is to move the person’s benefits to a non-SMSF superannuation fund and to cease being an SMSF member and trustee/director. Alternatively, the person could convert the SMSF into a small APRA fund (that is, not an SMSF) and arrange for a new special trustee (that is, a Registrable Superannuation Entity (RSE) licensee) to be appointed. Naturally, the special trustee will charge for their services. Once the person has finished their period of bankruptcy, they may return to having an SMSF.
Recent changes have made superannuation a very attractive asset for those facing bankruptcy. However, it is critical that those facing bankruptcy – and their advisers – are aware that certain actions should be taken. These actions are:
- ensuring sufficient evidence exists to show that the main purpose of any transfers to superannuation funds was not to prevent, hinder or delay creditors;
- taking care when withdrawing benefits from superannuation funds; and exiting the SMSF system before any period of bankruptcy and only re-entering after that period has finished.