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    Bankruptcy – the defence of the family home

    Summary

    Litigation Partner, John Melville-Smith looks at how a trustee and the bankrupt's desire to claim for or retain the family home is likely to play out....

    What does bankruptcy have in common with death?

    The answer is that everything you own becomes someone else’s: death vests your property in your personal representatives and, ultimately, your beneficiaries; bankruptcy vests it in your trustee in bankruptcy and, ultimately, your creditors.

    You don’t even have to do anything: “without conveyance, assignment or transfer”, Section 306 of the Insolvency Act 1986 says that everything you own becomes the property of your trustee. Unlike in death, there are some limited exceptions – “tools, books, vehicles and other items of equipment” necessary for the bankrupt to work and “clothing, bedding, furniture, household equipment and provisions” necessary for his and his family’s domestic needs – but everything else is the trustee’s.

    If, however, the books are first edition Dickens, the vehicle is a Ferrari and the household equipment includes a collection of valuable paintings, then the trustee will have those and replace them with something more modest with the sale proceeds.

    In most cases, the asset the trustee is really after, and the main one of any value, is the bankrupt’s home. The trustee wants to be able to sell the house – with the bankrupt in occupation if he is cooperative, after a possession order if not – and realise the asset, pay his own fees and distribute the balance among the creditors pro-rata to their debts.

    Piece of cake, no?

    Well, no, unless the bankrupt is a single person who owns his home outright and lives there alone. First of all, the trustee takes the property subject not just to any liabilities, most obviously a mortgage, but also to any equities to which it was subject when the bankrupt owned it.

    The most likely equity will be any interest held by the bankrupt’s spouse. The couple may have owned the property, as most married couples do, as beneficial joint tenants. The bankruptcy order automatically ‘severs’ the joint tenancy and they then hold as tenants in common, the starting assumption being as to 50% each. The bankrupt’s half is now the trustee’s.

    However, couples who previously would not have argued with the contention that they were equal owners often become very adept at fashioning an argument that the equity in the property favours the non-bankrupt spouse, in order to maximise the amount left over to buy another property, by asserting that that person paid all the deposit, financed the mortgage, or spent a lot on doing up the property and that thus ‘equity’ demands a greater share than 50%.

    The bankrupt may also, seeing what was coming, have transferred the home, or his share of it, into the name of his wife, or sold it to his father for a song in discharge of a substantial amount of money he ‘owed’ his father and had decided he was honour-bound to repay…..shortly before going bankrupt.

    Such transactions can be reversed by the trustee and the asset recovered on the footing that they are transactions at an undervalue (transferring the house to the wife) or preferences (discharging Dad’s ‘debt’ from an asset and ignoring all other creditors). The issues may not always be clear-cut, however, and doing so requires money, which the trustee will not usually have in large amounts because, self-evidently, the bankrupt had little to pass on.

    Even in the event that there are no such problems, where there is a co-ownership scenario, the trustee may have to bring an action to force the sale of the home under the Trusts of Land and Appointment of Trustees Act 1996. Where an application is brought by a trustee in bankruptcy, then under the Insolvency Act 1986, the court must have regard to:

    • the interests of the bankrupt’s creditors;
    • the conduct of the spouse, civil partner, former spouse or former civil partner, so far as contributing to the bankruptcy;
    • the needs and financial resources of the same people;
    • the needs of any children; and
    • all the circumstances of the case other than the needs of the bankrupt.

    In practice, all factors other than the first are overlooked because, the Insolvency Act 1986  provides, where such an application is made a year or more after the bankruptcy order, that the interests of the bankrupt’s creditors outweigh all other considerations, spouse and children included, unless there are exceptional circumstances.

    So, what are exceptional circumstances? Certainly, they have to amount to more than the natural consequences of debt and bankruptcy, as Lawrence Collins J said in Dean v Stout: “special circumstances which are outside the usual melancholy consequences of debt and improvidence or compelling reasons not found in the ordinary run of cases …  it is not uncommon for a wife with children to be faced with eviction in circumstances where the realisation of her beneficial interest will not produce enough to buy a comparable home in the same neighbourhood or, indeed, elsewhere. Such circumstances, while engendering a natural sympathy, cannot be described as exceptional …”

    Such circumstances were demonstrated in Claughton v Charalambous. Mrs Charalambous, aged 60, was in very poor health, with chronic renal failure and osteoarthritis. She could walk only with a zimmer frame and the house was fitted with a chair-lift. The judge suspended his order for sale until her vacation of the property or death, whichever occurred first. In theory, this was an indefinite suspension but, the evidence suggested, in practice, it was likely to be a short one.

    This case may be contrasted with Grant v Baker. The couple’s 30-year old daughter, Samantha, suffered from global developmental delay, dyspraxia, and obsessive-compulsive disorder. She had a mental age of 8 or 9, was thus incapable of living on her own, and had mobility problems on stairs or uneven ground. There was no prospect of her condition ever-improving but her life expectancy was unaffected. A Claughton-type order was set aside on appeal: an indefinite suspension, potentially of decades, was incompatible with the underlying purpose of bankruptcy law and, save in the most truly exceptional circumstances (which this was not) that purpose must require realisation within months rather than years. 12 months would allow ample time for a suitable replacement property to be found on the rental market, and for the move to be prepared with Samantha's welfare and best interests at heart.

    Even if exceptional circumstances are demonstrated, the effect is no more than to disapply the requirement that the needs of the creditors outweigh all other considerations.  The court will then have regard to all the matters specified above, the interests of creditors included, with the appropriate weight to attach to them being in the discretion of the court. A postponement of the inevitable is the most likely outcome, with a likely best-case scenario of 12 months.

    Finally, it is worth noting that the clock ticks against the trustee. Three years after the bankruptcy order, the home will re-vest in the bankrupt, unless the trustee has realised his interest, applied for an order of possession and sale, a charging order, or a postponement, or entered into an agreement with the bankrupt regarding the interest.

    Realising his interest may, of course, involve selling to the non-bankrupt co-owner, perhaps providing an opportunity for some recovery of equity by the back door if it is more cost-effective to sell to the co-owner at a discount than realise the asset on the open market with all the associated costs that will involve.

    Should you have any questions regarding the above, or need any contentious probate related legal advice, please contact John Melville-Smith, at john.melville-smith@seddons.co.uk, or 020 7725 8027.

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