Divorce and bankruptcy: Double trouble

Divorce and bankruptcy
Photo by Melinda Gimpel on Unsplash
Layla Babadi
Legal Director
Solicitor
Nelsons

Divorce and bankruptcy have been two big topics in recent times.

The impact of Covid-19 has resulted in companies going under, leaving employees without a job, and couples being cooped up in lockdown together – but what happens when these two, already stressful, situations happen at the same time?

Bankruptcy

Bankruptcy is a legal process through which people, or other entities, who cannot repay debts to creditors may seek relief from some or all of their debts.

The bankruptcy application process must be followed very carefully and the application submitted, after completing the necessary form and paying the fee (currently £680) to become bankrupt. At this point, it’s over to the adjudicator to make a decision.

The adjudicator has 28 days to decide whether to make a bankruptcy order or to reject the application. On the basis that the adjudicator decides to make the bankruptcy order, it is at that stage that you are officially declared bankrupt and your bank or building society accounts will be frozen immediately.

Divorce

You can get divorced in England and Wales if all of the following apply:

  • You have been married for more than a year;
  • Your relationship has permanently broken down;
  • Your marriage is legally recognised in the UK; and,
  • The UK is your permanent home or the permanent home of your husband or wife.

When you apply for a divorce, you need to prove that your marriage has broken down irretrievably and prove one of the following five facts:

  • Adultery;
  • Unreasonable behaviour;
  • Desertion;
  • Two-years separation with the other party’s consent; or,
  • Five years separation without the other party’s consent.

The Government’s Divorce, Dissolution and Separation Act 2020 will reform the divorce process introducing no-fault divorce. The new legislation, which is due to come into force on 6 April 2022, will replace the five facts with a new requirement – to provide a statement of irretrievable breakdown, remove the possibility of contesting the divorce, and introduce an option for a joint application.

In order to get a divorce, there is a court fee of £593, although some applicants will be eligible for help with fees, and a separate application can be made in this regard.

Has Covid-19 had an impact on divorce and bankruptcy rates?

Bankruptcy rates

Figures from the Insolvency Service Official statistics show that, during 2020, there was a 25% reduction in people going bankrupt compared to 2019. Quarter three of 2021 has also seen a fall of 33% compared to the same quarter in 2020.

The decrease in the number of bankruptcies in quarter three of 2021 has almost certainly been assisted by an increase in the number of people starting a Debt Relief Order (DRO). A significant relaxation of the DRO qualification criteria from June 2021 has made this cheaper alternative more accessible.

That being said, the total number of bankruptcies and DROs is still likely to be lower overall than during 2020. This suggests mass financial hardship predicted by some at the beginning of the pandemic may have been avoided.

Divorce rates

The Family Court’s quarterly statistics, published on 25 March 2021, show that:

  • Between October and December 2020, 28,672 divorce petitions were filed, which was up five per cent on the equivalent quarter in 2019.
  • There were 23,810 decree absolutes, the legal document that ends a marriage, granted in October to December 2020, a decrease of 24% from the same period last year.
  • Annually, there were 111,996 divorce petitions filed and 97,068 decree absolutes granted throughout 2020, down four per cent and 11% respectively from 2019.

Despite the news seemingly reporting a rise in divorces during the pandemic, it seems that, according to the statistics, the annual figures don’t coincide with this and divorce rates are pretty similar to pre-pandemic levels.

However, with Covid-19 not going away anytime soon, and with continued restrictions putting a strain on both business and homelife environments, discussion around dealing with bankruptcy and divorce could become more frequent in the months ahead.

What is the process of divorce and bankruptcy?

When a property, or any other type of asset, is owned jointly by a divorcing couple and one of the parties has been declared bankrupt, the property or asset cannot be transferred to the other party as part of the financial settlement in the divorce proceedings without the consent of the trustee who is dealing with the bankruptcy.

The trustee is responsible for handling all the assets and income of the party that has been declared bankrupt. They deal with the assets in a variety of ways in order to pay the creditors of the bankrupted party. This will be the main consideration of the trustee.

What happens if one party is declared bankrupt during a divorce?

What happens with regard to finances depends largely on whether and when the bankruptcy petition has been filed.

Prior to a bankruptcy petition being filed, the court retains its full power and discretion with regards to finances and divorce. For example, debts need to be taken into account and consideration should be given to options such as negotiating a reduced lump sum towards the debt or instalments to repay the debt and financial orders are binding upon trustees in bankruptcy

Thought should also be given to the financial position if a party is made bankrupt. This is particularly the case if the debt is in one party’s name and is more than the value of the assets in their name or joint names. Sometimes, bankruptcy is the best option as it addresses the debt while preserving what is left of the matrimonial assets.

Ideally an agreement will be reached as to a division of the assets, but, if the parties are unable to reach an agreement, the court may make a final order in financial remedy proceedings. This can result in an unequal division of the matrimonial assets if, for example, it is necessary to meet needs. I

f that order provides for a property to be transferred to a spouse, either outright or on the basis that it will be subject to a chargeback payable at some point in the future, that order will take effect upon pronouncement of decree absolute, the final order that concludes the divorce process.

The impact of a bankruptcy order

Once the bankruptcy order is made, the court has no jurisdiction to make a subsequent property adjustment order transferring or ordering a sale of a matrimonial property. If a property adjustment order has already been made but not implemented before the bankruptcy order, it is still binding on the trustee, as long as the decree absolute has been pronounced to make the order effective under section 24(3) of the Matrimonial Causes Act (MCA) 1973.

Lump sum orders (an order that one party pay a certain amount to another, are a provable debt in a person’s bankruptcy meaning that a spouse can prove in the bankruptcy as a creditor and will be entitled to participate in any distribution of the bankruptcy estate. Other financial obligations are not provable but survive.

The court does have the discretion to release a party from lump sum obligations post-bankruptcy under section 281(5) of the Insolvency Act 1986, which it may do in circumstances where there is no likelihood of satisfying it. For example, if there is a lapse of time since the order was made and where it may be used as a source of harassment to the discharged bankrupt.

Financial provision and property adjustment orders under the MCA 1973 are valuable rights conferred and recognised by law, whereby one spouse will give and the other will receive consideration.

A negotiated agreement to settle an application for financial provision is not a disposition because it is subject to the court’s discretion in deciding whether accord has been reached. The agreement only becomes effective when the order is made.

A court order comprising an application for financial provision and property adjustment is a disposition by the individual and not the court. The order has the effect of vesting beneficial ownership in the recipient and section 284 will apply if the disposition is at the relevant time.

In the case of Robert v Woodall [2016], the trustee in bankruptcy sought to set aside a consent order under section 284.

A petition was presented against the husband on 9 March 2009, the consent order was signed on 5 June and approved by the court on 16 July. The husband was made bankrupt on 7 July, therefore the court held that the provisions in the order for periodical payments from the husband to the wife and the children were void under section 284.

The right under section 24D of the MCA to apply for financial relief constitutes consideration and, therefore, once a court has made an order or approved a consent order, the trustee cannot seek to challenge it under section 339 of the Insolvency Act unless there has been collusion or fraud, mistake or misrepresentation.

In the case of Sands v Singh [2016], the husband bought a property in 2006 for £976,000 and married two years later in 2008. The husband then spent £200,000 on building work and, apparently, owed a further £913,719 plus VAT. In January 2009, the husband charged the property to secure a £500,000 loan from his father. In July 2009, the wife instructed divorce lawyers and registered home rights under the Family Law Act 1996.

In April 2010, the husband charged the property in favour of his sister for the sum of £70,000.

A divorce petition was issued on 17 September 2010 with both parties signing a consent order in December 2010. The terms stated that the husband would put the matrimonial home on trust for the children, pay £375 per child per month, be responsible for the mortgage, pay a lump sum of £50,000 and have the rights of occupation. The wife moved into the property and decree absolute was granted in February 2011. £50,000 was received in June 2011 and the husband was adjudged bankrupt in September 2011.

It was held that the trustee in bankruptcy had made out his case was a sham as no evidence had been provided that there had ever been a loan; there was no evidence of collusion or that the husband’s sister was aware of her husband’s financial difficulties.

The negotiations took a long time to conclude as the husband did not agree to the wife’s proposals immediately. The court, therefore, could not conclude that a matrimonial court would not have made the consent order and, as such, that it would be set aside as a transaction at an undervalue.

What happens to the assets?

When a property, or any other type of asset, is owned jointly by a divorcing couple and one of the parties has been declared bankrupt, the property or assets cannot be transferred to the other party as part of the financial settlement arising from the divorce proceedings without the consent of the trustee who is dealing with the bankruptcy.

As long as no bankruptcy petition was filed before the decree absolute, the order will be binding even if the property has not yet been transferred. If the spouse transferring their interest is subsequently adjudged bankrupt, the trustee in bankruptcy is also bound by the order.

In the event that a bankruptcy petition is filed before the decree absolute is pronounced by the court, then the entirety of the bankrupted party’s estate will rest in the trustee in bankruptcy, and the court is unable to make a property adjustment order without the validation of the bankruptcy court.

What about bankruptcy after a divorce settlement?

Subsequent bankruptcy can also cause issues with regard to lump-sum payments that have yet to be paid. While these debts can be sought through bankruptcy, unlike other debts, the spouse is not released if they are not paid when they are discharged from bankruptcy.

Other orders that are made in matrimonial proceedings include pension sharing or attachment orders, which are not affected by bankruptcy, and maintenance but the payer’s ability to pay can be restricted if they are required to pay an element of income to the creditors.

Can the non-bankrupt spouse apply to annul the bankruptcy order?

If the one party made themselves bankrupt on their own petition and it appears that they did so in order to defeat a family finance order, the other party may, in some circumstances, apply to annul the bankruptcy under section 282 of the IA 1986 on any grounds existing at the time the order was made that mean it shouldn’t have been. The court may annul a bankruptcy order whether or not the bankrupt has been discharged from bankruptcy.

However, a court will only be prepared to annul the bankruptcy when it can be shown that the individual was not insolvent on either a cash flow or balance sheet basis at the time of the bankruptcy order. It is immaterial what the motivation was for presenting the petition.

The evidential burden of demonstrating insolvency will shift, if the other party can show that assets exceed liabilities. The individual will then need to prove they were unable to pay the debts as they fell due.

Don’t forget

When it comes to bankruptcy and divorce, it is important to remember the outcome is dependent on when the bankruptcy and divorce have been filed.

There are also numerous other factors that need to be taken into consideration such as property, matrimonial assets and financial provisions, as well as being able to annul the bankruptcy in certain circumstances.

In an ideal world, divorcing parties should reach a financial settlement prior to either party being declared bankrupt. However, separation, divorce and the issues concerning breakdown in relationships are often complex. For this reason, it’s always advisable to consult a specialist family solicitor at the earliest opportunity in order to discuss these matters, take the appropriate advice and necessary action.

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About Layla Babadi

Layla is a Legal Director at Nelsons. She qualified as a solicitor in 2005 and joined the Family Law team in 2015.

Layla specialises in divorce and separation, with a particular emphasis on international divorce law. She also advises on pre and post nuptial agreements and separation agreements.

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