Counting the pennies

Family lawyers are seeing more cases involving the insolvency '“ or possible insolvency '“ of one divorcing spouse. This is certainly my experience, with more of my clients or their spouses suggesting that they are at 'significant risk of bankruptcy' as we embark on financial disclosure, be that through the court route or as part of the voluntary disclosure process. Colleagues also say they have noticed an increase in the prevalence of personal insolvency issues arising on divorce.

Current statistics confirm the size of the problem. According to the Insolvency Service, there were 119,850 individual insolvencies in England and Wales in 2011. Figures for previous years have been similarly high.

When one spouse threatens bankruptcy on the breakdown of a marriage, it is impossible for this not to impact on the resolution of the couple's financial affairs. On occasions, it is nothing more than an idle threat. At other times, it is more serious, and may result in a bankruptcy order being made.

The non-bankrupt spouse feels powerless, as the control they thought they had over the process, especially if they were the ones who instigated the divorce and financial proceedings, suddenly disappears. Having a familiarity with insolvency laws, together with the options available to a non-bankrupt spouse, is essential for a family lawyer to ensure that their client is protected as much as possible.

Finding out if someone has been made bankrupt is the first important step. A bankrupt has no duty to provide their spouse with prior notice of possible bankruptcy, or a copy of their petition or subsequent order.

While some spouses will readily disclose this information, others are not so forthcoming. Fortunately, a public list is available. Every bankruptcy petition in England and Wales is registered at the land charges department of the Land Registry.

A search will indicate whether there are any registered or pending bankruptcy petitions against an individual. This should be made using form K16, to be sent to: Land Charges Department, Search Section, Seaton Court, 2 William Prance Road, Plymouth, PL6 5WS; DX 8249 PLYMOUTH (3). But what then?

Judgement call

An important distinction is that between provable and non-provable debts. With provable debts, the non-bankrupt spouse can 'prove' as a creditor in the bankruptcy. For non-provable debts, they can have no involvement in the bankruptcy proceedings '“ while being subject to their effect '“ and have to wait to recover what they can from what is likely to be a very diminished pot once the bankruptcy proceedings have been discharged.

Lump sum and costs orders are provable in bankruptcy. If you do decide that it is in the best interests of your client to try and prove in the bankruptcy, efforts should be made to advance the position of the non-bankrupt spouse above other creditors, before the bankruptcy order is made, for example, by seeking security, given that secured creditors rank higher in the list of priority for estate distribution than those without security. If there is the prospect that the other spouse might be made bankrupt, any final financial court order should be drafted with this in mind.

A judgment call must be made whether to prove in the bankruptcy. There may be good reason not to prove. For example, if the bankrupt spouse is expected to come into a substantial amount of money at some point in the future, it may be appropriate to delay in pursuing the non-bankrupt's claims until that time.

When divorce financial proceedings are ongoing but a final order has not been made, these may be adjourned, before the making of the final order, until after the conclusion of the bankruptcy proceedings.

Discharge of a bankruptcy order does not release the bankrupt from any debt arising under an order made in family proceedings. However, it should not be assumed that the non-bankrupt spouse can always pursue a provable debt in the bankruptcy, and then go on to pursue the remainder of the debt afterwards using the standard family enforcement methods.

The court can put conditions on any bankruptcy release. The bankrupt could therefore specifically request that the court discharges the provable divorce financial order, to protect himself from further claims, once the bankruptcy has been discharged. In addition, on a practical level, if the bankrupt has lost everything in bankruptcy, there will be few assets available from which to recover a lump sum after discharge in any event.

Property transfers

Case law in recent years has firmed up the position in relation to property adjustment orders. You should act fast, securing a property adjustment order in a court-approved financial consent order, together with pronouncement of decree absolute, before the making of any bankruptcy order (Haines v Hill [2007] EWCA Civ 1284). Implementation of the order is not necessary. If a final financial order has been made within matrimonial proceedings before the start of bankruptcy proceedings, that order cannot be challenged by the trustee, even if it has the effect of reducing the bankrupt's estate, as long as there is no evidence of collusion between the spouses.

A judge may not, however, approve a consent order where there is the risk of a bankruptcy order being made. The court's refusal to approve a proposed order leaves the non-bankrupt spouse in a vulnerable position, especially if, under the terms of the consent order, they would receive more than 50 per cent of the equity in a jointly held property.

Pension position

The treatment of pensions on bankruptcy means they may be a very useful resource available to the non-bankrupt spouse to recover some assets from their bankrupt spouse following the breakdown of the relationship.

Since 2000, pension rights in approved schemes have been excluded from the bankrupt's estate, and therefore remain available for consideration in divorce proceedings taking place even during the subsistence of a bankruptcy order. 'Approved schemes' include tax-approved occupational pension schemes, personal pension schemes and retirement annuity contracts. This means that annuities and lump sums from pensions remain vested in the bankrupt. Most pension schemes will be approved.

This leaves open a relatively safe area of the bankrupt's finances that cannot be touched by the trustee in bankruptcy. Although unlikely to be adequate for the non-bankrupt spouse, in view of the restrictions on when pensions can start paying out, and the level of pension income likely to be available, a 100 per cent share of that pension may go some way towards meeting the non-bankrupt spouse's claims on divorce.

The pension scheme is, however, vulnerable to attack by the trustee if excessive contributions can be shown. That will usually only happen in exceptional circumstances. Any assessment of excessive contributions would have to be based on complicated actuarial valuations. The trustee can apply to the court for an order to recover excessive contributions paid to approved and unapproved pension schemes, and to any scheme including monies from a pension sharing order on divorce. In other words, a non-bankrupt spouse's pension share could be vulnerable, resulting in the need to consider carefully the level of pension contributions made to any pension by a spouse threatening bankruptcy.

Work with the trustee

The role of the trustee in bankruptcy is to strike a balance between the bankrupt and his family on the one hand, and the rights of creditors on the other. It is this balance, protecting the creditors, which the non-bankrupt spouse does not often understand.

While they may be tempted to avoid any contact with the 'cold-hearted' trustee, hoping that by doing so they can minimise the impact which the trustee might have on their financial affairs, their interests are usually better protected if a relationship is formed with the trustee as soon as possible. By building up a rapport with the trustee, the non-bankrupt spouse can be kept informed about the bankruptcy proceedings and, if appropriate, negotiate a deal with them, for example in relation to their interest in the family home.

There are several key legal principles to be applied in valuing the non-bankrupt spouse's interest in the family home. The most well known is to show a common interest to hold the beneficial interest in a certain way and then acting detrimentally in reliance on this common intention. Beyond that, the equitable principles of equitable accounting or exoneration accounting can further assist the non-bankrupt spouse in ring fencing for themselves as much of the equity in the family home as possible. This is the starting point to calculate your client's legal or beneficial interest in the property, and you should do this as soon as possible, seeking agreement to such quantification from the trustee.

The trustee will insist on realising the bankrupt's interest at the first available opportunity, once the 12 months period of grace is complete. The worst-case scenario for the non-bankrupt spouse who does not agree to a sale of house would involve the trustee seeking an order for sale under The Trusts of Land Act 1996. In that event, they may be faced with a substantial costs order if they cannot reach an agreement with the trustee. This means that spouses who, through the family courts, might have expected to achieve an unequal share of assets, now end up substantially worse off.

If a non-bankrupt spouse has a provable debt, they can have a say over who the trustee is. There may be merit in exercising this right. Not only is it sensible to try and have a trustee appointed whom the non-bankrupt spouse can work with, but also one who is cost effective, given that any fees levied by the trustee will diminish their return.

Scope of privilege

The treatment of solicitor/client privilege in bankruptcy proceedings can often catch out family lawyers.

The trustee has the power to access all of the bankrupt's papers, including files held by family practitioners on behalf of the bankrupt '“ including file notes of advice given regarding the financial settlement in any divorce proceedings.

There is apparent logic in the bankrupt's papers coming under scrutiny but the non-bankrupt spouse is also vulnerable. They can be summoned for cross-examination, as can the family practitioner, who can also be required to file an affidavit. It is important to bear this in mind when acting in a case where this may become relevant.