Research published by Benenden Health in October 2022 suggests that the most stressful life event in the UK was, perhaps not unsurprisingly, the passing of a family member or a friend. Closely behind, however, were four further life events that are, far too often, closely entwined. Financial challenges and issues at work came in second and third in the poll, and changes in relationship or an outright divorce came in at fourth and fifth.
Any family law practitioner will be all too familiar with the fact that financial difficulties can often lead to a divorce, and a divorce can often lead to stress and anxiety for those engaged in the process about their future financial security. But what happens when financial challenges and difficulties reach such a level that one (or both) of parties to a broken-down marriage is facing the prospect of bankruptcy? In circumstances where it is human nature for the parties engaged in financial remedy proceedings to want to protect their financial security as much as possible, those interests can, and very often will, rub up against interests of third party creditors or a trustee in bankruptcy and create nauseating uncertainty for separating spouses.
Bankruptcy proceedings vs financial remedy proceedings
The general interplay
Let us assume that Spouse A is in financial difficulty and there are creditors looming, seeking to call in debts but not having the means to pay them. In these circumstances, Spouse A may find themselves subject to a petition for bankruptcy pursuant to Section 264 of the Insolvency Act 1986 (“the IA 1986“). In the event that Spouse A is unable to defend a bankruptcy petition, (it is beyond the scope of this article to delve into the technicalities of bankruptcy law and procedure) then the Court will very likely make a formal Bankruptcy Order. Upon such an order being made, a Trustee in Bankruptcy (“TiB“) will be appointed whose role it is to realise and distribute the assets of Spouse A for the benefit of Spouse A’s creditors.
Proceedings for a financial remedy consequential to a divorce involve the Family Court exercising the distributive powers bestowed upon it pursuant to Part II of the Matrimonial Causes Act 1973 (as amended – “the 1973 Act“). Pursuant to Section 24 of the 1973 Act, the Family Court has the power to make a Property Adjustment Order, which can require either party to a marriage to transfer to the other party (or to any child of the marriage) their interest in any property i.e. the former matrimonial home (“FMH“). It is a feature of cases up and down the land that the parties’ interest in the FMH, be it mortgaged or free from encumbrance, often constitutes the largest asset of the divorcing spouses and, as such, Spouse B in our case is keen to secure the FMH as part of an overall settlement. Spouse B’s ability to do so, however, may be curtailed to an exclusive degree if, prior to the Court making a Property Adjustment Order pursuant to the 1973 Act, a petition for Spouse A’s bankruptcy has been presented.
In circumstances such as those alluded to above, and assuming no challenges have been made to the bankruptcy, the Family Court will find itself lacking the power to make a Property Adjustment Order. Spouse A’s interest in the FMH is likely to fall into their estate, and may well constitute the TiB’s only likely means of being able to satisfy the claims of Spouse A’s creditors in the bankruptcy. Putting it another way, the legitimate claims of Spouse A’s creditors in bankruptcy proceedings may well trump the legitimate claims of Spouse B in proceedings for a financial remedy.
The timing of the two conflicting claims is critical. For example:-
- If a Property Adjustment Order in the FMH is made in Spouse B’s favour before a bankruptcy petition is presented, then the TiB will be bound by the Family Court’s Order. Whilst it may still be open to the TiB to unravel the Property Adjustment Order pursuant to Section 339 of the 1986 Act, such an application is only likely to be successful if the TiB can establish some form of underhand conduct on the party of either (or both) of the divorcing spouses. Put another way, a bone fide transfer of Spouse B’s interest in the FMH to Spouse A via a Property Adjustment Order prior to a bankruptcy petition being presented should survive unscathed.
- If, however, a bankruptcy petition is presented or a Bankruptcy Order is made before a Property Adjustment Order, then the Bankruptcy Court will need to approve the transfer of Spouse B’s interest in the FMH to Spouse A.
Whilst many a spouse present to the Family Court as impecunious, pleading financial difficulty in an effort to minimise their financial exposure to their estranged spouse, it is, thankfully, a rare occurrence for a spouse to take the extreme step of applying for their own bankruptcy in a bid to defeat the other’s claims for financial provision upon a divorce. Should a situation such as this arise then the 1986 Act permits an application to annul the bankruptcy with the most common reason being that the Bankruptcy Order should not have been made in the first place.
The effect on Spouse B
As set out above, there are circumstances where Spouse B could readily face difficulty when divorcing Spouse A, who is either going through, or likely to face, insolvency proceedings. However, it is not all doom and gloom for Spouse B on the basis that the insolvency rules provide that lump sum Orders and costs Orders made in favour of Spouse B are provable debts in a bankruptcy.
Lump sums and Costs Orders
Let us assume that Spouse A has been made bankrupt one year after a financial remedy award was made in Spouse B’s favour. Pursuant to the terms of that financial remedy award, Spouse A is to pay to Spouse B a lump sum of £50,000 and a £20,000 costs order six months after being made bankrupt. Spouse B would be able to present their award to the TiB and mount a claim to be included in the list of creditors owed monies by Spouse A’s estate in bankruptcy. Whilst recovery of the full amount may be uncertain on the basis that all creditors rank in pari passu, the granting of a Bankruptcy Order following an award for financial remedies is not necessarily the end of the road for Spouse B.
What effect does bankruptcy have on divorcing parties that have the benefit of pension schemes? Prior to changes enacted pursuant to the Welfare Form and Pensions Act 1999 (“the 1999 Act“), a person facing bankruptcy could have found that their pension interests vested in the TiB. However, since the making of the 1999 Act, approved pension arrangements are now expressly excluded from forming part of the bankrupt estate which may provide some relief to either the bankrupt or their spouse hoping to receive some benefit from the pension or any subsequent Pension Sharing Order. Further specialist advice may be required as to whether any lump sums drawn from a pension arrangement, be that by Spouse A as an undischarged bankrupt or Spouse B benefiting from a Pension Sharing Order, could fall subject to a claim from the TiB. Similarly, be aware that should it transpire that excessive contributions have been made by the bankrupt spouse that have the effect of depressing their assets and risk, as a result, the legitimate claims of their creditors, then those pension contributions may possibly be clawed back by the TiB as voidable dispositions pursuant to the 1986 Act.
Simply because one spouse may be facing bankruptcy does not preclude the Family Court from making an Order for periodical payments pursuant to Section 23 of the 1973 Act. The family Court will retain the jurisdiction to make such Orders but that may give rise to conflict with the bankruptcy Court’s powers pursuant to Section 310 of the 1986 Act. These latter powers enable the bankruptcy Court to make Income Payment Orders, so that the TiB can claim from the bankrupt’s estate such income during the currency of the bankruptcy to satisfy the claims of creditors. The exercise of Income Payment Orders should not interfere with the ability of the bankrupt (or their family) from meeting their “reasonable domestic needs” and, as such, it is clear that the two Courts will need to give careful consideration as to how to balance the competing interests.
Financial remedy proceedings can be complicated enough without the added stress, anxiety and the financial uncertainty that bankruptcy brings with it. The need to take expert advice as soon as possible is likely to be all the more necessary where financial strain may be one of the causes of the irretrievable breakdown of the marriage.