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Voiding superannuation contributions: How does bankruptcy affect superannuation?

How superannuation is treated in bankruptcy is a somewhat complex area and it's critical to get advice/guidance from a bankruptcy trustee. This factsheet outlines the basics of how bankruptcy and superannuation works.

Bankruptcy trustees of bankrupt estates investigate pre-bankruptcy transfers or transactions when they believe the transaction improperly dissipated or removed assets that would otherwise be available to creditors. The Bankruptcy Act 1966 will in some cases permit voiding these transactions and require the other party to return an asset, or make a payment, to the trustee. Sometimes contributions made by or on behalf of the bankrupt (pre-bankruptcy) to superannuation funds fall into this category.

To void this type of transaction, the trustee must show:

  1. A transaction was entered into.
  2. They can identify the other party to the transaction.
  3. The transaction occurred within a specific period, or while the debtor was insolvent.
  4. The transaction was either undervalue, or had the required purpose of improperly removing assets from a bankrupt estate.
  5. It does not involve protected property.

This Guide deals with contributions that are made prior to bankruptcy that have all of these factors.

Reasons for voiding these transactions
One of a trustee’s roles is to ensure that all of a bankrupt’s divisible assets are available to distribute to their creditors. Part of this role is to find whether a bankrupt entered into a transaction before they became bankrupt that reduced the assets available for distribution. For this reason, the trustee seeks to recover these assets. The Bankruptcy Act provisions give trustees the power to recover monies paid to eligible superannuation plans in the period before the bankruptcy.

Occasionally when debtors face bankruptcy, they try to protect some of their assets by hiding, moving or transferring assets to a third party to hold during the period of bankruptcy. Sometimes debtors make payments to their superannuation plan, as superannuation is generally an exempt asset.

The provisions attempt to deter debtors from moving assets into their superannuation plan at their creditors’ expense, and allow trustees to recover the money from the fund when payments fall under the relevant conditions.

Voiding the bankrupt’s superannuation contributions
Various sections of the Bankruptcy Act are designed to void transactions, or transfers, of property in order to provide a fair distribution of a bankrupt’s assets to their creditors. Section 121 ‘Transfers to defeat creditors’ is designed to void transfers where the intention of that transfer is to remove the property out of reach of the trustee or creditors.

Subdivision B of Division 3 of Part VI of the Bankruptcy Act is aimed at voiding transfers of property to eligible superannuation plans where the intention of the transfer was to defeat creditors. The main provisions are very similar to section 121, but target superannuation plans, as the Bankruptcy Act generally excludes monies in superannuation plans from being divisible property.

Under section 128B of the Bankruptcy Act, transfers made by a debtor are void if they occurred after 28 July 2006, and:

  • they are made to eligible superannuation plans of the bankrupt
  • the property would have formed part of the bankrupt estate if the transfer had not been made
  • the main purpose of the transaction was to keep an asset from falling into the trustee’s hands and being available to creditors.

Most people will initially consider payments as transfers, but any property transfers can be subject to these provisions. Section 128B goes one step further to include any transaction that creates new property. This is usually in the form of securities or equitable/legal interests over assets the bankrupt still owns i.e. creating a charge in favour of the superannuation plan may be deemed a transfer of property.

A trustee will examine payments to superannuation plans and any other assets created, and will assess whether the payment falls within the provisions. The inherently difficult part to determine is the debtor’s intention at the time of the transfer.

Contributions by a third party
Transfers to superannuation plans made by third parties on the debtor’s behalf may also be caught under these provisions. Third parties may also hold assets that belong to the debtor, or owe money to the debtor. Paying that money into a superannuation plan on the debtor’s instruction will be a transaction that can be examined. Again, the intention of the transfer must be to defeat creditors.

Under section 128C, transfers made by third parties are void if:

  • They are made to eligible superannuation plans of the bankrupt.
  • The property would have formed part of the property available to creditors in a bankrupt estate (usually as a debt due) if the transfer had not been made.
  • The transfer occurred under a scheme that the debtor was a party to—effectively, it was done under the debtor’s direct or implied instructions.
  • The main purpose of the transaction was to keep that asset from falling into the trustee’s hands and becoming available to creditors.

One of the main purposes of the transaction must be to protect the asset from creditors—to defeat the creditors’ interest in the property. This intention only needs to be one main purpose of the transaction, not the only purpose. This is subjective, and is usually inferred from the transaction circumstances, the debtor’s financial position at that time, and the result of the transaction.

This intention can be deemed by the debtor’s (i.e. pre-bankrupt) actual or impending insolvency, but only if it can be shown that the debtor was—or was about to become—bankrupt at the time of the transaction. If the debtor was solvent at the time and remained solvent for some time after the transaction—with no indication of an impending bankruptcy—it would be difficult to connect the eventual insolvency to the transaction.

It is common for debtors to undertake transactions with this intention when legal action against them is pending and it appears likely or inevitable that judgment will be brought against them. Alternatively, a loan or other agreement that has been breached could lead to a demand that a debtor cannot meet. In these circumstances, showing or deeming that the intention existed may be quite easy. Most bankrupts who undertake transactions to protect assets, usually only do so close to the time of bankruptcy.

The trustee will also examine the debtor’s history of personal contributions to eligible superannuation funds. If the payment is one of a series of similar payments over a long period, there could be an argument that the required intention did not exist. If the payment is a once-off large payment—especially if significantly larger than any previous payments—it is likely that the intention existed.

Third party contributions
The same deeming provisions apply to transfers by third parties. If it can be shown that the debtor was insolvent, or was about to become insolvent at the time, the intention can be deemed. The same indicators can determine the debtor’s intention. There is no requirement for the other party to know or suspect the insolvency, as there is no claim against that other party.

The debtor does not have to have been insolvent at the time of the transaction for it to be void. As detailed in Section 128B, it is the debtor’s intention that is important, and showing insolvency or pending insolvency is a key means of showing that intention. If the trustee relies on that deeming provision, the court will require evidence of insolvency.

The Bankruptcy Act provides for a presumption of insolvency if the debtor did not keep proper records of their financial affairs during that period. That presumption is rebuttable, i.e. it may be disproved by positive evidence of solvency. This may be quite difficult if there are truly no records on the debtor’s financial affairs. The same rebuttable presumption of insolvency applies to transfers made by third parties.

The rebuttable presumption is designed to stop bankrupts from avoiding their past transactions being overturned by simply destroying or hiding the records needed to examine the transaction. In essence, the presumption deems that the debtor is insolvent at a particular time, unless there are records that prove otherwise. As a consequence of that deemed insolvency, the transactions under examination can be said to have been done under the required intention.

Protection of other parties
The Bankruptcy Act goes to some lengths to ensure that innocent parties to void transactions are not prejudiced any more than necessary. The provisions that relate to the voiding of superannuation contributions are no different. The Bankruptcy Act provides protection for two parties: the bankruptcy trustee and the superannuation plan trustee.

The first party is the trustee of the eligible superannuation plan. When a contribution is received, certain taxes and other charges are deducted and paid to the government, fund managers, etc. The bankruptcy trustee will seek the voiding of the transfer (i.e. the entire amount of the contribution). Payment of the entire contribution would leave the superannuation trustee (the plan) out of pocket to the extent of the taxes and charges. Section 128B of the Bankruptcy Act provides that when an amount of the superannuation contribution is recovered, the amount of taxes and charges that applied to that contribution must be paid to the superannuation trustee, to ensure that they are not left with a shortfall.

Interestingly, this protection only applies to payments that are made to the bankruptcy trustee under a section 139ZQ notice. It is debatable whether this protection applies if the superannuation trustee voluntarily returns the contribution to the bankruptcy trustee, or even if the bankruptcy trustee obtains a court order for the contribution to be returned.

Innocent parties are protected when they receive title to any property in good faith (i.e. without any knowledge of the intention of the transfer).

Third party contributions
This protection also applies to superannuation trustees when contributions are made by other parties, but are voided under the appropriate Bankruptcy Act provisions. The provisions in section 128B and 128C also apply to third party contributions, except they are referred to as ‘contributions’ by other parties. Section 128C(8) of the Bankruptcy Act provides protection to parties that obtain title to property without knowing the intention of the transfer when the contribution is made by another party.

Protection against criminal and civil prosecution
Section 128L of the Bankruptcy Act protects superannuation trustees from criminal and civil prosecution for acts done in good faith. These acts include complying with a superannuation account-freezing notice (section 139ZQ notice under the Bankruptcy Act) or a court order.

Superannuation account-freezing notices
Section 128E of the Bankruptcy Act gives bankruptcy trustees certain powers to help them make these claims. One is the power to issue a superannuation account-freezing notice. The Official Receiver issues the notices when the bankruptcy trustee has satisfied to the Official Receiver that there are “reasonable grounds” that a contribution to a superannuation plan is void under Sections 128B or 128C. The notice comes into force when it is given to the trustee of an eligible superannuation plan.

These notices affect the superannuation plan trustee’s rights to deal with the funds in the plan, except in limited circumstances. The notices are designed to ensure that money is not paid out, or otherwise disbursed, before potential void transactions are resolved.

One important point is that the notice is either directed at the money paid into the plan from the contribution under examination (the money must be traced and identified in the plan at the time of issuing the notice), or the bankruptcy trustee must apply for to the court for an order under section 139ZU in relation to rolled-over superannuation interests.

The trustee can also apply to the Official Receiver to issue a notice under section 139ZQ whereby the Official Receiver can seek repayment from the recipient of the funds. Because the notice is given by the Official Receiver and affects the rights of the bankrupt on what would be otherwise exempt (non-divisible) property, the notice must set out why the Official Receiver believes that the contributions to the superannuation plan are void.

A superannuation account-freezing notice is not an open-ended right for a bankruptcy trustee. Section 128F of the Bankruptcy Act states that the Official Receiver can revoke the notice at any time. The notice is automatically revoked if the money is claimed under a revoked 139ZQ notice, or if the court sets aside the 139ZQ notice.

For example, if the superannuation account-freezing notice was supporting a section 139ZQ notice and that notice is satisfied or revoked, the freezing notice is also automatically revoked.

The bankruptcy trustee has 180 days to take, or conclude, their action after the Official Receiver issues a freezing notice. If a bankruptcy trustee cannot provide sufficient evidence within 180 days to satisfy to the Official Receiver that a section 139ZQ notice should be issued, the freezing notice will be revoked.

Similarly, if a bankruptcy trustee seeks relief through a section 139ZU order, then the court may order:

  • compliance with that order
  • that the order be set aside or dismissed.

If the application for the order is withdrawn within the 180-day period, the freezing notice will be automatically revoked.

The notice is also revoked if no order under section 139ZU is made within the 180-day period. The trustee is bound by a 180-day period, but may be extended by applying to the court.

Section 139ZU orders
The provisions that allow bankruptcy trustees to recover money paid into eligible superannuation plans also contemplate the transfer of money (the rollover of superannuation interests) between more than one plan, or between one or more people. These provisions allow the tracing of the void money into a second plan. Section 139ZU of the Bankruptcy Act allows the court to order a payment from the second plan to the bankruptcy trustee, but there are limitations.

The first limitation is that the contribution to the first plan must be void under sections 128B or 128C. But if the money has been transferred (rolled-over) to another plan, there may be insufficient funds in the first plan to satisfy a claim.

If there is sufficient money in the first plan to pay the claim, this provision will not be necessary, but there may be a shortfall. The money, or part of it, would now be in a second plan.

The shortfall contemplated in section 139ZU is the shortfall between the money remaining in the first plan and the bankruptcy trustee’s claim amount. Only the shortfall amount may be claimed from the second plan. Essentially, the trustee can keep tracing the money into the new plan and recover the shortfall.

The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 3.11.2017