Voidable transactions in bankruptcy and how a trustee can recover assets

When a person goes bankrupt, the whole point of the process is that their assets are gathered up, sold and shared fairly among the people they owe money to. That only works if the assets are still there. The Bankruptcy Act 1966 (Cth) anticipates that someone facing bankruptcy might try to move assets out of reach, and it gives the trustee specific powers to reverse those moves. A transaction the trustee can reverse is called a voidable transaction, and the rules governing them sit in Part VI, Division 3 of the Act.

"Void against the trustee" is the key phrase. It means the transfer is treated as if it never happened, so far as the trustee is concerned, and the property, or its value, can be recovered and added to the pool for creditors. This matters for anyone who has moved assets to family members, sold property cheaply, or paid out some creditors before bankruptcy. It matters just as much for the people who received those assets, because the trustee can pursue the recipient directly rather than relying on the bankrupt.

This article explains how the regime operates: who the players are, which transactions can be reversed, the time limits that apply, the defences available, and where legal help is usually needed.

The players and what each one does

The regime has a small cast of players, each with a different role:

• The trustee: a registered trustee or the Official Trustee appointed to administer the bankrupt estate. The trustee investigates the bankrupt's affairs, identifies vulnerable transactions, and recovers property for creditors.
• The bankrupt: must cooperate with the trustee, hand over books and records, and provide information when required under s 77 of the Act.
• The recipient: the person or company that received the property. The trustee can pursue the recipient directly, and the recipient usually carries the risk of having to hand the property back.
• The creditors: the people owed money. They benefit from recoveries, and a creditor who was paid out before bankruptcy can find itself having to repay the money and rejoin the queue.
• The court and the Official Receiver: recovery is enforced through the Federal Court, and the Official Receiver can issue statutory notices that speed up the recovery of money.

The interests here are in direct tension. The bankrupt and the recipient usually want the transfer to stand, while the trustee, acting for the creditors, wants it undone. That is why the Act sets out clear tests: a transfer is only void if it fits one of the defined categories, and only within defined time limits.

How a transaction comes under review

Bankruptcy begins with a sequestration order made on a creditor's petition, or with a debtor's own petition. From that point, control of the bankrupt's property passes to the trustee, whose job is to work out what the estate is worth and what can be recovered for creditors. Within 14 days of being notified of the bankruptcy, the bankrupt must file a statement of affairs with the Official Receiver under s 54 of the Act, setting out assets, liabilities and past dealings. The trustee can investigate the bankrupt's conduct, examinable affairs, books, accounts and records under s 19AA, and the bankrupt must cooperate under s 77.

The investigation typically works backwards from the present. Bank statements, property registers, loan accounts and payments to related parties are reviewed for the period before the bankruptcy. A transfer to a spouse at a suspicious price, a sudden gift, the repayment of a family loan, a lump sum into superannuation: each is checked against the categories below. If the trustee decides a transaction is void, the trustee can demand the property back, issue a recovery notice, or start court proceedings.

Undervalued transfers: the five-year look-back

The first and most common category is the transfer made for no value, or for less than market value. Under s 120 of the Act, a transfer of property is void against the trustee if it happened within five years before the commencement of the bankruptcy, and the recipient gave no consideration, or consideration worth less than the property's market value at the time of the transfer.

The five-year window is not absolute. The section draws a distinction based on when the transfer happened and who received it:

• If the transfer was made more than two years before the bankruptcy, it is not void if the recipient proves the transferor was solvent at the time.
• If the recipient was a related entity, the same solvency defence applies to transfers made more than four years before the bankruptcy. Related entity is a defined term in s 5 of the Act that captures relatives and spouses, companies they are involved with, and connected trusts.

The practical effect is that gifts and below-market sales in the final two years before bankruptcy are almost always recoverable, whatever the transferor's financial state at the time. Beyond that, everything turns on whether the transferor was solvent when the transfer happened, and the burden of proving solvency sits with the recipient. That burden is made harder by a presumption: if the transferor failed to keep, or preserve, proper books and records, the court presumes the transferor was insolvent at the time of the transfer, unless the contrary is proved, under s 120(3A).

A few details are worth noting:

• A transfer includes a payment of money: Handing over cash counts as much as transferring a car or a house, under s 120(7).
• Some consideration has no value at all: The fact that the recipient is related to the transferor, a promise to marry, love and affection, and a right to keep living in the transferred property all count for nothing under s 120(5).
• The trustee must refund genuine consideration: If a transfer is void, the trustee pays back whatever real consideration the recipient actually gave, under s 120(4).
• Later buyers in good faith are protected: A person who acquired the property from the first recipient in good faith and for at least market value keeps it, under s 120(6). The classic example: you sell a $10,000 car to a friend for $5,000, and the friend sells it on to a stranger for $10,000. The trustee can recover from your friend, but not from the stranger who paid market value and knew nothing of the arrangement.

Transfers made to defeat creditors: no time limit

The second category targets transfers made with the purpose of keeping assets away from creditors. Under s 121 of the Act, a transfer is void if the property would probably have formed part of the estate, and the transferor's main purpose in making the transfer was to prevent the property from being divided among creditors, or to hinder or delay that process.

The striking feature of s 121 is that there is no time limit. A transfer made years before bankruptcy can still be attacked if the purpose is established, and the trustee can start an action under s 121 at any time, under s 127(4) of the Act. The practical constraint is evidentiary: the older the transfer, the harder it is to prove purpose.

The Act helps the trustee with that task. If it can reasonably be inferred from all the circumstances that the transferor was insolvent, or about to become insolvent, at the time of the transfer, the required purpose is taken to be established, under s 121(2). The classic case is the business owner who can see bankruptcy coming and moves the house into a family member's name to keep it out of the estate. The defence for the recipient is narrow: the transfer is not void if the recipient paid at least market value, did not know and could not reasonably have inferred the transferor's purpose, and could not reasonably have inferred that the transferor was insolvent or about to become insolvent, under s 121(4).

Preferences: paying one creditor ahead of the others

The third category is the preference. This is where an insolvent debtor transfers property to a creditor, and the effect is to give that creditor a preference, priority or advantage over the other creditors, under s 122(1) of the Act.

For a bankruptcy that follows a creditor's petition, the vulnerable period is six months: transfers made in the period beginning six months before the presentation of the petition and ending immediately before the date of the bankruptcy, under the table in s 122(1). The debtor must have been insolvent at the time of the transfer.

A preference is not about intent, it is about effect. If a struggling business repays one supplier in full a month before a petition is presented, while other suppliers later receive only a dividend of cents in the dollar, the repaid supplier has been preferred even if everyone acted honestly. The repayment is void against the trustee, and the supplier must repay the money. The preferred creditor does not lose its underlying claim: it can prove in the bankruptcy for the debt as if the payment had never been made, under s 122(5), which simply puts it back in the queue with everyone else.

There are protections for honest dealings. Purchasers, payees and encumbrancers in the ordinary course of business who acted in good faith and gave at least market value are protected under s 122(2)(a). But a creditor is taken not to have acted in good faith if the circumstances would have led it to suspect that the debtor could not pay its debts as they fell due, and that the payment would give it an advantage, under s 122(4)(c).

The protection for ordinary business dealings

The fourth provision in this area is widely misunderstood. Section 123 of the Act does not create another category of void transaction. It protects certain transfers from being invalidated at all. Payments to creditors, transfers for market value, and present advances made by an existing creditor are protected if they happened before the bankruptcy, the other party had no notice of a petition against the debtor, and the transaction was in good faith and in the ordinary course of business. The person relying on the transaction carries the burden of proving those things, under s 123(2).

The protection is subject to the specific attack provisions. A transaction cannot hide behind s 123 if it is itself an undervalued transfer, a transfer to defeat creditors, or a preference, and the same applies to superannuation contributions caught by ss 128B and 128C.

Superannuation and indirect benefits

Contributions to superannuation are a recognised way of moving money out of a bankrupt estate, so the Act deals with them specifically. A contribution made to an eligible superannuation plan on or after 28 July 2006 is void if the contributor's main purpose was to defeat creditors, under s 128B. The same applies where a third party makes contributions under a scheme involving the person who later becomes bankrupt, under s 128C.

The reach of these provisions was confirmed in Davidson v Official Receiver [2021] FCAFC 73. The Full Court of the Federal Court upheld a recovery notice issued against a recipient of payments from a bankrupt estate. The payments, totalling about $12.5 million, were said to be transfers at undervalue. Notably, the notice was issued after the bankrupt had already been discharged from bankruptcy, and the Court confirmed that recovery can proceed in that situation.

There is also a rule for transactions where the consideration went somewhere else. If a transfer is made to one person but the benefit of the consideration flows to a third party, ss 120 and 121 treat the payment of that consideration as if the transferor had made it, and the trustee can recover it, under s 121A. This catches arrangements where value is routed through intermediaries.

How the trustee actually recovers the property

Once a transaction is void against the trustee, the trustee can recover the property, or its value, through one of two main routes:

• The administrative route: a statutory notice under s 139ZQ of the Act. The trustee, through the Official Receiver, issues a notice demanding payment of the amount of the void transaction, and that amount can then be recovered as a debt in court, under s 139ZQ(8). A recipient who wants to challenge the notice must apply to set it aside within 60 days of receiving it, under s 139ZS(1A). The notice must set out the facts and circumstances on which the claim is based.
• The litigation route: a court action. Time limits apply. An action under s 120 must be started within six years of the bankruptcy, as must an action under s 122, under ss 127(3) and 127(5) of the Act. An action under s 121 can be started at any time, under s 127(4). There is also a general 20-year cap on the trustee claiming property of the bankrupt, under s 127(1).

Where the traps usually sit

A few patterns come up again and again:

• Gifts to family in the last two years: These sit inside the window where no solvency defence is available. If the trustee can identify the transfer, recovery is usually straightforward.
• Transfers to related entities in years two to five: The recipient must prove the transferor was solvent at the time. Without proper books and records, the presumption of insolvency will often decide the issue.
• Cash movements: Because a payment of money is a transfer of property, money handed to a relative to look after is as recoverable as a house transfer.
• Repayments to connected creditors: Paying out a director's loan or a family member's loan in the six months before a petition is a classic preference.
• Superannuation top-ups: A large contribution made as insolvency looms can be clawed back, and the trustee can reach it even after discharge.
• Recipients who spent the money: The trustee pursues the recipient, not the bankrupt. A family member who received and spent the money can face a personal claim for its value, with only the narrow good-faith defences available.

When a lawyer should be involved

The point at which legal advice pays for itself is early. If you are facing insolvency and have made gifts, below-market sales, or unusual payments in the past few years, advice before the trustee identifies them gives you the best chance of a negotiated outcome, and there are formal alternatives to bankruptcy that can change the whole picture. If you are a recipient of assets from someone who has since become bankrupt, a demand letter or recovery notice is not the time to guess. The 60-day window for challenging a s 139ZQ notice, the burden of proving solvency, and the value of contemporaneous records are all things a lawyer can assess quickly. The same applies to a creditor who was paid out and now faces a preference claim: the ordinary course and good faith defences turn on evidence of what the creditor knew at the time.

The records that decide recovery claims

Across all the categories, one factual question decides most disputes: what did the parties know, and when. The trustee must show that a transfer was undervalued, made with a prohibited purpose, or preferential, and the recipient's best answers are contemporaneous proof of market value, solvency and good faith. Records kept at the time, valuations, loan agreements and correspondence are worth far more than any argument made later. If those records exist and the parties acted genuinely, most voidable transaction claims can be defended or settled on reasonable terms. If they do not, the statutory presumptions usually carry the day. That is why a consultation before the trustee acts, while the records and witnesses are still available, is the cheapest insurance in this area of law, and it is often not as expensive as people assume. A short conversation about your transaction history can steer you towards the right outcome before a recovery notice arrives.