What happens when a member of a Self Managed Super Fund enters Bankruptcy?[1]

What happens when a member of a Self Managed Super Fund enters Bankruptcy?[1]

The number of members of self managed super funds (“SMSFs”) has been growing in recent years; in June 2014 it was 1,011,686, up from 758,589 in June 2009.[2] A large proportion of those members are members of a two-person SMSF (usually, a husband and wife or de facto partners). There are many rules governing the establishment and continuation of SMSFs, and bankruptcy of a member may have important ramifications for the other member(s) of the SMSF, as well as the bankrupt.

  1. What are the general requirements for the number of members?

1.1  Each individual trustee of the SMSF must be a member of the SMSF

This means, for example: if there are two members and the members have elected to have individual trustees of the SMSF rather than a corporate trustee, both members of the SMSF must also be trustees of the SMSF.

Ultimately, this has ramifications further down the line if one of the members enters bankruptcy, because that will also mean one of the trustees has entered bankruptcy.

1.2  Each trustee must not be a disqualified person

A disqualified person includes a number of types of people (for example, someone convicted of certain types of offences). Among other things, it includes someone who is insolvent.

That is, if you are a bankrupt, you are a disqualified person for the purposes of the laws governing SMSFs. Ipso facto, if you are a bankrupt you cannot be a trustee of an SMSF.

1.3  Where there is a corporate trustee, each director of the corporate trustee of the SMSF must be a member of the SMSF

This means, for example: if there are two members the members have elected to have a corporate trustee of the SMSF, both members of the SMSF must also be directors of the corporate trustee of the SMSF.

Again, this has ramifications further down the line if one of the members enters bankruptcy, because that will also mean one of the directors of the trustee has entered bankruptcy.

1.4  The corporate trustee cannot know or suspect a responsible officer is a disqualified person

As a result of the disqualified person definition, this means that if you are a bankrupt, you cannot be a director of a corporate trustee of an SMSF. It further means that a person who has become a bankrupt must resign as director of the corporate trustee as soon as that person becomes aware they are bankrupt.

  1. Can you have a single member SMSF?

Technically, you can have a single member SMSF. However, there are rules regarding single member SMSFs which must be followed. Those rules include:

(a) If there’s a corporate trustee, the member must be a sole director, or one of only two directors where the other director is:

a. A relative of the member; or

b. A person who does not employ the member;

(b) If there are individual trustees, the member must be one of only two trustees (and cannot be the sole trustee) where the other trustee is:

a. A relative of the member; or

b. A person who does not employ the member;

(c) No trustee may receive remuneration for services performed for the SMSF; and

(d) No director of a corporate trustee may receive remuneration for services performed for the SMSF.

  1. What does the Australian Taxation Office require when a member of an SMSF enters bankruptcy?

3.1       The Australian Taxation Office (“ATO”) will provide a six (6) month “grace period”[3] before the SMSF is ceased, which will allow a restructure of the SMSF so that it either:

(a) Meets the basic conditions required; or

(b) Can be rolled over into an industry/corporate fund.

3.2        During that six (6) months, the ATO requires the following:

(a) the bankrupt must remove themselves as trustee/director of corporate trustee as soon as possible;

(b) the bankrupt must inform the ATO in writing using Form NAT 3036;

(c) the bankrupt must notify ASIC of the resignation as director if the SMSF is run by a corporate trustee; and

(d) where the ATO is being informed of a change in trustee, there is a requirement that the ATO be notified within 28 days of the change.

  1. What should you do if you are a member of an SMSF and you face bankruptcy?

4.1  What happens when it’s a single member fund?

If there is a power to appoint a new director of a corporate trustee contained within the SMSF trust deed, that new director can be appointed and then organise for:

(a) the sale of the property; and

(b) the transfer of liquid assets (including the proceeds of sale of the property) into a managed fund.

This can be done during the six (6) month grace period where the member can remain a member as long as that person is no longer the director of the corporate trustee.[4]

The same would apply for individual trustees, as there must be a second trustee in the case of a single member SMSF.

4.2  What happens if it’s a fund with more than one member, but only one of the members enters bankruptcy?

The bankrupt member will need to resign as director or trustee as soon as possible and again, the member who is not bankrupt will need to act to remove the bankrupt’s property from the SMSF before the grace period is over.

The non-bankrupt member will need to:

(a) sell any real estate and halve the proceeds;[5]

(b) transfer the bankrupt’s share of the liquid assets to a managed fund; and

(c) consider whether they want to remain as a single member SMSF, or otherwise roll over their entitlements to a managed fund.

4.3  What happens if both members enter bankruptcy?

If there is a corporate trustee, the actions noted at 4.1 could be followed. However, it should be noted that this would not be acceptable if the SMSF had individual trustees.

In the event of the latter, the trustees would need to immediately sell all assets for the market value available at the time, and then transfer all of the liquid assets to a managed fund.

4.4  When will a bankruptcy trustee try to claw back payments to an SMSF?

A bankruptcy trustee may claw back payments or contributions which are made to defeat creditors. We therefore recommend that from the beginning of the SMSF, the members contribute monies on a regular basis, and, ideally, those monies should be in regular amounts. The regularity of payments would demonstrate that monies held in the SMSF have not been paid in to defeat creditors, but rather for the purposes for which the SMSF is intended.

Bankruptcy of a member can significantly affect the operation and even existence of an SMSF. If you face bankruptcy or have been made bankrupt, we recommend you immediately seek financial and legal advice in order to meet your ATO requirements, change the structure of the SMSF and/or roll over your entitlements to a managed fund.

Author: Sarah Jones, Legal Practitioner Director

Published: May 2015

[1] This article is not a substitute for obtaining legal advice. We recommend you seek both legal and financial advice before proceeding with any of the actions suggested in this article.

[2] Australian Taxation Office: Self-Managed Super Fund Statistical Report, June 2014 https://www.ato.gov.au/super/self-managed-super-funds/in-detail/statistics/quarterly-reports/self-managed-super-fund-statistical-report—june-2014/

[3] Pursuant to section 174A(4) of the Superannuation Industry (Supervision) Act 1993 (Cth). Note that this grace period is the earlier of 6 months or the appointment of a Registrable Superannuation Entity licensee to the fund.

[4] Keep in mind that if the member is the shareholder of the corporate trustee, then the trustee in bankruptcy could potentially have the right to appoint a different director (using his/her rights as a shareholder).

[5] The benefit of real estate cannot remain wholly with the non-bankrupt member where the property was bought for the SMSF as a whole.

Section 54 – Insurance Contracts Act 1984

Section 54 – Overview

(i)     Operates as shield for insured parties to prevent Insurers from denying claims based on minor breaches of the insurance policy.

(ii)    Does not ordinarily grant a right of action to Third Parties – limited usefulness in recovery.

Section 54 (1)

  • Insurer may not refuse to pay claims in certain circumstances: – (1)  Subject to this section, where the effect of a contract of insurance would, but for this section, be that the Insurer may refuse to pay a claim, either in whole or in part, by reason of some act of the Insured or of some other person, being an act that occurred after the contract was entered into but not being an act in respect of which subsection (2) applies, the Insurer may not refuse to pay the claim by reason only of that act but the Insurer’s liability in respect of the claim is reduced by the amount that fairly represents the extent to which the Insurer’s interests were prejudiced as a result of that act.
  • Previously, a breach of policy conditions would allow an Insurer to refuse payment of the claim.
  • Section 54 prevents the Insurer from refusing to pay the claim.
  • Claim may still be reduced by the Insurer – the question is what monetary prejudice has been caused by the act?

Example

  • A has a policy that covers him only while driving with a licence.
  • A drives unlicensed and is involved in an accident with B.
  • The accident was 100% the fault of B and was in no way connected with A driving unlicensed.
  • The Insurer is not able to deny coverage to A because he was driving unlicensed and will not be able to reduce the amount paid out.

Section 54(2)

  • (2)  Subject to the succeeding provisions of this section, where the act could reasonably be regarded as being capable of causing or contributing to a loss in respect of which insurance cover is provided by the contract, the Insurer may refuse to pay the claim.

Section 54(3) and (4)

  • (3)  Where the Insured proves that no part of the loss that gave rise to the claim was caused  by the act, the Insurer may not refuse to pay the claim by reason only of the act.
  • (4)  Where the Insured proves that some part of the loss that gave rise to the claim was not caused by the act, the Insurer may not refuse to pay the claim, so far as it concerns that part of the loss, by reason only of the act.

Sections 54(2) – (4)

  • Briefly:

– If the act COULD cause the loss to arise, the claim may be refused.

– The Insured may still prove that the act DID NOT cause the loss to arise, and if they do, then the claim cannot be refused.

– Otherwise, the Insured may prove that the act only CONTRIBUTED to the loss, and if they do, then the claim cannot be refused, but can be reduced (potentially to nil).

Example

  • A has an insurance policy that covers him only while driving in a sober state. A drives his car while drunk. He is involved in an accident with B.
  • B was also drunk and the accident was 50% his fault and 50% the fault of A due to his drunkenness. This is the finding at a final hearing by a magistrate.
  • The Insurer in not able to fully deny the claim, but would be able to reduce the payout by 50%.

Example 2

  • Driver “A” has an insurance policy for a work truck. The policy stipulates that he is not allowed to carry flammable materials.
  • A sees a gap in the market and begins transporting highly flammable gas canisters.
  • A’s truck’s engine catches fire one day and the whole truck, loaded with flammable gas is destroyed.
  • At Hearing, if A manages to prove that the truck would have been destroyed regardless of the gas it was carrying.
  • The Insurer would not be able to refuse the claim, or even reduce it in this instance.

Example 2 – Twist

  • What if A had been required to notify his Insurer if he was undertaking in activities outside of the insurance policy (such as carrying flammable material) but had not done so?
  • The claim still could not be refused.
  • May be reduced to nil. Insurer was denied the opportunity to collect higher premiums, or deny the policy outright if the risk was too great.
  • The operation of section 54 will always depend on the wording of the insurance policy.

Excess Clauses

  • Provide a monetary value which the Insured must bear on each claim.
  • Exist to:

– Clear Insurer’s books of small claims

– Create an incentive for people to manage their own risk/ disincentive to claim.

  • Do not exist to:

– Allow the Insurer to escape paying claims of Insured’s who are bankrupt or insolvent.

Excess Clauses – Cont.

  • Generally, the Insurer in a regular contract of insurance cannot require payment of an excess as a precondition for accepting liability for the claim.
  • Even if it was a precondition, section 54 would operate to prevent the claim being refused.
  • However – in practice with motor vehicle claims – Insurers use excess clauses as a ‘stonewall’ to avoid paying claims when their Insured’s cannot pay the excess.

Usage of Section 54 in Recoveries

  • Generally, only the Insured or a beneficiary of the policy party can invoke section 54.
  • Section 54 gives no right of action to third parties.

– Note, in NSW, an Insurer may be proceeded against directly with leave of the court. This has proven difficult to obtain.

What can be done in the situation of unpaid excess?

  • Request can be made to Insurer to settle the claim less the excess.
  • Insured third party may be coached/ educated into making the request themselves.

Requesting the Insurer pay under S 54

  • Advantages

– Cheap – no harm in asking.

  • Disadvantages

– Ineffective – many Insurers will refuse/ ignore.

– No legal recourse if they do refuse.

– Even if they are willing, they may still need to discuss with their Insured before doing so and must be able to contact them.

Author: Shan Auliff, Senior Associate

Published: May 2015