Australia: The Importance Of A Healthy Relationship – How Marriage Breakdown Can Impact Lenders And External Controllers

Although many lenders and external controllers would be unaware, since 17 December 2004, all loan transactions and external administrations involving a person married under Australian law, have been conducted subject to the provisions contained in Part VIIIAA of the Family Law Act 1975 (FLA).

In fact, the rights and powers of all lenders and external controllers are subject to interference by the Family Court of Australia. For example, the Family Court has the power to prevent a lender from exercising its power of sale, regardless of the extent of any default under the security, effectively giving primacy to the FLA over the lender’s security rights.

The pain associated with the breakdown of marriage now extends well beyond the warring spouses.

It’s important to mention that the Family Court has always had the power to make orders affecting third parties. However, Part VIIIAA is an entirely different regime that empowers the Court to discretionarily interfere with the rights and powers of ‘third parties’.

These far-reaching provisions were introduced by the enactment of the Family Law Amendment Act 2003 which has largely remained under the corporate radar; perhaps because the provisions are only applied in Family Court proceedings which, unless high profile individuals are involved, slip by without mention. It is also relevant that there has been no challenge to the constitutional validity of the provisions, perhaps because only a handful of decisions have applied Part VIIIAA against a third party. We acted for the third party lender in the most recent decision under the provisions.

Obviously, Part VIIIAA has the potential to impact many ‘third parties’ to a marriage other than lenders and insolvency practitioners. However, the scope of this article has been confined to an examination of the legislation as it impacts on these two, sometimes competing commercial interests. This article focuses on the provisions most likely to affect lenders and insolvency practitioners, and in particular, how the rights of lenders and the powers of insolvency practitioners may be fettered by discretionary interference from the Family Court. Where relevant, the practical impact of the provisions is explored, including by reference to our first-hand experience.

The provisions most relevant to this discussion are found in sections 90AA to 90AK of the FLA. The intent of these provisions was detailed in the explanatory memorandum that accompanied the Family Law Amendment Bill 2003, which may be summarised as follows:

• The provisions provide clear power for the Family Court to make orders binding on third parties when dealing with property settlement proceedings under the FLA.
• The Family Court will be given the power to bind third parties in order to give effect to property settlements including creditors or a party to a marriage who may be a friend, relative or financial institution.
• Procedural rights will be afforded to third parties to ensure that the provisions do not affect the underlying substantive property rights of a creditor.

Section 90AC(1) of the FLA provides that, among other things, Part VIIIAA has effect despite anything to the contrary in any other law (whether written or unwritten) of the Commonwealth, a State or Territory and anything in a trust deed or other instrument (whether made before or after the commencement of the Part). Accompanying these provisions is a release from contravention of a law or instrument which may be committed by a third party in complying with an order made under the Part.

In short, the provisions contained in Part VIIIAA override all Commonwealth and State legislation in force in Australia including the Corporations Act 2001 and the Trade Practices Act 1974. They may also be invoked to alter securities such as company charges and real property mortgages held by lenders. Essentially, nothing is sacred.

The provisions catch third parties by the notion that ‘debt’ is to be treated as ‘property’ for the purpose of property settlement proceedings brought under section 79 of the FLA. This means that the Court is now empowered to deal with debts of a marriage, including the rights, obligations and property of third parties. Because many section 79 proceedings conclude by the lodgement of consent orders, a third party may be joined to the proceedings simply to give effect to the agreement reached between the husband and wife. As detailed below, the basis for resisting such an agreement, even if it impacts negatively upon a third parties’ rights, is not clear cut.

Section 90AB defines ‘third party’ as a person who is not a party to the marriage. This means that a third party need not have an existing legal or other relationship with either spouse; third party status may arise by virtue of an order made at the discretion of the Court under Part VIIIAA to enable further orders to be made to bind that person or entity.

It is also important to note that these provisions may be invoked in proceedings for both interim and final relief which means that a third parties’ rights may be suspended by way of interim order or injunction pending the outcome of a trial and the making of final orders. The potential impact of such orders is obvious.

It remains to consider what orders can be made by the Court and how, in a practical sense, third parties such as lenders and external controllers may be affected.

Sections 90AE and 90AF of the FLA are of significant effect. Set out below is a description of the types of orders the Court may make under these sections, and a reflection on how those orders may impact lenders and external controllers:

The preceding three provisions permit any number of variations to credit and security arrangements between a lender, the parties to the marriage and related corporate entities, for example:

• The removal of joint liability under a mortgage or other security.
• The substitution of one spouse in favour of another in relation to a liability.
• The substitution of one party for another under a guarantee for another entities’ obligations.
• The substitution of a related corporate entity in place of the parties to a marriage under a mortgage or other security.
• These orders may be used to reallocate liability under securities where for instance, a house was used as collateral to purchase a business.

An order of this nature may result in a change to the majority shareholding within a company, sufficient to shift the balance of power. This could have a substantial negative impact on the value of a company, both as a going concern and in respect of any assets offered as collateral under a fixed and floating charge.

The right to obtain orders of this nature may also impact on the traditional approach to valuing a parcel of shares.

These provisions allow the Court to order the transfer of real property held in the name of a third party (including an entity subject to external administration) to one or both of the parties to the marriage.

The Court may determine that such an order is appropriate in circumstances where for instance, one or both spouses had contributed personal income to the cost of the property, or repayments made to a lender. Director’s loan accounts may be used by one or both spouses to attempt to establish a contribution made toward property held in the name of a company.

The impact these types of orders may have on a lender’s security position is substantial and should now be taken into account by lenders.

In addition to directly impacting a lender’s ability to enter into possession of secured assets, these provisions may also be invoked by a spouse to stop a trustee in bankruptcy or external controller of a related corporate entity from taking possession of assets for creditors.

We recently acted for a financial institution in an application for an injunction brought under these provisions. The wife (without the support of the husband), successfully restrained our client from entering into possession of numerous residential properties, despite the existence of clear defaults. The Judge’s justification for granting the injunction (of six months duration) was that there appeared to be sufficient equity in the properties to protect our client’s position until the Family Court proceedings could be resolved.

Lenders may also be affected if, say for instance, a landlord was restrained from entering into possession of certain property. It is conceivable that in such circumstances, the landlord may fall into default with its lender which may in turn seek to enter into possession of the premises. It is arguable that the lender could also be joined to the proceedings as a third party and in turn be restrained from entering into possession of the premises.

It is worth noting that all of these provisions may also be used to the advantage of a lender or external controller in certain circumstances. For instance, where Family Court property proceedings are under way, and a lender or external controller detect that one or both spouses have illegally transferred assets from, or assigned liability to a corporate entity, they may seek to intervene in the proceedings as third parties to seek appropriate orders.

The Court may only make an order under section 90AE, or grant an injunction under section 90AF, if all affected third parties have been accorded procedural fairness. This requires that all third parties must be notified and be given a right to be heard before any order is made against their interests.

In addition, before making an order or granting an injunction, the Court must be satisfied that certain criteria have been met, which include:

• The making of the order or granting of the injunction is reasonably necessary, or reasonably appropriate to effect a division of property between the parties to the marriage.
• The third party has been afforded procedural fairness in relation to the making of the order.
• It is not reasonably foreseeable that to make the order or grant the injunction would result in the debt not being paid in full.
• The court is satisfied that it is just and equitable to make an order, or just and convenient to grant an injunction.
• If the order or injunction concerns a debt of a party to the marriage, the capacity of a party to the marriage to repay the debt;
• The economic, legal or other capacity of the third party to comply with the proposed order or injunction.

While these provisions provide some protection to third parties, they contain no set criteria for determining what is ‘just and equitable’, and represent a fetter on third party’s rights. Accordingly, third parties must rely heavily on the solicitude of Family Court judges to ensure the provisions are applied appropriately. Perhaps most unnerving are the provisions that displace the ability of a lender to determine credit-worthiness of a potential borrower and the ability of the Court to determine whether it is likely that a debt will be paid in full. Commerciallydriven third parties will derive little comfort from these supposed ‘safeguard’ provisions.

Given the continued strong performance of Australia’s economy, and indeed that of the world economy since the introduction of Part VIIIAA to the FLA, the true impact of its provisions are not likely to be felt for some time. Likewise, high real property values and the relative ease with which parties to a failed a marriage can refinance their affairs will also have assisted these provisions to retain a low profile for so long. A downward turn in the economy may be all that is required to tighten the financial matrix; sufficient to cause parties to agitate more aggressively for their rights, and in turn, attempt to more vehemently interfere with the rights of third parties.

One thing is for sure, there is little a lender or external controller can do contractually to avoid exposure to contested Family Court proceedings. Perhaps one way for lenders to protect against the risk (and costs) of being joined to such proceedings is to incrementally adjust the interest rate charged to borrowers who may present such a risk. Likewise, external controllers accepting an appointment as receiver where there is a perceived risk of being joined to such proceedings, should ensure their indemnity covers any costs that may be incurred as a result of being joined to such proceedings.

This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.