Bankruptcy and Divorce: An Unhappy Marriage

The bankruptcy of a party, or the risk of it, adds an additional layer of misery and complexity to financial remedy proceedings. This article aims to mitigate at least the latter issue.

It covers the following:

• An overview of the bankruptcy process for the financial remedy lawyer:
• The basics of bankruptcy.
• How obligations arising out of financial remedy orders are treated both within a bankruptcy and after the bankruptcy order has been discharged.
• The impact of a party’s bankruptcy before and after a final financial remedy order has been made:
• When is the final financial remedy order safe from challenge?
• What impact will the bankruptcy have on enforcement of the final financial remedy order?
• Practical and procedural considerations, namely what to consider both before and after a bankruptcy petition has been presented.

For ease of reading, it is assumed throughout that a husband, ‘H’, is the party who is either bankrupt, or at risk of bankruptcy, and that a wife, ‘W’, is the non-bankrupt spouse.

An overview of the bankruptcy process for the financial remedy lawyer

The basics of bankruptcy

In broad terms (see Insolvency Act 1986, ss 264–271 for the full detail), the bankruptcy process usually starts with a statutory demand, i.e. a written demand for payment of a debt, from a creditor to a debtor. If the debtor does not pay the sum due under the statutory demand within 3 weeks, and the demand is for £5,000 or more, the debtor is at risk of the creditor issuing a bankruptcy petition against them.

If a bankruptcy petition is issued, it will be heard by the Insolvency and Companies List (ICL), previously known as the Bankruptcy Court. If the ICL deems that the debtor owes his creditors £5,000 or more in unsecured debts and appears to be unable to pay or have no real prospect of being able to pay those debts, a bankruptcy order will be made.

An individual can also seek to make himself the subject of a bankruptcy order, albeit on application to an adjudicator at the Insolvency Service rather than to the court (IA 1986, s 263H). This involves an online application, following which the adjudicator checks whether the requirements for bankruptcy are met, and decides whether or not to make a bankruptcy order.

It should be noted that all those who meet the criteria for bankruptcy are insolvent, but not all those who are insolvent will meet the criteria for bankruptcy. An individual can be insolvent: (1) if they are unable to pay their debts as they fall due; or (2) if the value of their debts exceeds the value their assets. A person may satisfy the latter test but nonetheless have sufficient cashflow to pay their debts, and thus not meet the criteria for bankruptcy.

On the making of the bankruptcy order, the estate of the bankrupt (subject to a few exceptions, considered below) vests first in the Official Receiver and then, when appointed, the bankrupt’s Trustee in Bankruptcy (TIB). It is not just the assets which the bankrupt owns at the point the bankruptcy order is made which vest in the Official Receiver/TIB. Rather, the assets owned and acquired by the bankrupt from the date of the bankruptcy petition up until the date the bankrupt is discharged from bankruptcy (IA 1986, s 307) vest in the Official Receiver/TIB.

The TIB will then set to work administering the bankrupt’s estate so as to satisfy, as far as possible, the debts which fall within the scope of the bankruptcy. This will include the sale of any family home. If the bankrupt’s spouse or ex-spouse lives at the property, the TIB will usually wait for a year after the making of the bankruptcy order before seeking an order for sale, as after a year it is much easier for the TIB to obtain an order for sale (IA 1986, s 336). The TIB must, however, apply for such an order within 3 years of the bankruptcy order (IA 1986, s 283A), otherwise the TIB’s interest in the property will revest in the bankrupt, known as the ‘use it or lose it’ provision.

There is an order of priority in which the creditors in the bankruptcy will be paid. For our purposes it is important to note that the TIB’s costs will be paid first, that secured creditors, e.g. mortgagees, are next in line, and unsecured creditors are at the very bottom of the pile.

The bankrupt is usually discharged from bankruptcy a year after the bankruptcy order is made (IA 1986, s 279(1)). Following discharge, the bankrupt is generally no longer liable for the balance of their remaining debt (IA 1986, s 285), although there are some key exceptions in respect of obligations arising out of financial remedy orders, which are considered below.

From the point at which a bankruptcy petition is presented, up until the bankrupt’s discharge from bankruptcy, the Financial Remedies Court (FRC): (1) will only be able to make limited orders against a bankrupt, as their assets will, in the main, vest in their TIB for distribution to their creditors; and (2) is unlikely to make any orders in favour of a bankrupt, as those assets will also, in the main, simply vest in their TIB for distribution to their creditors.

How obligations arising out of financial remedy orders are treated within a bankruptcy

Debts in a bankruptcy can be either provable or non-provable. If a debt is provable, the creditor can seek to recover it from the bankrupt’s estate as part of the bankruptcy process. If it is non-provable, it cannot be recovered as part of the bankruptcy.

An obligation arising out of a financial remedy order is not a provable debt in the bankruptcy unless it is an order to pay a lump sum or an order to pay costs (Insolvency (England and Wales) Rules 2016 (SI 2016/1024), r 14.2(c)(ii)). That is, if at the time a bankruptcy order is made against H, there is a financial remedy order in place requiring him to pay a lump sum or costs order to W, W can become a creditor in the bankruptcy and seek to recover the sums from H this way. Note that CMS child maintenance obligations are also not provable in the bankruptcy (IR 2016, r 14.2(c)(iii)).

How obligations arising out of financial remedy orders are treated after the bankrupt is discharged from bankruptcy

The general rule is that all provable debts are wiped out upon an individual’s discharge from bankruptcy. However, the Insolvency Act 1986 makes an exception for any debt which arises under an order made in financial remedy proceedings (whether provable or non-provable) and for CMS obligations, such that these will remain alive and enforceable unless the ICL directs otherwise (IA 1986, s 281(5)). Such a direction from the ICL is rare (Hayes v Hayes [2012] EWHC 1240 (Ch)), although see McRoberts v McRoberts [2012] EWHC 2966 (Ch), [2013] BPIR 77 for a case in which the husband succeeded in having his provable obligations arising out of a financial remedy order erased on his discharge from bankruptcy. Note that this does not affect the FRC’s own powers to vary a party’s obligations pursuant to a financial remedy order, e.g. by remitting arrears of maintenance pursuant to Matrimonial Causes Act 1973, s 31.

The impact of a party’s bankruptcy before a final financial remedy order has been made

The final orders the FRC is able to make against a party after a bankruptcy petition has been presented against them up until their discharge from bankruptcy are extremely limited. Specifically, as set out below:

• Property adjustment orders: these are not possible, as the bankrupt’s interest in any property will have vested in his TIB (IA 1986, s 306). Bear in mind, though, that the court is able to make declaratory orders regarding where the beneficial interests in any given asset lie, i.e. orders determining what has vested in H’s TIB and what remains beneficially with W. This will be carried out in line with general property law principles as opposed to the discretionary approach that ordinarily applies between divorcing spouses.
• Lump sum orders: the bankrupt does not hold any assets in respect of which lump sum orders can be made (IA 1986, s 306). However, the court can make an order for a lump sum out of future assets, if it is able to make a clear finding as to what those future assets will be. This will usually only arise in the very specific scenario where there is likely to be money left over after H’s creditors have been paid within the bankruptcy process. An order can then be made for H to pay W a lump sum out of the anticipated residual estate (Hellyer v Hellyer [1996] 2 FLR 579 (CA); Gudmundsson v Lin [2024] EWHC 1576 (Fam) at [25]).
• Periodical payment orders: the bankrupt’s income does not automatically vest in the TIB, so the court can theoretically make an order against H for periodical payments (Albert v Albert [1996] BPIR 233).

Note, though, that the FRC is not alone in its ability to reach the bankrupt’s income. The ICL is also able to do this, on application of the TIB, by way of an income payments order (IPO) (IA 1986, s 310). This is an order whereby the bankrupt is required to contribute part of his income to meet his creditors’ claims. An IPO can last for up to 3 years after an individual is discharged from bankruptcy (IA 1986, s 310(6)(b)) and will take precedence over any order of the FRC (Albert). The bankrupt may thus simply not have the available income to warrant a periodical payment order being made, at least during the currency of the IPO.

• Pensions: pension assets do not vest in the TIB but remain with the bankrupt (Welfare Reform and Pensions Act 1999, s 11(1)). They remain available for re-distribution as usual in financial remedy proceedings through the making of pension sharing orders, etc. A few words of caution should, however, be borne in mind:
• If a pension is in payment, the income from it can be made subject to an IPO. Note, however, that a bankrupt cannot be forced to elect to exercise his pension rights (Horton v Henry [2016] EWCA Civ 989), i.e. if a pension is capable of being drawn, but has not been drawn, the TIB cannot force the bankrupt to draw it.
• In order to be protected from the TIB, the pension has to be in an ‘approved’ pension scheme (WRPA 1999, s 11(1)).
• If, in the run up to his bankruptcy, H has made pension contributions which are deemed to be excessive, the TIB can claw these back (WRPA 1999, s 15), thus reducing the overall pension pot available for distribution.
• Costs orders: these can be made. They will be provable in the bankruptcy if deemed to relate to an obligation incurred prior to the bankruptcy (see Re Nortel Companies [2013] UKSC 52) and will, in any event, ordinarily survive H’s discharge from bankruptcy, although he is not likely to have much by way of assets at this point by which to meet them.

The impact of a party’s bankruptcy after a final financial remedy order has been made

When is the final financial order safe from challenge?

As long as the final order in the divorce has been made and the final financial remedy order has been sealed, the TIB is extremely unlikely to be able to challenge the terms of the order. Note that the financial remedy order does not need to have been implemented (Mountney v Treharne [2002] EWCA Civ 117).

There are certain, limited, circumstances in which the TIB can apply for the final financial remedy order to be set aside, as the TIB has the power, in certain situations, to unravel transactions made prior to the bankruptcy (see IA 1986, ss 339, 340 and 423). For such an application to succeed, the TIB must show that there has been fraud and collusion between H and W, or some other vitiating factor, in reaching the order (Hill v Haines [2007] EWCA Civ 1284, [2008] Ch 412). Note that parties frequently declare they are solvent at the time of entering into a financial remedy consent order in an effort to reduce the likelihood of any such allegation.

In practice, the bar for establishing such fraud and collusion is very high, and there have been no reported cases from Hill v Haines onwards in which a financial remedy consent order has been set aside on this basis in a bankruptcy context. For an illustration of just how difficult it is for the TIB to succeed in such an application, see the case of Ball v Jones [2008] 2 FLR 1969. Here, a consent order was made giving the husband almost all of the matrimonial assets, whilst the later bankrupt wife retained next to nothing. The court found that the consent order had been reached in circumstances where the wife: (1) was probably insolvent at the time the order was agreed; (2) had likely understated her debts; and (3) had agreed to the order against the advice of her solicitors. It was held that this did not amount to collusion or constitute any other vitiating factor, and the TIB was not able to set the consent order aside.

What impact will bankruptcy have on enforcement of the final financial remedy order?

Whether it is possible to enforce a final financial remedy order against an undischarged bankrupt will depend on the type of order sought to be enforced:

• Property adjustment orders: these are enforceable, even if not yet implemented, on the basis that once a property adjustment order takes effect with the making of the final order in the divorce, it confers on the receiving party an equitable interest in the property in question (Mountney v Treharne).
• Lump sum orders and costs orders: these cannot be enforced as H has no assets against which the enforcement can ‘bite’. However, as set out above, lump sum orders and costs orders which exist at the time the bankruptcy order is made are provable debts in the bankruptcy. W can thus claim these as a creditor in the bankruptcy. As both will ordinarily survive the bankruptcy, W can also enforce them in the usual way once H is discharged from bankruptcy (if and when H has accumulated sufficient assets to meet them, of course). Note, however, that interest will not accrue on these debts after the date of the bankruptcy order (IR 2016, rr 14.23(1) and 14.1(3)).

The situation is different if the final financial remedy order provides for H to pay W a lump sum with a sale of property in default. In those circumstances, W is deemed to have an equitable interest in the relevant property, which she can realise unaffected by H’s bankruptcy (DW & Anor v CG [2016] EWHC 2965 (Fam)).

• Pension sharing orders: as H’s pension assets remain vested in him, these are enforceable in the usual way.
• Periodical payment orders: as set out above, an obligation to make periodical payments will continue during and survive H’s bankruptcy. In practice, however, W is likely to struggle to seek for arrears to be paid whilst H is an undischarged bankrupt due to the lack of assets available to him from which to do so. Whilst W can theoretically seek payment of the arrears on H’s discharge from bankruptcy, this will be subject to the FRC’s powers to remit the arrears under MCA 1973, s 31.

Additionally, recall that the ICL has the power to make an IPO in respect of H’s income, and that this will take priority over any periodical payment order made by the FRC. H might well have a strong case for a downward variation of a periodical payment order if an IPO has been made which renders it unaffordable.

Practical and procedural considerations

What to consider before a bankruptcy petition has been presented

The following should be borne in mind:

• It is crucial to obtain final orders in both the divorce and the finances as soon as possible. Once a bankruptcy petition has been presented, there is a real limitation on the orders the FRC can make and the assets which will be available for distribution in financial remedy proceedings.
• If there is a concern that a party might make themselves bankrupt, it is worth inviting them to offer an undertaking not to apply for bankruptcy without the other’s agreement, and considering an application for an injunction prohibiting them from doing so if the undertaking is not forthcoming.
• Think very carefully about the substantive final orders you ask the court to make. For example:
• Be wary of seeking any kind of chargeback order. If a party has a deferred interest in a property, and is then made bankrupt, the TIB can apply for an order for sale of that property before any of the trigger events have occurred in order to realise the bankrupt’s interest in it (Avis v Turner [2007] EWCA Civ 748).
• If seeking a lump sum order, ensure that wherever possible you also ask for a default order for sale in order to give W the protection set out in DW & Anor v CG.
• Consider whether it is possible to ensure that any monies due to W are secured. Then, if H is made bankrupt, W avoids being at the bottom of the pile in terms of creditors in the bankruptcy.

What to consider after a bankruptcy petition has been presented

Think carefully about the point at which you want the court to be making final orders. For example, if you are for W, you may want W’s claims to be adjourned until H is no longer an undischarged bankrupt and has had the time and opportunity to accrue assets post-bankruptcy. Similarly, if you are for H, and W has significant assets in her name, you may also want to wait until H’s discharge so that H can benefit from a share of these assets in due course. Note, however, that there does not to date appear to be a reported decision where an adjournment has been sought and/or granted on this basis.

Is this a case where an application to annul the bankruptcy should be considered? A bankruptcy order may be annulled if it appears to the court that the order ought not to have been made (IA 1986, s 272(1)). An application to annul is not to be made lightly but may need to be considered if, for example, H has unnecessarily petitioned for his own bankruptcy with the intention of defeating W’s claims. See Paulin v Paulin [2009] EWCA Civ 221 for a case where an application to annul succeeded and Merkarska v Ruiz [2011] EWCA Civ 1646 for a case where it did not. Also see the case of DDR v BDR [2024] EWFC 278 for a judgment in a financial remedy claim following a failed application by the wife to annul the husband’s bankruptcy (it is also worthwhile reading as the court considered the question of the wife’s beneficial interest in the family home legally owned by her bankrupt spouse).

Negotiate and attempt to narrow the issues between the parties and the TIB. For example, can agreement be reached on the beneficial ownership of the assets? Can W buy out the share of the family home which has vested in the TIB?

Consider whether the TIB should be joined to proceedings. There will likely be a need for this if there is a dispute about the beneficial ownership of any assets, and thus a dispute regarding what vests in the TIB and what does not:

• Note that the TIB must in any event be made aware of the proceedings so that they have the opportunity to apply to intervene. The risk otherwise is that proceedings get underway, the TIB becomes aware of them, and raises a reason for them to be undone.
• If there is no real dispute between the parties and the TIB, invite the court to carefully scrutinise any application by the TIB to join (applying the usual test, i.e. whether joinder is ‘desirable’ (FPR 9.26B(1))) but remembering that proportionality is also relevant (Behbehani v Behbehani [2019] EWCA Civ 2301). The TIB’s costs of involvement in the financial remedy proceedings will come out of the bankrupt’s estate, with the result that less money is available for distribution elsewhere (including, potentially to W, who may be a creditor of H in the bankruptcy, or have a claim to any residual lump sum).

Final thoughts

Whilst by no means a comprehensive treatment of the topic, the above should provide the financial remedy lawyer with an overarching framework for dealing with a case involving issues of bankruptcy, making it a little less complex and perhaps (even if only from the perspective of the practitioner) a little less miserable.