By Christian Pakpahan, Lawyer and Bryce Figot, Special Counsel, DBA Lawyers
Bryce Figot is also the author of Complete Guide to SMSFs: Planning for Loss of Capacity and Death, you can refer to the book for more in-depth insights on the topic.
Broadly, a member’s interests in a superannuation fund are fully protected upon bankruptcy. This protection even extends to lump sums being paid to the bankrupt.
A question that may arise is whether this would be true if the benefit being received by the bankrupt is in respect of someone who has died (eg, a death benefit being paid to the deceased’s member’s bankrupt spouse). Would those benefits be protected from creditors? This would have implications for estate planning where there is potential for a dependant to go bankrupt.
Two recent cases help answer this question.
all property that belonged to … a bankrupt at the commencement of the bankruptcy, or has been acquired … after the commencement of the bankruptcy and before his or her discharge,
is property divisible among creditors of a bankrupt.
Property that is exempt from being divisible among creditors of a bankrupt is contained in s 116(2) of the Act. Subject to several anti-avoidance provisions, certain superannuation interests and payments are included in this exemption, particularly in s 116(2)(d)(iii) and (iv) of the Act.
the interest of the bankrupt in: (A) a regulated superannuation fund (within the meaning of the Superannuation Industry (Supervision) Act 1993) …
a payment to the bankrupt from such a fund received on or after the date of the bankruptcy, if the payment is not a pension within the meaning of the Superannuation Industry (Supervision) Act 1993.
That means the bankrupt’s interest in their own superannuation fund and lump sum payments from their fund are exempt from being divisible to creditors. However, the question is whether this extends to payments received from another person’s superannuation fund where that other person has died and it is determined that the bankrupt is to receive a death benefit. Two recent cases have helped clarify this.
Are lump sum death benefit payments to a bankrupt divisible among creditors?
The Federal Court handed down its decision in Morris v Morris  FCA 846 on 22 July 2016. A widow was made bankrupt on 28 August 2013, about three months after her husband passed away (19 May 2013) and seven months after she gave birth to her second child (26 January 2013).
After being made bankrupt, the widow received various death benefit payments from superannuation funds in respect of her late husband. The widow’s trustees in bankruptcy claimed that two of those payments were divisible to creditors of the bankrupt widow as they did not fall under the exemptions in s 116(2) of the Act. They argued that the interest in a regulated superannuation fund is the interest of the late husband and not the widow. Therefore, the property should not fall under either s 116(2)(d)(iii) or (iv) of the Act.
The court decided that although the widow initially did not have an interest in the superannuation fund, when the trustees of the respective superannuation funds exercised their discretion to pay death benefits in the widow’s favour, an interest in the superannuation funds was created thereby satisfying s 116(2)(d)(iii)(A) and exempting the property from being divisible to creditors. Further, the court also decided that s 116(2)(d)(iv) was satisfied, as the bankrupt widow directly received payments from the funds after the date of bankruptcy, and it was not a pension.
This case has clarified that, broadly, lump sum death benefit payments will be protected from creditors provided that the payments were determined using the exercise of appropriate powers of superannuation fund trustees and that they are directly received by the bankrupt.
Are lump sum death benefit payments divisible among creditors if the bankrupt receives it from a distribution of a deceased estate?
The Federal Court handed down a summary judgment that further clarifies death benefit payments and bankruptcy on 13 July 2017. In Cunningham v Gapes  FCA 787, the wife of a bankrupt received a distribution from the bankrupt’s deceased mother’s estate. The payment was made to the bankrupt but the wife received the money because the bankrupt did not have a bank account in his name. The distribution from the estate came from death benefit lump sum payments from the deceased mother’s superannuation fund.
The trustee of the bankrupt’s estate argued that the payment did not fall under s 116(2) exemption because the bankrupt did not have an interest in the superannuation fund, rather it was the deceased mother’s estate that had the interest. Further, in respect of s 116(2)(d)(iv), payment was not received from the fund, but rather it was received from the deceased mother’s estate. They argued that if it was accepted that it could pass through the deceased mother’s estate and still be considered a payment from the fund, then it would allow bankrupts to avoid property being made divisible to creditors simply by showing the source of their property was from a third party’s superannuation fund, regardless of how many hands the funds passed through.
The court agreed with the trustee of the bankrupt’s estate. The matter was distinguished from Morris v Morris by the fact that the benefits from the superannuation fund of the deceased were paid to the estate of the deceased prior to being distributed to the bankrupt. The court concluded that as a result, it could not be said that the money represented an interest of the bankrupt in a superannuation fund. The bankrupt only received the funds because he was a residuary beneficiary under his mother’s will and not because the trustee of the superannuation fund ever exercised any discretion giving him a proprietary interest in the fund.
This case clarified that for the relevant s 116(2) exemptions to apply, the superannuation fund death benefit payments must come directly from the exercise of the appropriate powers of the superannuation fund trustees in favour of the bankrupt and the bankrupt must receive the payments directly from the superannuation fund. If the benefit passes to the deceased estate first, in most cases, the benefit will become divisible among the creditors when it devolves to the bankrupt in accordance with s 116(1)(a) of the Act.
Estate planning lessons that can be learned from these two cases
It can be seen that, when it comes to bankruptcy, there are asset protection advantages in ensuring that death benefits go directly to the intended dependant. Keep in mind that pension payments are not exempt under s 116(2)(d)(iv) of the Act.
If one is aware of the bankruptcy or potential bankruptcy of a dependant, it would be wise to structure the succession plans so that the dependant receives lump sum death benefits directly from the superannuation fund, rather than having their portion go to the estate first and be dealt with by a will. (Naturally the situation could be different if the will caters for a testamentary trust under which the bankrupt is a mere discretionary object.)