Enforcing a mortgage in bankruptcy

One of the frequent issues that arises in the context of personal insolvency matters is the right of a secured creditor to take or continue legal action against property of the bankrupt.

Section 58 of the Bankruptcy Act 1966 (Cth) (Bankruptcy Act) sets out the longstanding general rule that:

• where a debtor becomes bankrupt, their property (with limited exceptions) vests in the bankrupt’s trustee¹
• except as provided by the Bankruptcy Act, creditors cannot commence legal proceedings or enforce any remedy against the person or property of the bankrupt in respect of a provable debt²
• however, and importantly for mortgagees to note, section 58(5) states that section 58 does not affect the rights of a secured creditor to realise or deal with its security³

Relevantly, a secured creditor is defined in section 5 of the Bankruptcy Act, and includes a person holding a mortgage, charge or lien on property of the debtor as a security for a debt due to them from the debtor.

The recent decision of Morris Finance Ltd v Brown⁴ confirmed that there is well established authority to support the proposition that legal proceedings brought by a mortgagee seeking an order for possession of mortgaged property falls within section 58(5) of the Bankruptcy Act such that proceedings can be brought or maintained against a bankrupt’s property.

As the Court outlined, a mortgage might (and in our experience generally does) contain express terms conferring an entitlement to possession and a power of sale, so that it may be said the ‘legal proceedings are merely ancillary to enforcing otherwise conferred rights.’

Practically speaking, this means that where a secured property remains occupied by a bankrupt, a secured party will normally need to seek relief of the Court (by way of orders for possession) to give effect to its right to enforce its security but not to authorise the enforcement of that agreement secured by the property.

Fundamentally, provided a lender’s security is valid and enforceable, bankruptcy is no bar to exercising rights to enter into possession and sale of the property to pay the secured debt.

There are a range of other complications that may arise, for example:

• where debtors of the bankrupt have lodged caveats over the security property
• where Family Court proceedings have been commenced by a joint mortgagor (whose interest converts to a tenancy in common upon the bankruptcy of the other mortgagor) and / or
• if the property is held beneficially by the bankrupt (eg if they are the trustee of a family trust),

which will be the subject of a further bulletin.

If you are the trustee appointed over a secured property which has vested in bankruptcy, this is an important consideration affecting your dealings with the bankrupt’s estate.