Bankruptcy and life insurance

Section 116(2) of the Bankruptcy Act excludes (subject to certain provisions) from section 116(1) the following property:

• policies of life assurance or endowment assurance in respect of the life of the bankrupt or the spouse or de facto partner of the bankrupt;
• the proceeds of such policies received on or after the date of the bankruptcy.

There is a longstanding discrepancy between the Bankruptcy Act and Life Insurance Act as to what constitutes a policy of life insurance. This means that a life insurance policy under the Life Insurance Act may not be considered a life insurance policy under the Bankruptcy Act or at common law, and may therefore not be exempt from being property divisible amongst a bankrupt’s creditors under section 116(2).

The decision by the Supreme Court of Western Australia in Berryman v Zurich Australia Ltd [2016] WASC 196 held that a bankrupt’s entitlement to claim a TPD benefit under a life insurance policy is not an entitlement that is divisible among the bankrupt’s creditors and therefore does not vest in the Official Trustee in Bankruptcy.

Mr Berryman was a self-employed carpenter who suffered an accident at work on 7 July 2009, when a large granite rock crushed his foot. On 16 November 2009, he made a claim under his Protection Plus policy with Zurich, which commenced on 17 June 2009, for the payment of a TPD benefit of $2 million, which was subsequently declined. On 29 August 2014, Mr Berryman commenced an action for damages against Zurich for breach of contract in the sum of $2 million. He was declared bankrupt on 31 August 2015.

The judge, Justice Tottle, held that the TPD claim fell within sections 60(4) and 116(2)(g) of the Bankruptcy Act. Section 60(4) preserves the right of a bankrupt to continue with an action in respect of the rights specified in section 116(2)(g). It states:

Notwithstanding anything contained in this section, a bankrupt may continue, in his or her own name, an action commenced by him or her before he or she became a bankrupt in respect of:

(a) any personal injury or wrong done to the bankrupt, his or her spouse or de facto partner or a member of his or her family; or

(b) the death of his or her spouse or de facto partner or of a member of his or her family.

Section 116(2)(g) of the Bankruptcy Act excludes from property divisible amongst the creditors of a bankrupt:

any right of the bankrupt to recover damages or compensation:

(i) for personal injury or wrong done to the bankrupt, the spouse or de facto partner of the bankrupt or a member of the family of the bankrupt; or

(ii) in respect of the death of the spouse or de facto partner of the bankrupt or a member of the family of the bankrupt;

and any damages or compensation recovered by the bankrupt (whether before or after he or she became a bankrupt) in respect of such an injury or wrong or the death of such a person;

Justice Tottle considered that with respect to the law of bankruptcy, the TPD claim should be characterised as a claim for compensation for a personal injury or wrong which was not part of the legitimate entitlements of creditors.

Subject to one obtaining professional legal advice, it may be worthwhile for individuals who are generally at greater risk of being sued by potential creditors to consider having their spouses or de factor partners own TPD and/or trauma policies on the lives of the persons at risk, thus ensuring that any policy proceeds would be protected, regardless of bankruptcy status. However, this ownership structure has inherent risks, for example, that in the event of a relationship breakdown, there may be issues for insured persons in lodging a claim or accessing claim payments if they are not the policy owner.

Depending on one’s circumstances, one’s life insurance policies and their proceeds may afford protection for bankrupts against claims by creditors. The timing of a life insurance claim may be crucial in ensuring that policy proceeds are received on or after the date of bankruptcy of the insured person.