When the builder becomes bankrupt: what happens to the contract the site and the homeowner claim

What it is

Bankruptcy is the process under the Bankruptcy Act 1966 (Cth) that applies to an individual who cannot pay debts as they fall due. Where a residential builder operates as a sole trader (rather than through a company) and they become bankrupt the Act provides for a trustee in bankruptcy to take over the assets of the bankrupt person and distribute them to creditors. Bankruptcy is different from liquidation. Liquidation applies to companies under the Corporations Act 2001. Bankruptcy applies to natural persons.

For a homeowner mid-build with a sole trader builder bankruptcy has three immediate effects.

• The builder loses the legal right to deal with their property and finances. The trustee steps in.
• The contract is at risk. The trustee can disclaim onerous contracts under section 133 of the Bankruptcy Act.
• The builder license is at risk. Most states automatically suspend or cancel a builder license on bankruptcy.

How bankruptcy starts

Three paths.

Voluntary bankruptcy (debtor petition)

The builder lodges a debtor petition with the Australian Financial Security Authority (AFSA). On acceptance the builder is bankrupt from that date.

Creditor petition

A creditor with an unpaid debt over $10000 obtains a court order. Bankruptcy commences on the date of the sequestration order.

Part X arrangement gone wrong

A Part X personal insolvency agreement can fail and convert to bankruptcy.

The homeowner can confirm a bankruptcy by searching the AFSA National Personal Insolvency Index (NPII). The search returns the bankrupt name commencement date trustee name and contact.

What happens to the building contract

Under section 133 of the Bankruptcy Act the trustee has 28 days from receiving a written notice from a contract counterparty to elect whether to disclaim the contract. Most building contracts are disclaimed because they are onerous (the bankrupt cannot perform). On disclaimer the contract is terminated. The homeowner becomes an unsecured creditor for any deposit or progress payment made but not earned.

Where the trustee does not disclaim within 28 days the contract continues in form but the bankrupt builder is no longer licensed and cannot lawfully do residential work. In practice the contract is dead on its feet.

What survives

Two things survive the bankruptcy and matter most to the homeowner.

Statutory home warranty insurance

Statutory home warranty insurance is taken out at the start of the contract by the builder for the benefit of the homeowner. It is a policy on the work not on the builder. The bankruptcy of the builder is one of the trigger events under the policy. The homeowner can claim against the scheme insurer.

• NSW HBCF (icare) up to $340000 per dwelling.
• VIC DBI (VMIA) up to 20 percent of contract price for non-completion plus warranty cover.
• QLD QHWIS (QBCC) up to $200000 base $300000 with bolt-on.
• WA Home Indemnity Insurance through approved insurers.
• SA Building Indemnity Insurance through approved insurers.
• ACT Home Building Compensation Insurance.

Statutory warranties

The statutory warranties in each state Home Building Act run with the property. They are not extinguished by the builder bankruptcy. The warranties are enforceable against the builder personally for any debt above the insurance cap. The trustee handles the proof of debt.

Where the homeowner stands as a creditor

Any amount owed by the builder to the homeowner above the statutory insurance recovery is an unsecured debt provable in the bankruptcy. The homeowner lodges a proof of debt with the trustee using AFSA forms. The trustee assesses the claim and either admits or rejects it.

Recovery for unsecured creditors in personal bankruptcy is typically low. Statistics published by AFSA show most unsecured creditors recover cents on the dollar. The statutory insurance is the real recovery path. The proof of debt is a backup for amounts above the cap.

What the homeowner does in the first week

Get bankruptcy proof

NPII search printout and a copy of the trustee appointment letter. This is needed by the statutory insurer.

Secure the site

Lock it down. Take photos. Record what materials are on site (some belong to the trustee some belong to the homeowner depending on whether they were paid for).

Stop further payments

Cancel any direct debit. Do not pay any further progress payments to the builder personal account.

Contact the statutory insurer

NSW icare HBCF. VIC VMIA DBI. QLD QBCC. Lodge the claim with the trigger event proof and document checklist. Time matters. NSW 6 months from awareness. VIC within warranty period. QLD 3 months.

Notify the state regulator

NSW Fair Trading Consumer Affairs Victoria QBCC etc. The license is likely already cancelled but the notification creates the record.

Lodge a proof of debt

Lodge the proof of debt with the trustee for any amounts owed above the insurance recovery cap. AFSA forms.

Why bankruptcy is different from company liquidation

A company in liquidation is wound up. The directors lose control. Assets are sold and creditors paid in order of priority. The company is then deregistered. Personal bankruptcy is similar in structure but the bankrupt person remains alive. The bankruptcy lasts 3 years and 1 day from filing the statement of affairs. After discharge the person can apply for a new builder license (subject to state probity rules).

For the homeowner the practical effect is the same. The statutory insurance is the recovery path. The proof of debt is the backup. The contract is dead. A replacement builder is needed to finish the work.