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What happens on separation when relationship debts are greater than relationship assets?

What happens on separation when relationship debts are greater than relationship assets?

What happens on separation when relationship debts are greater than relationship assets?

Monday 29 June, 2020

It is not uncommon in a relationship for one partner to incur debts without the knowledge or consent of the other, or for one partner to have sole responsibility for a debt incurred for the benefit of both parties. Debts are classified as either relationship debts or separate debts under the Property (Relationships) Act 1976. A debt is generally considered relationship debt when it is incurred for the benefit of the relationship or relationship property pool.

If the parties separate, relationship debts are generally divided equally between the parties. However, if a couple incurs relationship debts that exceed the value of their relationship assets, this may not be possible.

The recent High Court decision in P v C [2020] NZHC 1178 is the latest word from the Courts on this important topic and concluded that the courts do not have jurisdiction to ‘split’ a liability between former relationship partners when there is negative equity.

P v C

The case involved a company of which Mr P was the sole director and in which Mr P’s trust owned 98% of the shares. There was a substantial current account debt owing by Mr P to the company which the Court found to be a relationship debt.

In determining the value of the relationship property that can be divided, section 20D of the Act provides that the total value of the relationship property is ascertained and then any relationship debts owed by either or both spouses or partners is deducted from that amount. After ascertaining the total value of the property and deducting the relationship debt, there was negative equity in Mr P and Ms C’s relationship property pool.

The Court held that where there is negative equity in the relationship property pool, the Court has no jurisdiction to divide the relationship property. The Court reasoned that the language of section 11 of the Act, which refers to an entitlement of each partner to share equally in relationship property, cannot apply to a negative equity situation.

Ramifications

If liabilities exceed assets when a relationship ends, then the Court is unable to make an order for division of the relationship property. If the parties cannot agree to share relationship debt, then a partner who has taken on a relationship debt in their sole name could be liable to repay the entire debt on their own. The liable partner may need to resort to ordinary civil remedies for recovery of a debt.

Conclusion

In these current uncertain times, with the full financial impact of the Covid-19 pandemic still unknown, this decision serves as a timely reminder to consider your asset planning carefully, including whether debt should be jointly or separately held. It is possible to restructure the ownership of debts and assets during the relationship, including through trust structures or indemnities for taking on a relationship debt, or enter into a contracting out agreement to clarify the division of property, including the division of a relationship debt in the event that the relationship pool is in negative equity. 

If you are concerned about your level of exposure to relationship debts, including amounts owed to a family company or trust, our private client and family law teams can advise you on how to protect and structure your assets, whether you are at the start of a relationship, or in a long-term relationship.