Bankruptcy – What is it?

Bankruptcy happens when a person is unable to pay their debts when they become due and payable, and a trustee is appointed to administer the debtor’s insolvent estate.

You are considered insolvent if you can’t pay your debts when they’re due.

A debtor can become bankrupt by filing their own debtor’s petition with the Official Receiver, or a creditor can make a debtor bankrupt by presenting a creditor’s petition to the Federal Circuit Court.

This article will answer the most-asked bankruptcy questions and give you information on becoming bankrupt.

How long does Bankruptcy last?

Bankruptcy lasts for three (3) years.

An undischarged bankrupt’s estate will be managed for that time, and upon satisfactory compliance with the trustee, will be over at the end of that period and the bankrupt will be discharged from bankruptcy.

Non-compliance with the trustee may result in the trustee filing an objection to the discharge (pursuant to 149B of the Bankruptcy Act) extending that time.

The Bankruptcy Amendment (Enterprise Incentives) Bill 2017 seeks to reduce the minimum time for bankruptcy from three (3) years, down to one (1) year.  However, at the time of writing this article, this has not been passed into law.

A debtor should be mindful however, that although becoming bankrupt only lasts three (3) years, their name will be on the National Personal Insolvency Index (NPII) permanently.  This means that their name will be searchable if a bank or investor chooses to conduct a search.

Is Becoming Bankrupt the Right Option to Take?

For both creditors and debtors, debt problems can be solved by going bankrupt.

For Debtors – The debtor doesn’t have any more debts and is able to start again after the discharge of the bankruptcy.  Almost all unsecured debts will be wiped by the bankruptcy.

This includes personal bank loans, credit card debts, etc.  However, there are some debts and obligations which are not wiped by the bankruptcy, HECS debt and child support payments, for example.

For Creditors – The creditors get a benefit of an independent person (the bankruptcy trustee) who works for the creditor(s) to manage the debtor’s estate to attempt to meet the obligations of the debtor.

If there are funds and assets to realise, then there is likely to make some payment toward the creditors debts that have not been paid by the debtor.

A creditor may not get paid everything that they are owed by the debtor, but it may be better than receiving nothing from the debtor.

How do you become bankrupt?

For Debtors – If a debtor wants to become bankrupt, they must file the statement of affairs and the debtor’s petition with the Official Receiver (AFSA).

If the debtor’s petition is accepted then the debtor has the option of appointing a registered trustee for the administration of the estate, however creditors can change the trustee later if they do not agree with the debtor’s choice.

The AFSA can also not accept the debtor’s petition on a number of grounds, such as the debtor not actually indebted enough to warrant bankruptcy, and that the debtor could likely pay the debts.

For Creditors – If a creditor wants to enforce a judgment with bankruptcy, they will need to apply to AFSA for a bankruptcy notice.  Once they are given the bankruptcy notice, they must serve the debtor with the notice.

The debtor then has twenty one (21) days to comply with the bankruptcy notice, by either pay the judgment debt, or make arrangements with the creditor for repayment.

The bankruptcy notice says:

You are required, within 21 days after service on you of the Bankruptcy Notice, to either:

(a) pay to the creditor the amount of the debt claimed; or

(b) make arrangements to the creditor’s satisfaction for settlement of the debt.

Non-compliance with the bankruptcy notice means that the debtor has committed an act of bankruptcy, and it is that act of bankruptcy which allows the creditor to present a creditor’s petition to the Federal Circuit Court.

Unless the debtor attempts to defeat the creditor’s petition, and ensuring that all of the special requirements of the Bankruptcy Act have been complied with, then the Registrar will likely make the sequestration order.

The sequestration order is the order making the debtor bankrupt.

What are the consequences of bankruptcy?

A bankrupt person has many obligations and restrictions which include:

1. The passport must be surrendered and permission must be given before there’s any overseas travel;
2. All the financial records of the bankrupt must be made available;
3. All of the divisible assets of the bankrupt must be available to the trustee;
4. The bankrupt isn’t able to act as a company officer (director or secretary);
5. The bankrupt isn’t able to trade with a registered business name without the disclosure that they are in fact bankrupt;
6. The bankrupt isn’t able to incur credit over a set amount with the disclosure to the lender that they in fact bankrupt.

The trustee will realise the bankrupt’s assets.  An asset that is able to be realised and can be divided among creditors and is called a divisible asset.  These divisible assets can include:

1. Property owned before the time the person becomes bankrupt or acquired during the proceedings;
2. Powers or rights over property that were in existence at the date of becoming bankrupt or doing the bankruptcy time;
3. The rights to exercise powers over any property.

Some examples of divisible assets may include:

1. Real estate – which includes the family home;
2. The contents of bank accounts; and
3. Items of personal property (vehicles for example).

The bankrupt’s assets which are not able to be realized may include:

1. Household items and necessary clothing;
2. Their tools of trade up to it indexed amount;
3. Any motor vehicles up to an indexed amount;
4. Property that has sentimental value;
5. Any superannuation payments;
6. Endowment policies or life insurance;
7. Compensation payments and certain damages; and
8. Any property that have sentimental value, being an award for cultural, sporting, academic achievement, or a military award.  This does not include any monetary awards.

A bankrupt person is still able to earn income up to a certain amount.  If there is an excess of this income, then a certain percentage must be paid into the estate.

If you want to end your bankruptcy, then you may be able to annul your bankruptcy.

How much can a Bankrupt Earn?

A bankrupt person is still allowed to work and earn money.  The amount that a bankrupt person can earn before making contributions is:

1. Number of Dependents – 0 – Income Allowable – $58,331.00
2. Number of Dependents – 1 – Income Allowable – $68,830.58
   
3. Number of Dependents – 2 – Income Allowable – $74,080.37
   
4. Number of Dependents – 3 – Income Allowable – $76,996.92
   
5. Number of Dependents – 4 – Income Allowable – $78,163.54
   
6. Number of Dependents – over 4 – Income Allowable – $79,330.16
   

So, this is a very reasonable amount of money.  If you are a working person with two (2) dependent children, then you can earn $74,080.37 before having to make any income contributions.

These amounts change, so you should always look here.

As well as collecting any income contributions, the bankruptcy trustee has a number of other duties.

What duties does the trustee have?

The trustee will:

1. Realise all of the assets of the bankrupt;
2. Investigate the financial affairs of the bankrupt;
3. Make any recovery of any assets necessary;
4. Report things to the creditors;
5. Report any offences;
6. Distribute any surplus funds to creditors.

The property and assets of the bankrupt will vest in the trustee once proceeding begins.  Vesting means that the trustee gains automatic rights and controls over assets and property without any special action being taken by the trustee. 

How are Creditors Impacted when someone becomes Bankrupt?

The unsecured and secured creditors of the bankrupt are impacted in different ways.

A secured creditor means that they have an interest over assets of the debtor.  One common example of this, is a bank that has a mortgage over real property.

If a creditor is unsecured they don’t hold a right or interest over a debtor’s asset.  An example of this, is a bank that is given a credit card to a customer.

A secured creditor can commence proceedings to enforce its security interest, to retake possession for example, or exercise the power of sale.

The unsecured creditors must lodge a proof of debt with the bankruptcy trustee and will be paid in the order of preference.

It is not just the current assets of the bankrupt which can be realised by the trustee, they can also void certain transactions to bring funds back into the bankrupt’s estate.

What are Voidable Transactions?

We have an entire article about voidable transactions in bankruptcy.

In the Bankruptcy Act, there are four (4) transactions which can be voided by the bankruptcy trustee, these are:

1. Undervalued transactions – section 120 of the Bankruptcy Act; and/or
2. Transfers to defeat creditors – section 121 of the Bankruptcy Act; and/or
3. Transactions where consideration given to a third party – section 121A of the Bankruptcy Act; and/or
4. Transactions giving preference to one creditor over other creditors – section 122 of the Bankruptcy Act.

The trustee is able to void the transactions above if he/she is able to do the following:

• Identify the transaction and identify the transaction as a voidable transaction in bankruptcy;
• Identify the other party to the transaction in order to get the property or money from them;
• Identify when the transaction occurred to prove it falls within the legislative time limits; and
• Ensure that the transaction was not protected property under the Bankruptcy Act.

As you can see, although bankruptcy is not a punishment, it can have very serious ongoing consequences for the bankrupt.

There are however some alternatives to bankruptcy.

What are the Alternatives to Bankruptcy?

There are a few alternatives to bankruptcy.  They are:

1. Informal debt agreements; or
2. Formal Part IX (Part 9) Debt Agreements; or
3. Part X (Part 10) Personal Insolvency Agreements.

Informal Debt Agreements

A bankruptcy lawyer can attempt to negotiate with the debtor or creditor in an attempt to resolve the dispute between the parties.

You must be mindful that accepting an “arrangements to the creditor’s satisfaction for settlement of the debt” is compliance with the bankruptcy notice.  This means that the debtor will not have committed an act of bankruptcy, and the creditor will be unable to present their petition to the Federal Circuit Court.

If you are going to attempt to negotiate an informal agreement, then it should be done before the issuance of, or after the twenty one (21) day period for compliance, with the Bankruptcy notice.

It should also be noted that it is the making of the arrangement, and not the adherence to the arrangement which complies with the bankruptcy notice.  See Deputy Commissioner of Taxation v Catanese [1999] FCA 564.

A Part IX Debt Agreement

A Part IX debt agreement is something more than an informal debt agreement, but something less than full bankruptcy.

We have a full article here about Part IX Debt Agreements.  But essentially:

1. Proposing a Part IX Debt Agreement is an act of bankruptcy;
2. A Part IX debt agreement is registered on the National Personal Insolvency Index, a search of which will show your name, which may affect your credit rating and your ability to borrow;
3. A Part IX Debt Agreement will only cover unsecured debts, a secured creditor can still attempt to realise their security interest; and
4. If you trade under a business name, being a name that is not your name, you have to disclose the Part IX Debt Agreement to all other people that you are in business with.

So, as you can see the Part IX is still serious and may have implications moving forward past the debt problems, however it is a lot better than becoming a bankrupt.

A Part X Personal Insolvency Agreement

A Part X Personal Insolvency Agreement is something more than a Part IX Debt Agreement, but something less than full bankruptcy.

We have a full article here about Part X Personal Insolvency Agreements.  But essentially:

1. Entering into a Part X Personal Insolvency Agreement is an act of bankruptcy. An act of bankruptcy, like non-compliance with a bankruptcy notice, allows the creditors to present a petition to the Federal Circuit Court.
2. A Part X Personal Insolvency Agreement is registered on the National Personal Insolvency Index forever, a search of which will show your name, which may affect your credit rating and your ability to borrow, and a default will appear on your credit file.
3. A Part X Personal Insolvency Agreement means that you will not be able to have any dealings with your assets (house or real property) without the consent of the trustee.
4. A Part X Personal Insolvency Agreement does not allow you to be the director of a company, and so if you are currently the director of a company (a trustee company of a self-managed-superannuation-fund, for example) then you will have to appoint another director.

Moving Forward with Bankruptcy

If you are a debtor having difficulty paying your debts, or you are a creditor having difficulty getting paid from a debtor, then you should contact our debt recovery / bankruptcy lawyers.

Becoming bankrupt is not a punishment.  It is simply a way for debtors to manage their obligations to creditors, and for creditors to effectively recover debts from a debtor.

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