What is Bankruptcy?

What is Bankruptcy?

By Jacob Carswell-Doherty

What is Bankruptcy? Bankruptcy is a process where a person is legally declared unable to pay their outstanding debts. The result is that the state will take possession of the property of the bankrupt until the bankrupt is discharged.

Becoming a bankrupt can occur in one of two ways:

1. Voluntarily – where the person files an application (a Debtor’s Petition) with the Australian Financial Security Association (AFSA); or
2. Involuntarily – where the person has failed to comply with a Bankruptcy Notice issued by a creditor, and the creditor has filed a Creditor’s Petition in the Federal Court, and the Court orders that the person’s estate be vested or transferred to the trustee (“a sequestration Order”).

Once a person has been declared bankrupt, a trustee (usually the Official Trustee in Bankruptcy or a registered trustee) will be appointed to take care of and manage their ‘estate’.

Following the appointment of a trustee, subject to some exceptions, the property of the bankrupt will be liquidated to pay the bankrupt’s debts.

The role of the trustee

The trustee’s role is to investigate the bankrupt’s financial dealings (potentially over the last 5 years) and review his/her assets to determine the most appropriate way to distribute the value of the assets to all of the bankrupt’s proven creditors.

However, the trustee cannot take possession of or sell:

  • a motor vehicle worth less than $7,350; and/or
  • tools of the bankrupt’s trade (if they are worth less than $3,600).

After reviewing the bankrupt’s financial affairs, the trustee may also, in certain circumstances, recover or “claw back” property which the bankrupt may have transferred or disposed of to someone else, immediately prior to the bankruptcy.

Furthermore, if an undischarged bankrupt earns more than the “income threshold amount” (currently $51,560.50 p/a), the trustee also has the power to deduct money from his or her income (as long as their income does not then fall below the “income threshold amount”). The threshold amount increases if there is a child in the bankrupt’s care.

How long does a person remain bankrupt?

Generally, a person who is made bankrupt will remain an ‘undischarged bankrupt’ for three (3) years, which period will commence on the date that his/her Statement of Affairs is lodged with AFSA.

  • In the case of a voluntary bankruptcy, a Statement of Affairs is usually lodged at the same time the Debtor’s Petition is lodged.
  • In the case of an involuntary bankruptcy, the Court will order that the bankrupt lodge a Statement of Affairs within 14 days of being notified that the Sequestration Order was made.

In some circumstances however, a trustee can object to a bankrupt being discharged and make an application to extend the period of bankruptcy for a period up to eight (8) years. The trustee may also object if the bankrupt fails to provide the trustee with certain information that will assist the trustee effectively managing the bankrupt’s estate (e.g. failure to disclose all assets).

What happens to debts incurred before the date of Bankruptcy?

At the date of bankruptcy (the date the bankrupt’s Statement of Affairs is lodged with AFSA) all debts owed by the bankrupt crystalise. Once a person has been made bankrupt, unsecured creditors are usually unable to commence or continue recovery proceedings for debts incurred on or before the date of bankruptcy. All of these debts should be included in the bankrupt’s Statement of Affairs.

There are however some exceptions to the types of debt which will crystalise as at the date of bankruptcy. An undischarged bankrupt is and will always be liable for:

  • fines imposed by a Court;
  • child maintenance or maintenance orders; and/or
  • debts incurred by way of fraud which are generally frozen during the period of bankruptcy, after which they must be paid.

Secured creditors (i.e. a debt which is secured by a mortgage) are treated differently to other creditors and their rights are not affected by bankruptcy, and they can still repossess the property of which they hold their security over to recover the outstanding debt.

The remaining property is distributed amongst the unsecured creditors according to the rules relating to priority.

What happens to debts incurred after the date of Bankruptcy?

It is important to note that an undischarged bankrupt is liable for any debts incurred after the date of bankruptcy.

The Bankruptcy Act also provides that it is offence for an undischarged bankrupt to enter into a transaction to obtain goods or services of which the amount payable is $3,000 or more, without informing the creditor, person and/or business that they are an undischarged bankrupt.

An alternative to Bankruptcy

A debtor may, as an alternative to Bankruptcy, enter into a binding agreement to repay all, or part of, of his/her outstanding debt with all of his/her unsecured creditors pursuant to Part IX of the Bankruptcy Act (a “Debt Agreement”).

To enter into a Debt Agreement, the debtor must prove that he/she is insolvent (unable to pay their debts when they fall due) and he/she must not have been declared bankrupt or entered into a Debt Agreement in the past 10 years. If the debtor meets these criteria, they may then lodge a formal proposal with AFSA which must include how much of the debt the debtor will repay to his/her creditors (the rate of payment must be the same for all creditors, however, this may be less than 100 cents to the dollar) and the time period in which this amount will be repaid.

The creditors will then vote, either accepting or rejecting the proposal. If the creditors accept the proposal, the Debt Agreement will become binding and the unsecured creditors will not be able to continue with, or commence, legal proceedings to recover their outstanding debts.

A secured creditor may still seize and sell any assets which the creditor holds security over. If the debtor then breaches the Debt Agreement, the creditors will then be able to lodge a Creditor’s Petition in the Federal Court and seek a Sequestration Order over the debtor’s estate.

If you are a creditor or a debtor and require advice in relation to any aspect of bankruptcy, please contact Foulsham & Geddes to speak to one of our solicitors.

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