Understanding bankruptcy

A person or company unable to pay their debts is insolvent. An insolvent person who cannot pay their debts may become bankrupt following a legal process which starts with a creditor’s petition or a debtor’s petition. An insolvent company goes into winding up under the Corporations Act.

Bankruptcy is a legal status that a person has under the Bankruptcy Act 1966 (Cth) where, once they are declared bankrupt:

1- Creditors are prevented from further pursuing them for payment (s 58(3));

2- Certain financial restrictions are placed on them; and

3- Their property is made available, through the trustee who manages their bankrupt estate, for distribution among their creditors (ss 109, 116).

The two main purposes of bankruptcy are:

1- To give the bankrupt debtor a fresh start by wiping most of their debts; and

2- To distribute the bankrupt debtor’s assets fairly among creditors.

There are three insolvency options under the Bankruptcy Act: 1 voluntary bankruptcy: the debtor files a debtor’s petition; 2 involuntary bankruptcy: the creditor(s) files a creditor’s petition; or 3 a debt agreement under Part IX of the Bankruptcy Act and a personal insolvency agreement under Par X of the Bankfuptcy Act, both discussed below.

1 Bankruptcy is a circuit breaker because the bankrupt is released from almost all debts after discharge from bankruptcy. 2 Once a person is declared bankrupt, most unsecured creditors cannot take any further legal action against the debtor in relation to the debts. 3 Once a person is declared bankrupt, unsecured creditors should stop making contact with and harassing the bankrupt, and should comm­unicate with the trustee about the bankrupt’s debts. 4 Bankrupts with no dependants who have an income of less than $68 769 net per annum (as at October 2023, indexed), the actual income threshold amount (AITA), cannot have any of that income taken to pay their debts (s 139K Bankruptcy Act). In contrast, debtors who are not bankrupt may be forced by creditors to make payments from income under a court-ordered attachment of earnings order. (See Chapter 5.2: Are you in debt?) 5 The Bankruptcy Act protects superannuation, life assurance payments and compensation payments for personal injuries. The Act also gives some protection to assets bought with these payments. These payments and assets are not protected if a debtor is not bankrupt and the creditor gets an order for payment of a debt in the Magistrates’ Court or other court.

1 It will probably be very difficult to obtain credit for some time after bankruptcy. A record of the bankruptcy is added to the debtor’s credit report and stays there for five years (see ‘Credit reporting’ in Chapter 12.2: Privacy and your rights) or two years starting on the day that you are no longer bankrupt, whichever is later. 2 The record is kept on the National Personal Insolvency Index (NPII), which is an electronic index that can be searched by anyone for a nominal fee. However, information about debt agreements is not publicly available on the NPII indefinitely. 3 Certain areas of employment are not open to bankrupts (because of the rules and legislation regulating that type of employment). A person who is considering bankruptcy should make enquiries about whether bankruptcy will affect the type of work they do or intend to do, especially if a licence is required. Bankruptcy might cause employment problems for company directors, people in managerial positions, lawyers, accountants, tax agents, police officers, estate agents, armed forces personnel, some public servants, licensed builders and security workers. (This is not an exhaustive list.) 4 A bankrupt cannot act as a director or promoter of a corporation, or be involved in the management of a corporation, without the court’s permission. 5 A bankrupt cannot be a trustee of a super- annuation fund. 6 The bankrupt will lose property that is defined by the Bankruptcy Act as divisible. This includes property acquired after the commencement of the bankruptcy (but before the date of discharge) (s 116). 7 The bankrupt might have to pay regular contributions to the trustee if their net annual income is above the actual income threshold amount (AITA) ($68 769 net per annum as at October 2023, indexed), if there are no dependants. 8 Insurers can cancel insurance contracts if the insured person becomes bankrupt if there is a term in the contract that specifically says this. 9 Some insurers refuse to insure bankrupts and refuse to renew insurance policies for bankrupts. 10 The bankrupt might be required to surrender their passport to the trustee, and must obtain permission from their trustee to leave Australia (s 272). 11 Depending on the bankrupt’s social circle, the bankruptcy might cause embarrassment. The stigma of bankruptcy is more likely to be felt by bankrupts who have business associates as creditors, by bankrupts who are unable to continue to operate a business, or by those who are barred from a position that they have held in the past, such as company director. 12 The trustee can investigate past financial dealings of the bankrupt. The trustee in some cases has power to recover property that the debtor has transferred in the period beginning five years before the commencement of the bankruptcy (or longer if it was done for the purpose of defeating creditors). 13 Obtaining credit (including writing cheques) of $6852 (as at October 2023, indexed) or more without disclosing the bankruptcy to the person extending the credit is a criminal offence (ss 269(1) (a), (ab), (ac), (ad), 304A(1), (j)). 14 If a debtor has had significant gambling debts and then bankrupts, they might be charged with a criminal offence under the Bankruptcy Act (s 271).

Debtors who are consideri­ng bankruptcy should seek advice from an independent and qualified source such as a financial counsellor (see Chapter 5.4: Financial counselling services). If a creditor is threatening a debtor with bankruptcy, the debtor should seek legal advice, especially where there is a court judgment and where the debtor owns divisible property (e.g. a house). For a list of free legal services, see Chapter 2.4: Legal services that can help. Options for managing debt include:

• coming to an agreement with the creditors;
• a temporary debt protection for 21 days;
• a debt agreement under Part IX to manage debt;
• a personal insolvency agreement under Part X, discussed below; and
• bankruptcy. There is a summary comparison of insolvency options under the Bankruptcy Act at the end of this chapter, based on AFSA’s document ‘Compare your insolvency options’ at www.afsa.gov.au/i-cant-pay- my-debts/compare-your-insolvency-options.