What is bankruptcy?
A person is bankrupt when he or she is unable to pay his or her debts. A trustee is appointed to control the person’s financial resources and assets and the bankrupt is afforded protection from being sued by creditors while his or her financial affairs are sorted.
An insolvent person may voluntarily enter bankruptcy by filing a debtor’s petition and statement of affairs with the Official Receiver. If accepted, a trustee is appointed to administer the bankrupt estate.
Alternatively, a creditor who is owed $5,000 or more may petition the court to have the debtor declared bankrupt. If a sequestration order is granted (an order declaring the person bankrupt) a trustee is appointed to manage the bankrupt’s affairs.
Consequences of bankruptcy
The financial, restrictive and emotional implications of bankruptcy will likely affect individuals differently. The following consequences apply to all bankrupts although not all will be enforced by a trustee.
- The bankrupt’s property, apart from protected assets pass to the trustee who assumes control of, and may sell the assets, to pay debts. Protected assets include:
- necessary clothing, household and personal possessions;
- tools of trade (or property used to earn income) up to a prescribed value;
- a motor vehicle up to a prescribed value;
- damages for personal injury and compensation payments; and
- superannuation and life policies, or proceeds of life policies received after the date of bankruptcy.
- Lottery winnings and inheritances are included during the three-year bankruptcy period as ‘after-acquired’ property and vest in the trustee.
- The bankrupt may continue to generate income however, once the income exceeds a prescribed threshold, may be required to contribute to the repayment of debts.
- The bankrupt must notify the trustee of any change of name or address, surrender any passport held, and may not travel overseas without written permission from the trustee.
- The bankrupt may be restricted from certain activities during the period of bankruptcy, such as:
- acting as a company officer or managing a company;
- continuing certain trades or professions which may be restricted or prevented by some professional bodies;
- borrowing money over a certain amount without advising the lender of their bankrupt status.
- A bankrupt is automatically discharged after three years unless there is an objection made by the trustee based on the bankrupt’s conduct. The person however may find it difficult to obtain future loans due to requirements to disclose a prior bankruptcy during the loan application process.
Bankruptcy and the family home
The family home is not a protected asset and therefore is available to the trustee.
If the bankrupt is the sole owner of the family home, then its full value vests in the trustee who assumes ownership and control of the property. The trustee will determine the net equity in the home, if any, and the commercial viability of selling it.
Where the home is held by a bankrupt as joint tenant, the joint tenancy is deemed to be severed and the bankrupt’s portion can be realised to pay creditors. Generally, a joint co-owner is provided an opportunity to offer to purchase the bankrupt’s interest in the property, however a trustee need not accept an offer.
Alternatives to bankruptcy
A person facing insolvency issues may avoid bankruptcy by entering an informal agreement. This is generally a first option involving negotiations between debtors and their creditors to settle outstanding debts. Informal agreements work best if entered promptly, when repayment becomes an issue, and are usually suited to a debtor with few creditors.
A debt agreement, which may be suitable for debtors with low income and debts below a prescribed threshold, is a binding agreement whereby a creditor may forgive the debt, accept a lesser sum, or allow the debtor to repay the debt by instalments.
A personal insolvency agreement may enable an insolvent person to avoid bankruptcy and some of its restrictive provisions, however details of the agreement are recorded on the national personal insolvency index which can make it difficult for the person to obtain future credit. The agreement is managed by a trustee who investigates the debtor’s financial position and coordinates creditors’ meetings to vote on a proposal regarding payment of the debts owed.
By making a proposal to creditors under a debt agreement or personal insolvency agreement, a debtor commits an act of bankruptcy. This means that if the proposal is not accepted, a creditor can then apply to a court to bankrupt the debtor. It is therefore important to obtain legal advice when considering these processes so an informed decision may be made.
The overriding purpose of bankruptcy law is to provide, as far as possible, a fair distribution of assets to a bankrupt’s creditors and enable a bankrupt to start afresh at the end of the bankruptcy period. During the process, the bankrupt’s affairs are also investigated to uncover conduct or transfers carried out to defeat creditors.
Being declared bankrupt, whether voluntarily or by court order, has significant implications so it is important to identify all available options, before applying for voluntary bankruptcy or when answering a creditor’s petition.
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