Bankruptcy and Debt

Based on the contribution of Andrew George and Colette Legeret for the NT Law Handbook, as amended by Graeme Blank of Blackburn Chambers and current to March 2022

The effect of bankruptcy on debts

After bankruptcy a bankrupt is released from most 'provable' debts. A bankrupt is however not released from any 'non-provable' debts.

Provable debts

The term provable means that a creditor can lodge a proof of debt (see s 84 of the Bankruptcy Act) or a claim to be paid, and then be paid a proportion of the money (if any) raised by the sale of the bankrupt's property. Most debts for which the bankrupt was liable at the date of bankruptcy are provable in bankruptcy.

Provable debts that are not wiped by bankruptcy

Some provable debts are not wiped by bankruptcy (see s 153 of the Bankruptcy Act). Provable debts that are not wiped by bankruptcy are debts:

1. Incurred by fraud;
2. Under a maintenance agreement order; or
3. In relation to a bond or to certain other criminal law penalties.

Non-provable debts

The main categories of debts that are non-provable (and so not wiped by bankruptcy) are:

1. Debts incurred after the date of bankruptcy;
2. Court fines;
3. HELP debts under the Higher Education Support Act 2003 (Cth); and
4. Unliquidated damages (an amount claimed by a creditor for damages that has not yet been fixed by formal agreement or by the court).

Secured debts

The trustee's rights to a secured property are subject to the rights of the secured creditor. A secured creditor keeps its interest in any secured goods or land (property) by way of its security even after bankruptcy.

The secured creditor's right to sell the security property

A secured creditor can only force a sale of the property if the debtor is in breach of the contract.

Under s 302 of the Bankruptcy Act, any provision in a mortgage, bill of sale, mortgage lien or charge that provides that a borrower might be in breach of a secured credit contract merely by entering into bankruptcy is void. Therefore, a creditor who has a mortgage etc. cannot take action against a debtor simply because the debtor bankrupts.

The trustee's right to sell the security property

The trustee can sell a security property whether or not the bankrupt has defaulted in payments. The trustee will sell the property if there is sufficient equity to make it commercially practicable. If the trustee sells the property it will pay the secured creditor from the proceeds of sale and keep the balance for the bankrupt estate.

Security over furniture and other household goods

In the past couple of years some fringe lenders have taken mortgages over people's essential household goods to secure payment of debts. The threat to repossess goods is then used to force payment of the debt even after bankruptcy. For credit contracts entered into on or after 1 July 2010 these types of mortgages are void under the National Credit Code (see s 50 of the National Credit Code). For credit contracts entered into before 1 July 2010, or for other types of contracts, this type of mortgage could breach various laws relating to unfair contract terms or unconscionable conduct.

Seek advice from Fair Trading (via Access Canberra 13 22 81) if this is happening to you.

Mortgages over houses and land

The trustee has no power to prevent the sale of a house by the mortgagee if the bankrupt is in default under the mortgage. If the bankrupt is not in default, the mortgagee will not be able to take action against the debtor. In this case, the bankrupt might be able to stay in the house and continue making payments, but the property will vest with the trustee and could be sold years later.

Guaranteed debts

The bankrupt as guarantor

A debtor who has guaranteed someone else's debt will be released from any liability under the guarantee after their own bankruptcy. Such a debt should be included on the bankrupt's statement of affairs as a debt (see s 185NA(1) of the Bankruptcy Act).

The bankrupt's friend or relative as guarantor

A bankrupt will also be released from debts that have been guaranteed by someone else. However, the guarantor will not be released from the debt (see s 185NA(3)(b) of the Bankruptcy Act). The guarantor or the person guaranteeing the bankrupt's debt is usually a friend or relative. Once the bankrupt stops paying the debt, the creditor will then usually take action against the friend or relative under the guarantee. Therefore, in many cases, a bankrupt will want to continue paying such a debt. The Bankruptcy Act does not prevent the bankrupt from doing this.

Although a mortgage cannot include a term providing that if the debtor becomes bankrupt the mortgage is breached (see s 302 of the Bankruptcy Act), this provision does not apply to guarantees. Therefore, a creditor might be able to say that a guarantee has been breached due to the bankruptcy of the primary debtor and so claim payment from the guarantor. This will depend on the terms of each guarantee.

Debts to friends or relatives

Debts owed to friends and relatives usually result from a verbal rather than a written contract. These debts should be shown on the statement of affairs as unsecured debts, regardless of whether or not the contract is in writing. A bankrupt can, if they wish, continue to pay such a debt after the date of bankruptcy.

Unliquidated damages

Unliquidated damages debts are not wiped by bankruptcy (see ss 82 and 153 of the Bankruptcy Act). This is a technical area of law. However, it is an issue that affects many consumer debtors, especially debtors who have car accident debts.. Damages are 'unliquidated' if a court has not assessed them or if the parties involved have not agreed on the amount of damages. The most common example of unliquidated damages for consumer debtors is a claim for property damage as a result of a car accident.

Under s 82(2) of the Bankruptcy Act, demands in the nature of unliquidated damages are not provable in bankruptcy unless they arise out of a breach of contract or breach of trust. A discharged bankrupt is only released from debts that are provable in the bankruptcy (see s 153 of the Bankruptcy Act) and therefore will not be released from debts arising from unliquidated damages.

If a debtor has a property damage debt and legal action for the debt appears unlikely in the short term, the debtor should consider whether:

1. It is worth bankrupting on this debt if this is the only debt it may not be worth bankrupting;
2. They are able to wait until the other party gets a court judgment against them; or
3. They can replace the claim for unliquidated damages with a claim under a contract or a deed by settling the claim.

Replacing a claim for unliquidated damages with a claim under a deed or contract.

A settlement of a damages claim in a deed, or via an exchange of letters, can liquidate a damages claim. If the exchange of letters forms a contract, the creditor will then have a claim in contract. If the settlement is in a deed, the creditor will have a claim under the deed. As a claim under a contract or a deed is provable in bankruptcy, the bankrupt should then be released from the claim by the bankruptcy.

WARNING: Debtors should be aware that a creditor could always challenge this type of settlement and, if such a challenge were successful, the debt would then become unprovable and so not extinguished by the bankruptcy.

The debtor must prove that the liquidation occurred at least the day before the hearing of the creditor's petition or a few days before the presentation of a debtor's petition. The debt will not be included in the bankruptcy if the liquidation occurs after the date of the bankruptcy.

Maintenance/child support

Maintenance debts under a maintenance agreement or order, and child support debts, are provable in bankruptcy. However, a bankrupt is not released from maintenance debts or child support debts on discharge unless the court orders otherwise (see s 153(2)(c) of the Bankruptcy Act).

Taxation

Tax debts that arise before the date of the bankruptcy

Tax debts for the period before the date of bankruptcy are provable and extinguished after bankruptcy whether or not they have been assessed by the Australian Taxation Office (ATO).

If tax has not been assessed at the time of bankruptcy

If the ATO has not issued and served a notice of assessment at the time of the bankruptcy, a tax liability is a contingent liability and is provable under s 82 of the Bankruptcy Act.

If a debtor becomes bankrupt before the end of a financial year, the Taxation Commissioner can issue a tax assessment for the year to date. Once the bankrupt gets this separate assessment they should only be liable for any tax amounts that arise after the bankruptcy.

If the ATO refuses to issue a separate assessment for the year to the date of the bankruptcy, the bankrupt can consider appealing this decision (see Deputy Commissioner of Taxation v Jones [1999] FCA 308 (29 March 1999)).

Tax debts that arise after the date of the bankruptcy

Debts arising from tax periods after the date of bankruptcy are not provable in the bankruptcy.

Tax refunds

The ATO's right to take refunds

The ATO can take refunds during the period of the bankruptcy if the bankrupt has a tax debt from before the bankruptcy. If a bankrupt is entitled to a refund, the ATO can offset the refund due during the period of the bankruptcy against tax debts, including those provable tax debts incurred prior to bankruptcy.

In general, under the Bankruptcy Act, a creditor is not entitled to take any action in respect of a provable debt once a bankruptcy has commenced (see s 58(3) of the Bankruptcy Act). However, the Federal Court in Taylor v Commissioner of Taxation (1987) 16 FCR 212 decided that the offset provisions of the Income Tax Assessment Act 1936 (Cth) (''ITA Act'') overrides section 58(3) of the Bankruptcy Act.

The trustee's right to take refunds

The trustee can take a refund if it relates to a year prior to the bankruptcy. If the refund relates to a year after the date of the bankruptcy, it is treated as income and the trustee takes the amount into account when calculating income contribution.

Centrelink debts

Except in limited circumstances, Centrelink debts are wiped by bankruptcy. However, this is a complicated area of law and debtors should seek advice from your local Community Legal Service, Aboriginal Legal Service, the Legal Aid Commission or a solicitor experienced in social security law and bankruptcy. Financial counsellors also have extensive experience in dealing with Centrelink debts and bankruptcy. Generally, the following will apply:

1. As soon as Centrelink receives notification of a client's bankruptcy from AFSA, it should stop all debt recovery action on the client's Centrelink debts (including withholding action);
2. Centrelink should stop all debt recovery action for the period of the bankruptcy; it should also refund any payments/withholdings that it has deducted after the date of bankruptcy and before discharge;
3. Non-fraudulent Centrelink debts are generally extinguished by bankruptcy;
4. Fraudulent Centrelink debts are not extinguished by bankruptcy. Centrelink will recommence withholdings for fraudulent debts when the debtor is discharged from bankruptcy.

(See Secretary, Department of Social Security v Southcott [1998] FCA 323.)

Centrelink overpayments

Centrelink debts are not wiped by bankruptcy if the debt occurred as a result of a consumer's fraudulent behaviour.

In the experience of consumer workers, Centrelink can make incorrect decisions as to what constitutes fraudulent behaviour. As a result of these incorrect decisions by Centrelink, many discharged bankrupts might be repaying Centrelink debts that should have been wiped by the bankruptcy. Dobson; Department of Family and Community Services [2000] AATA 41 indicates that not all overpayment debts are fraudulent.

If a debtor is bankrupting (or has bankrupted) and has a Centrelink debt, they should get advice on:

1. Whether there are circumstances to support an application that the debt was not fraudulently incurred;
2. The review processes within Centrelink and the Social Securities Appeals Tribunal in relation to challenging a Centrelink decision to pursue the debt after bankruptcy; and
3. If the debtor has already been discharged from bankruptcy, whether they can apply for a refund of any payments made to Centrelink or taken by Centrelink.

Fines

Section 82 of the Bankruptcy Act states that, with the exception of proceeds of crime orders, penalties or fines imposed by a court in respect of an offence against a law, are not provable in bankruptcy. In Victoria v Mansfield [2003] FCAFC 154 (18 July 2003), the full Federal Court held that parking fines issued by a local council were not provable in bankruptcy. However, the application of the Bankruptcy Act to fines is a complex area of law and legal advice should be sought where a person is considering bankrupting on a fine, as the particular circumstances surrounding the imposition of a fine may impact upon whether or not that fine is extinguished upon discharge from bankruptcy.

Debts resulting from fraud

A debt incurred by fraud, or fraudulent breach of trust, can be provable in bankruptcy, but generally is not extinguished on discharge from bankruptcy (see s 153(2) of the Bankruptcy Act).

Note that there is some case law holding that if a civil judgment has been made in relation to the debt, this might extinguish the debt (Power v Kenny [1977] WAR 87).

After bankruptcy a debtor can apply under s 60(1) of the Bankruptcy Act to stay an action by the creditor in relation to a fraudulent debt. Such an application, if successful, would have the same effect as extinguishing the debt.

Debts arising from restitution or compensation orders

There are various types of restitution or compensation orders. The Proceeds of Crime Act 2002 (Cth)) also contains the power to make such orders.

Non-provable orders

Section 82(3A) of the Bankruptcy Act provides that an amount payable under an order made under a proceeds of crime law is not provable in bankruptcy.

Provable orders

The Bankruptcy Act does not categorise other types of restitution orders as being either provable or not provable. In the past it was argued that a restitution order was not provable; however, the court decided in Re Lenske; Ex parte Lenske [1986] 9 FCR 532 that a debt payable under a restitution order is a provable debt. (Note that the debt in Re Lenske was not wiped by the bankruptcy even though it was held to be provable, rather the debtor applied to the court to stay enforcement of the orders insofar as they required payment of restitution.

Deciding whether to cease payment under the order

Before deciding that bankruptcy means that you can cease payment under a restitution order, first get a copy of the order to decide what type of restitution order has been made. Check that:

1. It is not an order made under proceeds of crime legislation;
2. The debtor will not face a criminal penalty or other adverse consequence for failure to pay; and
3. The debtor does not need to apply for a stay of restitution.

Other adverse consequences of non-payment

Even if the order is not one made under proceeds of crime legislation, check to see if the order has any adverse consequences on non-payment. For example, the order might include a condition that breach of the order results in imprisonment; if so, this condition may apply regardless of whether the debtor has become bankrupt.

However, note that under s 60(1) of the Bankruptcy Act, the court may exercise discretion to stay any legal process against the debtor, including imprisonment for non-payment of a restitution or compensation order.

Restitution/compensation orders and fraud

If the restitution order has been made in relation to a fraud, the debt arising under the order might be provable but might not be extinguished after bankruptcy.

Joint debts

Where a debt is in joint names and one debtor is bankrupt, the non-bankrupt debtor, in almost all cases, continues to be liable for the whole of the debt.

Rent

Rent debts are wiped in bankruptcy. However, this does not prevent the landlord from evicting a tenant for non-payment of rent.

Utilities/telecommunications

The practices of different companies vary. The law is that bills relating to the period up to the date of bankruptcy are wiped by the bankruptcy, but the bankrupt will still owe bills relating to the use of these services after the date of bankruptcy. After the bankruptcy, utility and telco companies sometimes open a new account, and require payment of a security deposit, or restrict the service in some way. For example, Telstra may disconnect its service and then reconnect it with a bar on long-distance calls.

HELP debts (previously HECS debts)

On 1 January 2005, the Higher Education Loan Program (HELP) came into effect, incorporating the Higher Education Contribution Scheme (HECS), with changes. On 1 June 2006, existing accumulated HECS debts converted to new accumulated HELP debts. HELP debts that arise under the Higher Education Support Act 2003 (Cth), are not provable in bankruptcy (see s 82(3AB) of the Bankruptcy Act). Accordingly, they may be recovered during and after bankruptcy.

For more information regarding the conversion of HECS debts to HELP debts and its effect on bankruptcy, contact AFSA on 1300 364 785 or the ATO's personal tax information line on 13 28 61.

Leaving Australia

Surrendering passports

Under s 77(1)(a) of the Bankruptcy Act, bankrupts must hand their passport to the trustee unless excused by the trustee. In general, AFSA, if it is the trustee in the bankruptcy, will not require bankrupts to hand in their passports.

Applications for permission to travel overseas

Bankrupts must apply in writing to the trustee for permission to travel overseas and pay a fee to make this application. If AFSA is the trustee, it generally considers the following criteria when deciding whether or not to give permission to travel:

1. Is the travel necessary to earn income?
2. Does the travel relate to the death or serious illness of a close relative?
3. Has the bankrupt made arrangements for making compulsory contributions in advance?
4. Can the bankrupt show that someone else is paying for the travel?
5. Is there a return ticket?

Offences

The Bankruptcy Act creates criminal offences that can arise from the behaviour of the bankrupt before and during bankruptcy. In some cases, this behaviour would not have been considered an offence if the debtor had not bankrupted (e.g. gambling). Prosecution for bankruptcy offences can lead to a prison sentence or a fine.

The Bankruptcy Act defines a number of offences, generally relating to acts of fraud or recklessness, which have led up to the bankruptcy, or which are committed during the bankruptcy. There are generally few prosecutions compared with the number of bankruptcies.

The Bankruptcy Legislation Amendment Act 2010 (Cth) made a number of changes to offence provisions under the Bankruptcy Act, including introducing stronger penalties for some offences.

Types of offences

Offences under the Bankruptcy Act include:

• Materially contributing to, or increasing the extent of, insolvency by gambling or rash and hazardous speculation (see s 271 of the Bankruptcy Act);
• Obtaining, after the date of bankruptcy, credit of $6,144 (indexed) or more without disclosure of the bankruptcy (see ss 269(1)(a) and 304A(1)(j) of the Bankruptcy Act);
• Leaving Australia with intent to defeat creditors, or without obtaining a court order where required;
• Incurring, within two years before the date of bankruptcy, a debt without any reasonable expectation of repayment (see s 265(8) of the Bankruptcy Act);
• Obtaining credit or property by fraud after bankruptcy;
• Failing to disclose to a trustee, particulars of any disposition of property made in the two years before the date of bankruptcy;
• Disposing of property before bankruptcy with intent to defraud creditors;
• Disposing of property after bankruptcy;
• Concealing property with intent to defraud creditors; failing to deliver up property divisible among creditors;
• Failing to attend before the Official Receiver when requested; obstructing a person with intent to defeat the seizure of property; failing to deliver up books of account and other records; and
• Failing to comply with a supervised account notice; and failing to deposit income into a supervised account.

Penalties

A debtor who has committed an act that is an offence under the Bankruptcy Act and who is considering bankruptcy should check both the maximum penalty for the offence and the probable penalty.

Details of prior prosecutions

The Annual Report by the Inspector-General in Bankruptcy, Operation of the Bankruptcy Act, contains details of prior prosecutions and the penalties imposed. AFSA publishes these annual reports on its website.

Whether a bankrupt is prosecuted for an offence, and the type of penalty imposed, will depend on a variety of factors, including the seriousness of the offence and the extent of the bankrupt's indebtedness.

A debtor need not reject the option of bankruptcy because a potential offence has been committed. Even if convicted, it might be worth paying the penalty in order to be released from the demands of creditors.