What is Bankruptcy?

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

Bankruptcy is a method that enables some control to be taken over a debtor's affairs, so that their financial disaster can be brought to an end, and they can make a fresh start. Bankruptcy was originally designed to prevent the incarceration of people who couldn't pay their debts.

The Bankruptcy Act 1966 (Cth) sets up a structure that enables the money received from the sale of a bankrupt's property to be distributed by the trustee to creditors on a pro rata (or percentage of overall debts) basis. With some exceptions, from the date the bankruptcy begins, creditors are prevented from taking any further debt recovery action against the bankrupt or their property.

Probably the best way to understand bankruptcy is to see it as a swap. In return for protection from further legal action by creditors and for total release from specific debts at the end of the bankruptcy period, the debtor agrees to give up to the trustee certain assets and (for a while) a large degree of control over their financial affairs. However, for people who don't have any valuable assets and are on a low income, bankruptcy amounts to no real change in their control over their financial affairs because there is nothing for the trustee to take. Bankruptcy is a sensible option for some people, but not the best solution for others. Information on your options can be obtained from a registered bankruptcy trustee, a financial counsellor, legal aid or a community legal centre, a solicitor, accountant or the Australian Financial Security Authority (AFSA).

Overview of bankruptcy

According to the Australian Financial Security Authority (AFSA) annual reports, in 2014 to 2015, just over 28,000 people commenced some form of personal insolvency administration. In 2016-17 that figure had risen slightly to just over 30,000. However, In NSW and Victoria the new administrations decreased in 2016-17 but in the ACT they increased by over 10%.

Bankruptcy is a legal status that a person has under the Bankruptcy Act 1966 (Cth) ('Bankruptcy Act') where, once they are declared bankrupt with some exceptions, creditors are prevented from further pursuing them for payment, their property (with some exceptions, e.g. household furniture, personal injuries compensation and certain vehicles) is made available, through a trustee, for distribution among creditors. See ss 58,109, and 116 of the Bankruptcy Act.

Key Terms

All references to legislation in this chapter are to the Bankruptcy Act or the Bankruptcy Regulations 2021 ('Bankruptcy Regulations') unless otherwise noted.

Key terms in relation to bankruptcy and the law:

• Asset: anything owned by an individual or entity that has value, monetary or otherwise. See liquid and Illiquid asset below;
  
• Bankrupt : a person who has become bankrupt either by a debtor's petition or a sequestration order;
• Creditor : person or entity to whom a debt is owed;
• Debt : a sum of money owed to another person or entity;
• Debtor : a person or entity who owes a debt to another, for example a creditor;
• Discharge from bankruptcy : A permanent order that releases the debtor from personal liability for certain specified types of debts, thereby releasing the debtor from any legal obligation to pay any discharged debts;
• Liquid or liquidated asset : an asset that is cash or something that can be readily turned into cash with minimal loss;
• Insolvent : a person who is not solvent, is insolvent;
• Solvent : person is solvent if they are able to pay all of their debts when they fall due;
• Secured creditor : a creditor that has lent money in exchange for security, such as a mortgage. Being a secured creditor means that if the debtor becomes bankrupt or insolvent, the debt can be paid by selling the asset(s) over which the loan was secured;
• Security : something promised to the lender (often the person’s house or the car bought with the car loan) if the loan is not repaid;
• Trustee : person appointed to oversee the management of the bankrupt's estate;
• Unsecured creditor : a creditor that has lent money without security. Being an unsecured loan puts the creditor at a disadvantage as secured creditors are paid out of the proceeds of the sale of the assets of which they were secured. This means that there are limited amounts available to the unsecured creditor to claim the debt;
• Illiquid or non-liquid asset : an asset that cannot readily be turned into cash.

Purpose of bankruptcy

The two main purposes of bankruptcy are:

1. To give a debtor who is in a difficult or hopeless financial position a fresh start by wiping most of their debts; and
2. To fairly distribute the debtor's assets among creditors.

Types of proceedings

A person can become bankrupt under the Bankruptcy Act in the three following ways:

1. Voluntary bankruptcy: the debtor files a debtor's petition (approximately 90% of bankruptcies), see Part IV, Division 3 of the Bankruptcy Act;
2. Forced bankruptcy: the creditor(s) files a creditor's petition, see relevant part IV, Divisions 2A and 3 of the Bankruptcy Act; or
3. Deceased bankruptcy: either the legal personal representative of the deceased or the creditor can petition for an order that treats the deceased person as a bankrupt, see relevant Part XI of the Bankruptcy Act.

NOTE: Many of the monetary limits referred to in this chapter change periodically. Check the amounts referred to by contacting the Australian Financial Security Authority (AFSA) on 1300 364 785, or check "Indexed Amounts" on AFSA's website (at www.afsa.gov.au).

Advantages

• After discharge from bankruptcy, the bankrupt is released from almost all debts, see Ending bankruptcy;
• Once a person is declared bankrupt, almost all unsecured creditors are unable to take any further legal action against the debtor in relation to almost all debts (in rare cases the court might grant the creditor a right to continue with court action);
• Once a person is declared bankrupt, unsecured creditors should stop making contact with and harassing the bankrupt, and should instead communicate with the trustee about the bankrupt's debts;
• Bankrupts with no dependants who have a net income of less than $60,515 net per annum cannot have any of that income taken to pay their debts. However in contrast, low-income wage earners who are not bankrupt may be forced by creditors to make payments from income under a Court attachment of earnings order;
• The Bankruptcy Act gives significant protection to superannuation payments (see Superannuation, this chapter), life insurance payments (see Insurance policies) and compensation payments for personal injuries (see Personal injuries compensation). 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 a Court.

Disadvantages

• 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 or two years starting on the day that you are no longer bankrupt, whichever is later;
• The Inspector-General keeps a record of the bankruptcy forever. The record is kept on an electronic index known as the National Personal Insolvency Index (NPII) and can be searched by anyone on payment of a nominal fee;
• Certain areas of employment are not open to bankrupts (because of the rules and legislation pertaining to that type of employment, not because of any provisions in the Bankruptcy Act). A person who is considering bankruptcy should make enquiries regarding the type of work they do or intend to do, especially if a licence is required. Bankruptcy might cause employment problems for the following people: company directors, people in managerial positions, lawyers, accountants, tax agents, sheriffs, police, estate agents, armed forces personnel, some public servants, licensed builders, and security workers (this is not an exhaustive list);
• A bankrupt cannot act as a director or promoter of a corporation, or be in any way involved in the management of a corporation, without the permission of the court;
• A bankrupt cannot be a trustee of a superannuation fund;
• 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), see relevant section 116 of the Bankruptcy Act. See Divisible property;
  
• The bankrupt might have to pay regular contributions to the trustee if net annual income is above a certain amount ($60,515 (indexed) net per year if there are no dependants up to $82,300.40 net where there are more than 4 dependants);
• Insurers can cancel some insurance contracts if the insured person becomes bankrupt, but only if there is a term in the contract that specifically says this. See Insurance policies;
• Some insurers refuse to insure bankrupts and refuse to renew insurance policies for bankrupts;
• The bankrupt might be required to surrender their passport to the trustee, and must obtain permission from their trustee to leave Australia, see relevant section 272 of the Bankruptcy Act;
• The trustee can investigate past financial dealings of the bankrupt. This includes payments made to creditors in the six months before the bankruptcy (‘preferences’), transfers of money or property for less than full value in the five years before the bankruptcy and transfers at any time prior to bankruptcy if the transfer was made for the main purpose of delaying or preventing creditors from being paid;
• Obtaining credit (including hiring goods or writing cheques) of $6,144 (indexed – as at 16 March 2022) or more without disclosing the bankruptcy to the person extending the credit is a criminal offence, see relevant sections 269(1)(a), (aa), (ab), (ad) and ss 304A(1)(g), (j) of the Bankruptcy Act;
• If a debtor has had significant gambling debts and then bankrupts, they might be charged with a criminal offence under section 271 of the Bankruptcy Act.

Considering all the options

It is strongly recommended that debtors considering bankruptcy seek advice from an independent and qualified source, such as a free financial counsellor. A financial counsellor can assist a low- income debtor to weigh up all of their options, including negotiating with creditors and seeking hardship arrangements.

If a creditor is threatening a debtor with bankruptcy, the debtor should seek legal advice urgently, especially where there is a court judgment and where the debtor owns divisible property, such as a house.

Who can be made bankrupt?

Can companies or businesses be bankrupted?

Only people can be made bankrupt, not businesses or companies. Where a partnership of individuals or persons trading under a business name are insolvent, it is not the business that is bankrupted but the individual or individuals who run that business. The Bankruptcy Act does not cover companies, see relevant section 7 of the Bankruptcy Act.

Companies can be ‘wound up’ and have a liquidator appointed by choice of shareholders, a vote of creditors or by order of the court. See the Corporations Act 2001 (Cth) for information on companies or businesses.

Can minors be bankrupted?

Under section 7(1A) of the Bankruptcy Act, a person under the age of 18 years can be made bankrupt, but not if the debts which are the trigger for the bankruptcy are unenforceable due to the person's age.

Can citizens of other countries be bankrupted?

Debtors who do not have Australian citizenship or residency can become bankrupt if they live in Australia or have a business connection with Australia.

Who administers the bankruptcy law?

The Bankruptcy Act is a Commonwealth Act; therefore it applies in all states and territories. The relevant courts are the Federal Court (General Division) and the Federal Circuit and Family Court. The Federal Circuit and Family Court of Australia also has jurisdiction under the Bankruptcy Act where the trustee is a party to family law property or spousal maintenance proceedings. Furthermore, the Federal Court is empowered to transfer proceedings to the Federal Circuit and Family Court under the Bankruptcy Act, see relevant sections 35 and 35A of the Bankruptcy Act.

Federal Court of Australia

Nigel Bowen Commonwealth Law Courts
Cnr Childers St and University Ave
Canberra ACT
Telephone: 1300 720 980
Website: http://www.fedcourt.gov.au/

Federal Circuit and Family Court of Australia

Nigel Bowen Commonwealth Law Courts
Cnr Childers St and University Ave
Canberra ACT
Telephone: 1300 352 000
Website: https://www.fcfcoa.gov.au/

Australian Financial Security Authority (AFSA)

The Bankruptcy Act creates the roles of Inspector-General in Bankruptcy, Official Receiver and Official Trustee in Bankruptcy. The Australian Financial Security Authority (AFSA) undertakes each of these roles. When a person becomes bankrupt all their "divisible property" (see Divisible property, this chapter) vests in (ownership rights are moved to) the Official Trustee in Bankruptcy or in the registered trustee if there is a private trustee. AFSA in its role as the Official Trustee in Bankruptcy is the trustee of around 80% of bankruptcies, the remainder are under the control of private registered trustees.

The trustee can require a bankrupt to provide all financial documents and any other information relevant to the bankruptcy. The trustee might require the bankrupt to hand over their passport. A trustee in bankruptcy also has the power to investigate the conduct and dealings of the bankrupt and the reason for bankruptcy; and seize and sell certain assets and distribute the proceeds. AFSA can be contacted at:

Post: GPO Box 821
Canberra ACT 2601
Telephone: 1300 364 785
Website: www.afsa.gov.au

The AFSA website is very useful: it includes legislation, statutory forms, indexable amounts, statistics and comments on recent events.

AFSA as trustee vs a private trustee

A non-business bankrupt with no assets who has bankrupted via a debtor's petition usually has AFSA as their trustee rather than having a private registered trustee.

A private registered trustee usually becomes trustee at the request of a petitioning creditor or debtor before the debtor becomes bankrupt. In some cases the creditor can ask for a private registered trustee to replace AFSA as the trustee after the debtor becomes bankrupt, see relevant sections 156A and 157 of the Bankruptcy Act).

For bankruptcies entered into after 1 December 2010 private trustees can (and usually do) charge a bankrupt a minimum administration fee of $5,000 (indexed). However private trustees can only recover this fee if there are any funds in the bankrupt estate.

Complaints about independent trustees

Anybody with a concern about a trustee or any other aspect of their bankruptcy administration can make a complaint to the Regulation and Enforcement area of AFSA, which reports directly to the Inspector-General. AFSA Regulation and Enforcement will investigate complaints against private trustees and against AFSA itself.

To lodge a complaint, visit the AFSA website and use the online enquiry/feedback/complaint form, write a letter, or telephone AFSA and ask to speak to someone in AFSA Regulation and Enforcement. (For more information on the Bankruptcy Regulation and Enforcement area and its complaints procedures, visit AFSA's website at www.afsa.gov.au).

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