Bankruptcy

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Contact us to discuss the specific details of your individual situation.

WHAT IS BANKRUPTCY?

Bankruptcy is the process of law that deals with administering the estate of a person who is bankrupt. The applicable legislation is the Bankruptcy Act, 1966 ("the Act").

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OBJECTIVES OF BANKRUPTCY

The general objectives of bankruptcy under the Act are to:

  • allow a Trustee to recover property and funds to distribute to creditors of a bankrupt;
  • provide equitable treatment of creditors' claims (apart from certain priorities stipulated in the Act);
  • give protection to creditors and debtors;
  • rehabilitate a debtor by providing the debtor with an opportunity for a fresh start;
  • protect the public interest.

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WHY CHOOSE BANKRUPTCY?

Creditors

The main reason why a creditor would bankrupt a debtor is to recover monies owing. Other reasons include to:

  • provide protection to the creditor and an orderly and equitable distribution amongst all creditors;
  • allow for the bankrupt's affairs to be independently investigated by a Trustee;
  • crystallise uncertainty;
  • uphold social responsibility.

Debtors

The main reason why debtors choose bankruptcy is because they are unable to pay some or all of their debts. Other reasons include to:

  • prevent creditors from pursuing or harassing them in relation to unpaid debts and remove the concerns as to how monies owing are going to be repaid;
  • allow the debtor to start life afresh;
  • provide protection to the debtor;
  • allow an orderly and equitable distribution amongst all creditors; or
  • crystallise uncertainty.

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HOW DO YOU BECOME A BANKRUPT?

Creditor's Petition

A creditor can make an application to the Federal Court of Australia or Federal Magistrates Court of Australia to bankrupt a debtor. The process of making a person bankrupt by way of a Creditor's Petition usually involves the following steps:

  1. A debtor incurs a debt and does not repay the debt.
  2. A creditor obtains a judgment of a Court to confirm the debt owed by the debtor.
  3. A creditor obtains a Bankruptcy Notice and serves this upon the debtor, requiring payment within a period of time.
  4. If the debtor does not satisfy the terms of the Bankruptcy Notice, the creditor obtains a Creditor's Petition. The Creditor's Petition is filed with the Court and is served upon the debtor. The Court will determine if the debtor should be made bankrupt.
  5. If an agreement is not reached between the parties prior to the Court hearing or the debtor does not raise a defence to the creditor's claim that is accepted by the Court, the Court issues a Sequestration Order against the estate of the debtor, resulting in the debtor becoming bankrupt.

Debtor's Petition

A debtor can file a Debtor's Petition with the Insolvency and Trustee Service Australia ("ITSA") to become bankrupt. This process involves the debtor completing and lodging with ITSA two forms, a Debtor's Petition and a Statement of Affairs. The debtor becomes bankrupt on the same the petition is accepted by ITSA.

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WHO CAN ACT AS A TRUSTEE?

  1. A Registered Trustee; or
  2. The Official Trustee (ITSA).

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DUTIES OF A TRUSTEE

The duties of the Trustee of the estate of a bankrupt are detailed in Section 19 of the Act and include the following:

  • notifying the bankrupt's creditors of the bankruptcy;
  • determining whether the estate includes property that can be realised to pay a dividend to creditors;
  • reporting to creditors within 3 months of the date of the bankruptcy on the likelihood of creditors receiving a dividend before the end of the bankruptcy;
  • providing information about the administration of the estate to a creditor who reasonably requests it;
  • determining whether the bankrupt has made a transfer of property that is void against the Trustee;
  • taking appropriate steps to recover property for the benefit of the estate;
  • taking whatever action is practicable to try to ensure that the bankrupt discharges all of the his/her duties under this Act;
  • considering whether the bankrupt has committed an offence against the Act;
  • referring to relevant law enforcement authorities any evidence of an offence by the bankrupt against the Act;
  • administering the estate efficiently and effectively to avoid unnecessary expense;
  • exercising powers and performing functions in a commercially sound way.

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POWERS OF A TRUSTEE

A Trustee in bankruptcy has very strong and broad powers under the Act to enable him/her to fulfil his/her duties. Some of the more relevant powers are to:

  • investigate the bankrupt's conduct and examinable affairs (examinable affairs extend to associated companies, trusts, partnerships and natural persons such as professional advisors and relatives);
  • take possession of and realise the bankrupt's divisible property;
  • obtain books and records relating to the bankrupt's examinable affairs from the bankrupt, entities holding records of the bankrupt (such as solicitors or accountants) and associated entities of the bankrupt;
  • require the bankrupt to attend upon the Trustee;
  • obtain information from the bankrupt about his/her conduct and examinable affairs;
  • require a bankrupt to attend a meeting of creditors;
  • require a bankrupt to execute such documents as the Trustee or the Court orders;
  • obtain access to premises and books of other persons;
  • conduct public examinations before a Registrar or appointed Deputies in the Federal Court of Australia or Federal Magistrates Court of Australia;
  • conduct examinations and obtain records and information from persons (including bankrupts) under oath pursuant to a notice obtained from the Official Receiver;
  • request that the Official Receiver issue an offshore information notice to a person residing outside Australia, if it is believed that the person's information or books or copies of books are relevant to the examinable affairs of the bankrupt.

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PROPERTY & FUNDS RECOVERABLE BY A TRUSTEE

The main objective of a Trustee is to maximise the recovery of funds where commercial and pay dividends to creditors in a timely manner. The most common means of recovering funds are via:

  • property available to the estate;
  • income contributions from the bankrupt;
  • antecedent/voidable transactions; and
  • voluntary contributions.

1. Property Available To The Estate Divisible Property

Generally, all property that the bankrupt owns, has a right to or an interest in, at the date of the bankruptcy, vests in the Trustee. Divisible property essentially includes all property available to the Trustee except exempt property (discussed below).

The bankrupt's property at the commencement of the bankruptcy is also available to creditors. The commencement date is not always the date that the person becomes bankrupt. For example, for a bankruptcy pursuant to a Creditor's Petition, the commencement date is the date of the earliest act of bankruptcy occurring within 6 months before the presentation of the petition. The Act sets out a list of various acts of bankruptcy.

A Trustee is also entitled to recover certain property acquired by a bankrupt after the date of bankruptcy and before the date of discharge from bankruptcy. Common types of "after acquired property" include entitlements from a deceased estate and windfall gains, such as lottery winnings.

Exempt Property

Some property does not vest in the Trustee, including:

  • property held by the bankrupt in trust for another person;
  • necessary household property and effects;
  • tools of trade to the value of $3,000*;
  • a motor vehicle to the value of $5,900* used by the bankrupt primarily as a means of transport;
  • a bankrupt's interest in a regulated superannuation fund or an approved deposit fund or policy's of life assurance or endowment assurance in respect of the life of the bankrupt or the bankrupt's spouse not exceeding the pension reasonable benefits limit (currently $1,238,440*);
  • any right of the bankrupt to recover damages or compensation for personal injury or wrong done to the bankrupt or their family or in respect of a death of a member of the bankrupt's family; and
  • amounts paid to the bankrupt under a scheme established between the Commonwealth and the States under the Grants (Rural Reconstruction) Act 1971 being amounts paid by way of loan as assistance for the purpose of rehabilitation. * indexed amounts, adjusted for the Consumer Price Index (CPI)

2. Income Contributions

A bankrupt is entitled to earn an income during the period of the bankruptcy. The Trustee is required to assess the bankrupt's income and if it is above a certain base level, the bankrupt will be required to make contributions to the Trustee. The bankrupt is required to contribute 50% of any net income earned in excess of the threshold amount. How the bankrupt pays the assessed contribution will be determined by the Trustee, usually in consultation with the bankrupt.

The bankrupt's failure to cooperate in providing information regarding income or failure to make the payments as assessed by the Trustee may lead to the bankruptcy being extended by an additional 5 years.

Contributions not met by the bankrupt are a debt due even after discharge. Non-payment of the contributions could result in a further bankruptcy.

The Trustee may obtain from the Official Receiver a Notice, similar to a garnishee order, to the bankrupt's employer or another entity that owes money to the bankrupt, in order to recover any income contributions owing by the bankrupt.

The base income that the bankrupt is able to earn before being required to make income contributions, is an indexed amount, varying vary from time to time. The amount is currently $35,763 (after tax) for a bankrupt with no dependents. The threshold increases if the bankrupt has dependents.

3. Antecedent/Voidable Transactions

The Act allows for certain transactions that occur prior to the bankruptcy to be recovered by a Trustee. Such transactions are often referred to as antecedent or voidable transactions. The main reason for these provisions in the Act are to ensure assets of the bankrupt that would be recoverable in a bankruptcy, but have been disposed of prior to bankruptcy, can be "clawed back" and sold by a Trustee with proceeds distributed rateably to all unsecured creditors. This ensures no creditors or other persons receive an unfair priority or benefit.

The following are antecedent/voidable transactions.

  • Property of a bankrupt recovered by a creditor prior to bankruptcy pursuant to action taken by the creditor. The most common form of recovery by a creditor is pursuant to a warrant of execution issued by a Court, where a Sheriff of the Court recovers and sells the property (Section 118, 119 & 119A).
  • Undervalued transactions, which are transfers of property (including money) of the bankrupt to another person within 5 years prior to the commencement of the bankruptcy, where the transferee gave no consideration for the transfer or gave consideration of lower value than the market value of the property (Section 120).
  • Transfers to defeat creditors, which are transfers of property (including money) that would probably have become part of the bankrupt's estate or would probably have been available to creditors if the property had not been transferred. Further, the transferor's main purpose in making the transfer must have been to prevent the transferred property from becoming divisible among the bankrupt's creditors or to hinder or delay the process of making property available for division among the bankrupt's creditors (Section 121).
  • Preferences (preferential payments), which are transfers of property (including money) of the bankrupt to a creditor in the relevant period prior to bankruptcy, where the transfer had the effect of giving the creditor a preference, priority or advantage over other creditors (Section 122). The relevant period can be up to 6 months prior to the commencement of the bankruptcy.

The law in regard to the above transactions is complex and the relevant transactions must occur within specific timeframes.

To recover one of the above transactions, the Trustee will generally write to the relevant party stating the case why the Trustee assesses the transaction is voidable. If a settlement cannot be reached between the parties, the Trustee must seek recovery by issuing a Notice that is obtained from the Official Receiver or by an Order of the Court.

In assessing any of the above claims, a Trustee must consider various defences available to the beneficiary of the transaction. The relevant defences are detailed in the Act.

4. Voluntary Contributions

A bankrupt or any person or entity may make voluntary contributions to the bankrupt estate. Reasons why voluntary payments may be made include:

  • to provide funding to assist the Trustee undertake investigations (such as examinations) or legal action;
  • payment as a commercial settlement in relation to a potential claim that the Trustee may have, where no liability is admitted on the part of the Trustee or the payee;
  • payment to effect an annulment, where sufficient funds are not recovered in a bankruptcy to pay all debts and costs in full, however voluntary payments can be made by the bankrupt from exempt property or income or by another person to pay all debts and costs; or
  • payment as a contribution towards some or all of the costs incurred by the Trustee in administering the bankrupt estate.

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THE EFFECT OF BANKRUPTCY ON CREDITORS

Unsecured Creditors

  • The major effect that bankruptcy has on unsecured creditors is that the creditors are no longer able to pursue the bankrupt for debts outstanding unless the permission of the Court is obtained. Unsecured creditors are also not able to enforce any remedies against property of the bankrupt after bankruptcy as the property vests in the Trustee for the benefit of all creditors.
  • Creditors' rights against the bankrupt lie in their ability to claim in the bankrupt estate and participate in any dividend that may be paid from funds recovered by the Trustee. Upon the bankrupt's discharge from bankruptcy, the bankrupt receives a release from provable debts generally.
  • Some debts though are not provable in bankruptcy and as a result will not by extinguished as a result of the bankruptcy. The bankrupt does not obtain a release from debts incurred by means of fraud, penalties or fines imposed by a Court, sums payable under maintenance agreement or order and HECS debts.

Secured Creditors

  • Secured creditors with valid security are able to enforce their rights pursuant to charges or securities that they hold over assets of the debtor.
  • Secured creditors are entitled to claim as an unsecured creditor for the amount by which their debt exceeds the value of the property over which they hold security.
  • A secured creditor may however forfeit its security and claim for the full amount of its debt.
  • Where a secured creditor has realised its security, it may lodge a claim in the estate for any resultant deficiency.

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RIGHTS OF CREDITORS IN A BANKRUPTCY

Some of the rights of creditors in a bankruptcy include to:

  • obtain from the Trustee information about the administration of the estate;
  • require a Trustee to call a meeting of creditors in some circumstances;
  • remove a Trustee;
  • appeal to the Court against a Trustee's decision;
  • fix and review the Trustee's remuneration;
  • receive a dividend;
  • attend or conduct public examinations.

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THE EFFECT OF BANKRUPTCY ON THE BANKRUPT

As well as some of the effects mentioned previously in this paper, a bankrupt must:

  • complete and file with the Official Receiver (ITSA) a Statement of Affairs, detailing among other things, the bankrupt's financial position (assets and liabilities);
  • provide details of his/her income as required by the Trustee;
  • give to the Trustee all books and records relating to his/her examinable affairs;
  • attend upon the Trustee when required;
  • surrender his/her passport to the Trustee;
  • give such information about his/her conduct and examinable affairs as the Trustee requires;
  • attend a meeting of creditors if required to do so by the Trustee;
  • give information at a meeting of creditors as the meeting requires;
  • execute such documents as the Trustee or the Court orders;
  • disclose to the Trustee all assets and liabilities and as soon as practicable and "after acquired" divisible property;
  • obtain written approval of the Trustee to travel overseas;
  • not obtain credit exceeding $4,083 (CPI adjusted) without disclosing the bankruptcy to the credit provider;
  • comply with directions of the Trustee;
  • advise the Trustee of his/her address and daytime telephone number;
  • in some circumstances, contribute a percentage of income to the estate;
  • not sell or otherwise deal with any property existing as at the date of bankruptcy as all divisible property vests in the Trustee;
  • not to take part in the management of a body corporate without the consent of the Court.

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DISTRIBUTIONS / DIVIDENDS TO CREDITORS

The Trustee will collect the funds and/or property available in the bankrupt estate and distribute it to creditors when the Trustee believes sufficient funds and/or property are available.

The Act provides that prior to the payment of a dividend, the Trustee must issue a notice to those creditors who have not lodged a formal claim (known as Proof of Debt), requiring them to lodge a claim by a certain date. If creditors do not lodge a formal claim by the required date, they may be excluded from receiving a dividend. The Trustee them must wait a further 21 days (after the date by which claims must be lodged) before the dividend is paid.

The Act provides for certain priorities to different classes of creditors when a dividend is paid. The funds available to pay a dividend are to be distributed in the following order:

  1. Wages, salary, superannuation or commission due to employees, including allowances or reimbursements (presently limited to $3,500), but excluding long service leave, extended leave, annual leave, recreation leave and sick leave;
  2. Compensation payable relating to workers' compensation;
  3. Amounts payable in relation to workers' leave entitlements;
  4. As the Trustee deems fit, refunds of any apprenticeships / indenture fees paid;
  5. Such preferences, priorities or advantages as creditors approve by special resolution;
  6. Such costs, charges and expenses incurred in the interests of creditors before the date of bankruptcy as creditors approve by special resolution;
  7. Unsecured creditors proven debts;
  8. Any deferred entitlement to interest; with
  9. Any surplus refunded to the bankrupt.

The payment of a dividend may also be affected if there is joint property and joint creditors. In short, the Act requires joint assets of the debtors to be first applied to the joint debts incurred by the debtors and any surplus is then passed on to the separate estates of the debtors(s).

Conversely, separate estates of the debtors must first be applied to separate debts of the debtors, that is, separate assets of each debtor must be first applied to debts incurred solely by the respective debtor. Any surplus from the respective separate estate(s) will then flow to the joint estate and will be paid to joint creditors.

If joint property and creditors are applicable, the Trustee is required to advise creditors of the implications on the payment of the dividend.

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REMUNERATION & COSTS OF THE TRUSTEE

The remuneration and the costs of the Trustee may be paid by the bankrupt, a third party or from the funds/property available in the bankrupt estate. Generally, the remuneration and costs are paid from the assets/funds recovered under the bankruptcy.

Pursuant to the provisions of the Act, remuneration/expenses/outlays of the Trustee will be paid in priority to the claims of unsecured creditors (government charges are paid in priority to both).

The alternative methods available to approve the remuneration of a Trustee are as follows:

  1. a resolution passed by creditors at a meeting of creditors;
  2. a resolution passed by creditors via a single resolution postal process;
  3. a resolution passed by a committee of inspection (if appointed); or
  4. the Bankruptcy regulations.

Where no funds or nominal funds are recovered in the bankruptcy, the Trustee will generally not seek approval of the remuneration from creditors and will draw any remuneration in accordance with section 162(4) and regulation 8.08 of the Act (Bankruptcy regulations).

If sufficient funds are recovered in the bankruptcy, a Trustee would then seek to have creditors approve the remuneration. In this case, the Trustee is required to advise creditors of the amount of remuneration sought and will request that creditors approve his/her remuneration. Creditors will then determine the remuneration of the Trustee by a vote (either at a meeting or by postal vote).

Where either the bankrupt or a creditor are dissatisfied with the amount of remuneration taken by a Trustee, that party may, by notice in writing lodged within 28 days of being notified in writing or becoming aware of the amount of the claim for remuneration, request a taxing officer to tax the remuneration.

If taxation results in a reduction of at least 15% in the amount of a claim for remuneration, the Trustee must meet the costs of the taxation. Otherwise, the person who asks for the taxation must meet the costs. If any creditor wishes to have remuneration reviewed, you should contact the Insolvency and Trustee Service Australia, Level 13, 340 Adelaide Street, Brisbane, telephone (07) 3360 5444.

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PUBLIC RECORD

Bankruptcy details are available to the public via a Government database known as the National Personal Insolvency Index ("NPII") and usually on databases of credit reference agencies. Access to the Government database can be obtained by contacting ITSA or information brokers such as Australian Business Research ("ABR"). Searches can be conducted by accessing our website at www.svpartners.com.au.

Details of the bankrupt's name, address, date of birth, occupation and the number of the bankruptcy administration will remain on the NPII forever.

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DISCHARGE FROM BANKRUPTCY

The statutory period of bankruptcy is 3 years. This period commences from the date the bankrupt's Statement of Affairs is filed with the Official Receiver (ITSA). The bankruptcy still takes effect from the original commencement date. If a bankrupt does not file a Statement of Affairs, the bankruptcy will continue indefinitely.

The bankruptcy may end at a different date in the following instances.

1. Objection to Discharge

A trustee may object to the discharge of a bankrupt in certain circumstances - essentially when a bankrupt does not comply with his/her obligations under the Act. There are a number of grounds for an objection and the severity of any breach of obligation will set the term of bankruptcy. The effect of lodging an objection to discharge is that the bankruptcy can be extended to 5 years or 8 years, or longer if the non-compliance of the bankrupt relates to unauthorised overseas travel.

2. Early Discharge

For bankruptcies prior to 5 May 2003, a bankrupt is entitled to make an application to the Trustee for a discharge after six months from the date of filing a Statement of Affairs. In determining whether a bankrupt is entitled to an early discharge, the Trustee must consider the requirements set out in the Act. The Trustee does not have any discretion in determining whether a bankrupt is entitled to an early discharge. Not all bankrupts are successful with their application.

The early discharge provisions are not available to bankruptcies commencing on or after 4 May 2003.

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ANNULMENT OF BANKRUPTCY

A bankruptcy can be annulled in the following instances:

  • all of the debts and costs of the bankruptcy administration have been paid in full;
  • the bankrupt puts forward a proposal through the Trustee to the creditors pursuant to Section 73 of the Act and the proposal is accepted by the creditors by special resolution; or
  • by an Order of the Court.

An annulment by its very meaning means that the bankruptcy is taken to have never occurred.

A proposal pursuant to Section 73 of the Act is effectively a Part X proposal within a bankruptcy. A proposal may be in the form of a Composition or a Scheme of Arrangement. This process involves the bankrupt agreeing to terms with creditors through the Trustee to make a payment or payments to creditors, which they accept in final satisfaction of their debts. In this case, the bankruptcy is annulled upon the creditors accepting the bankrupt's proposal at a meeting convened to consider the proposal.

It does not have to represent a payment of 100 cents in the dollar and may include a payment by way of a lump sum or over a period of time. This topic is covered in more detail in a separate paper.

Contact us to discuss the specific details of your individual situation.

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