What is bankruptcy

Bankruptcy is a legal status where a person who cannot afford to repay the debt owed to a creditor is removed from controlling their financial situation either voluntarily or forced. Bankruptcy offers protection from creditors further pursuing people for payment.

Introduction

In 2013 to 2014, just under 30,000 people across Australia either declared themselves bankrupt or were forced into bankruptcy by a creditor.

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

1 with some exceptions, creditors are prevented from further pursuing them for payment (s 58(3));

2 certain restrictions are placed on them; and

3 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 (ss 109, 116).


NOTE

All references to legislation in this chapter are to the Bankruptcy Act or the Bankruptcy Regulations 1996 (Cth) (“Bankruptcy Regulations”) unless otherwise noted.


Purpose of bankruptcy

The two main purposes of bankruptcy are:

1 to give the debtor 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);

2 forced bankruptcy: the creditor(s) files a creditor’s petition; 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.


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

1 After discharge from bankruptcy, the bankrupt is released from almost all debts (the exceptions are discussed in this chapter).

2 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).

3 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.

4 Bankrupts with no dependents who have an income of less than $53,653.60 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 Magistrates’ Court (or other court) attachment of earnings order. (See Are you in debt?, in relation to attachment of earnings orders and “What happens to the bankrupt’s income?” for details regarding income contributions in bankruptcy.)

5 The Bankruptcy Act gives significant protection to superannuation payments (though note the strict regulation of these referred to below), 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.

Disadvantages

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 (seeCredit reporting” in Privacy and your rights) or two years starting on the day that you are no longer bankrupt, whichever is later.

2 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.

3 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.)

4 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.

5 A bankrupt cannot be a trustee of a superannuation 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). (SeeDivisible property”.)

7 The bankrupt might have to pay regular contributions to the trustee if net annual income is above a certain amount ($53,653.60 (indexed) net per year if there are no dependants).

8 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. SeeInsurance policies”.

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 whose creditors are business associates, who are unable to continue to operate a business, or 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 hiring goods or writing cheques) of $5,409 (indexed) or more without disclosing the bankruptcy to the person extending the credit is a criminal offence (ss 269(1)(a), 304A(1)(g), (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).

(For further information visit Victoria Legal Aid’s website at www.legalaid.vic.gov.au.)

Considering all the options

It is strongly recommended that a debtors considering bankruptcy seek advice from an independent and qualified source, such as a free financial counsellor (see Financial counselling services). A financial counsellor can assist a low income debtor to weigh up all their options, including negotiating with a 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 (for a list of legal services, see Legal services that can help).

Recent changes to bankruptcy law

The most recent amendments to bankruptcy law are contained in the Bankruptcy Legislation Amendment Act 2010 (Cth) and the Bankruptcy Amendment (2014 Measures No.1) Regulation 2014 (Cth).

The key change for debtors is the payment of a fee for the debtor to apply to travel overseas.

For further information regarding the above developments, check the AFSA website (at www.afsa.gov.au) or the Parliament of Australia website (at www.aph.gov.au).