People who are unable to pay all of their debts as and when they fall due makes them ‘insolvent’ and they can be declared bankrupt. Bankruptcy involves much more than simply not being able to repay debts. This article will take you through the legal concept of bankruptcy and explain its effects and application.

1. Purpose

Bankruptcy has two important purposes. Firstly, it provides a system for the fair distribution of a debtor’s assets among creditors. Secondly, debtors can obtain some relief from creditors and eventually have the chance to make a new financial start.

A third function that bankruptcy has is to enable the investigation of the debtors’ conduct before they are declared bankrupt. This assists with determining whether there has been any improper or dishonest activity or transactions that have occurred pre-bankruptcy, which may attract penalties or be set aside.

2. Types

Bankruptcy can be either voluntary or involuntary.

Voluntary bankruptcy is when a debtor presents a debtor’s petition to the Official Receiver through AFSA. If the debtor’s petition is accepted, and there is no bankruptcy application by a creditor, the person will be made bankrupt and cannot change their mind.

Involuntary bankruptcy is when the court makes a sequestration order on a creditor’s application. This occurs when a debtor fails to pay debts to one or more creditors.

3. Management

The property of the bankrupt vests in a trustee. A trustee can either be a private trustee in bankruptcy or the Official Trustee.

Property usually excluded from being taken by the trustee includes personal and household property, a car (under $7,600), superannuation and property held in trust.

Once the bankrupt’s property has been recovered, the trustee must sell the property. Any proceeds are then divided among the bankrupt’s creditors.

Proceeds are distributed rateably among the creditors. Before distribution, creditors must have evidence of the debt owed to them.

4. Effects

Formal bankruptcy proceedings can last a long time, and a bankrupt person is required to assist the trustee during that period, attend creditors meetings and make contributions from their income to pay off their debts to creditors. They may also be required to surrender their passport and be restricted from travelling, disclose their status if they apply for credit and will not be entitled to take part in managing a company as a director.

5. Discharge

A bankrupt can generally be discharged three years and one day after they became bankrupt, either on a debtor’s petition or from the date they filed a statement of affairs following receipt of a sequestration order. An annulment of a bankruptcy can take place if all the bankrupt’s debts are paid off. Alternatively, the trustee may object to the discharge and extend the period of bankruptcy to 5 or 8 years. A bankrupt following their discharge is released from all proveable debts and creditors have no further claim against the bankrupt.

6. Alternatives

As an alternative to bankruptcy, it may be possible to enter into a personal insolvency or a debt agreement.

A personal insolvency agreement is a flexible arrangement that can suit debtors and creditors and is sometimes used when a debtor has a high income but few if any assets, or a substantial asset but only limited income.

A debt agreement is an informal type of administration that is used where debtors have a small amount of debt, low incomes and only a few assets.

Both of these avenues can provide a creditor with more favourable conditions than a formal bankruptcy.

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If you are a debtor or a creditor and require advice in respect of bankruptcy or alternative debtor arrangements, get in touch with one of our insolvency lawyers on 1300 544 755.

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