Bankruptcy, Insolvency and Formal Debt Arrangements – A Guide for Creditors and Debtors

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Table of Contents

• What does insolvency mean?
• I am a creditor who is owed money, what do I need to do to bankrupt a debtor?
• I am facing financial hardship – what are my options?
• What are the consequences of bankruptcy?
• Conclusion

Do you run a business and are owed money by your customers and consequently facing financial hardship? Having a general understanding of the bankruptcy process and your options as a creditor or debtor are important. This article provides you with a general guide to obtaining a sequestration order against a debtor and voluntary insolvency options for debtors including debtors’ petitions, debt agreements and personal insolvency agreements.

What does insolvency mean?

Insolvency is where a person or company is unable to pay their debts when those debts are due and payable. If a person or company is in this situation, they are considered to be insolvent. When a company becomes insolvent, the three most common corporate insolvency procedures are voluntary administration, liquidation and receivership.

We discuss this further in our article Corporate Insolvency: voluntary administration, liquidation and receivership basics. If an individual becomes insolvent, then he or she may enter into bankruptcy or a personal insolvency arrangement.

I am a creditor who is owed money, what do I need to do to bankrupt a debtor?

If a person is unable to pay his or her debts when they fall due, then a creditor who is owed at least $5,000 may apply to the court for a sequestration order (i.e. an order to make the person a bankrupt). The legal effect of a sequestration order is that the bankrupt’s estate is vested in the trustee for the benefit of a creditor(s).

To obtain a sequestration order, the creditor will generally:

1. File a bankruptcy notice: a bankruptcy notice is a formal demand for payment of a debt, based on a court judgment, requiring payment of the judgment debt within 21 days of service of the bankruptcy notice on the debtor;
2. File a creditor’s petition: if the person fails to comply with the bankruptcy notice, the creditor may then file a creditor’s petition. This relies on the act of bankruptcy committed by the debtor within the six-month period before the presentation of the creditor’s petition (for example, the debtor’s failure to comply with the bankruptcy notice); and
3. Attend a hearing of the creditor’s petition: once the court accepts the creditor’s petition, a hearing will be set. If the creditor is successful, the debtor will be made a bankrupt, and a trustee will be appointed.

I am facing financial hardship – what are my options?

If a person is insolvent, they may wish to obtain relief from their creditors by filing a debtor’s petition. A debtor’s petition is a form of voluntary bankruptcy and is an application made by a debtor to become a bankrupt. Once the debtor’s petition is accepted, the debtor becomes a bankrupt.

To avoid the harsh consequences of bankruptcy, a debtor may enter into a debt agreement with a creditor (also known as a Part IX agreement) as an alternative to bankruptcy. A debt agreement is a legally binding agreement under the Bankruptcy Act 1966 between a debtor and a creditor whereby the creditor agrees to accept a sum of money as settlement of the debt. There are eligibility requirements if you are considering proposing or entering into a debt agreement. This includes the fact that proposing a debt agreement is an act of bankruptcy.

Another alternative to bankruptcy is entering into a personal insolvency agreement also known as a PIA. A personal insolvency agreement is a legally binding agreement between a debtor and a creditor to repay a debt in full or in part. Such offer must be accepted by a special resolution (i.e. at least 75%) of creditors. The difference between a PIA and a debt agreement is that there are no debt, income or asset limits for an individual’s eligibility to propose a PIA.

What are the consequences of bankruptcy?

The consequences of bankruptcy are serious. There will be a record of the bankruptcy on the National Personal Insolvency Index (also known as the NPII) and the bankrupt must also forfeit to the trustee:

• any real estate he or she owns and other particular assets;
• any money held in bank accounts; and
• any income the bankrupt earns over a certain limit.

The trustee will also investigate the bankrupt’s financial affairs and may in certain circumstances recover property that the bankrupt has transferred to someone else before his or her bankruptcy.

Bankruptcy generally lasts for a term of three years but may be extended to five or eight years if an objection is lodged to the bankrupt’s discharge by the trustee.

A bankrupt may not, without the permission of the trustee, apply for credit or loans and may not otherwise incur debt. A bankrupt will also need permission from their trustee to travel outside of Australia.

Conclusion

Bankruptcy is a complex area of law, both as a creditor and as a debtor. If you require advice or assistance with personal insolvency, LegalVision has a team of experienced insolvency lawyers ready to assist. For more information, get in touch on 1300 544 755.