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If someone owes your business a debt, it can be frustrating when they avoid contact and refuse to pay what they owe you. There are several enforcement options available to assist you in recovering your money. However, sometimes it is difficult to know which enforcement action is worthwhile or the best option to pursue. While technically not a debt recovery tool, bankrupting your debtor may still be an option worth considering. This article takes a look at some of the pros and cons of bankrupting your debtor.

When Is Bankruptcy an Option and What Is the Process?

Someone that owes your business money is known as a debtor. You must meet a number of pre-conditions before you can commence bankruptcy proceedings against your debtor. These conditions require that:

  • a court enters judgment against your debtor; 
  • the judgment is against an individual, not a business; and
  • the debt owed to you exceeds $5,000. 

You can only commence the multi-step bankruptcy process once you have met these pre-conditions. Then you need to follow a specific course of action, which includes:

  • lodging a bankruptcy notice with Australian Financial Security Authority and delivering the notice to your debtor; and
  • giving your debtor 21 days to make payment or to take steps to have the bankruptcy notice set aside.

If your debtor fails to make payment within the 21 day time period, they will be deemed to have committed an ‘act of bankruptcy’. You may then rely on the act of bankruptcy to commence bankruptcy proceedings in the Federal Circuit Court of Australia.

Temporary COVID-19 Arrangements

Temporary changes to insolvency laws are currently in place as a result of COVID-19. Whilst your business can still make use of bankruptcy notices, the time frame for making payment and the minimum monetary thresholds have changed considerably.

Pre COVID-19 Current temporary changes
Bankruptcy Notice

Debt exceeds $5,000

21 days to comply

Debt exceeds $20,000

six months to comply

While these temporary changes were due to lapse on 25 September 2020, the Federal Government has announced that they will continue to remain in place until 31 December 2020.

As a creditor, you currently have two options:

  1. issue a bankruptcy notice now, giving your debtor six months to make payment; or 
  2. wait to issue a bankruptcy notice after 31 December 2020 in the hope that the Federal Government does not extend the temporary insolvency provisions further and that the time for compliance reverts to the usual 21 days.

What Are the Pros?

1. Motivate Your Debtor to Settle the Debt

Being declared bankrupt has serious consequences for your debtor. In many instances, these consequences will result in your debtor attempting to settle the debt owed to you if they have the means to do so.

Bankruptcy will affect your debtor in a number of ways, including that:

  • the bankruptcy will be on public record;
  • it will impact their credit rating, which in many instances will prevent your debtor from obtaining future finance or credit;
  • their name will appear on the National Personal Insolvency Index (NPII) register for life; 
  • it will prevent them from being a director of a company whilst they are bankrupt; and 
  • it may prevent them from travelling overseas.

These consequences will generally last for a period of three years.

2. Have a Trustee Appointed to Settle the Debts

As the petitioning creditor, you get the opportunity to choose an independent trustee. A trustee is someone who is appointed to administer your debtor’s estate. This means that they will manage the bankrupt person’s remaining money and assets. 

They have significant powers to search for assets and funds that could be used to repay any debts. This power extends to investigating and reversing previous transactions, including clawing back payments which have been made prior to the bankruptcy.  

The trustee can also sell any real property owned by your debtor, which can be a good source of funds to pay debts.

3. Receive Contributions from their Salary

If your debtor is employed, they will be required to pay a contribution from any earnings they receive over a certain threshold. The trustee shall determine the amount of the contribution, but will be adjusted to take into account factors such as the number of dependents a debtor has.

What Are the Cons?

1. No Guaranteed Payment

Bankrupting a debtor does not guarantee payment. There is a possibility that you will only receive a small portion of the debt owed to you, or in some instances, nothing at all.  

2. Difficult to Assess Your Debtor’s Financial Position

Prior to your debtor being made bankrupt, there is no clear way of knowing:

  • what funds or assets they owned before commencing bankruptcy proceedings;
  • the amount of equity held in any real property; or 
  • the number of other creditors that they owe money to, or the amounts owed to them.

3. Other Creditors Might Get Paid Before You

Your debtor might owe a number of businesses money. Even if you initiated the process of bankrupting your debtor, you may not get paid before other creditors. The trustee must pay out dividends in a clear order of priority, which is mandated by law as follows:  

  • the costs that you incur as a result of the bankruptcy proceedings;
  • the costs of the trustee appointed to manage the debtors finances;
  • secured creditors; 
  • any employee wages, salary or leave entitlements; and
  • unsecured creditors.

This means that there is no guarantee that your debt will be repaid.

Is Settlement Still an Option?

You can negotiate and accept a commercial settlement at any time before bankrupting your debtor.

However, if you reach a resolution with your debtor and you choose to discontinue the bankruptcy proceedings, another creditor can take steps to continue the proceedings. In this scenario, there is a risk that the trustee may later deem any settlement payment you have received to be a preference payment. This means that it can be clawed back by the trustee to repay creditors in the priority order set out above.  

Key Takeaways

It is clear that there are both pros and cons to consider before bankrupting your debtor. Indeed, it may: 

  • incentivise your debtor to settle their debts to avoid the serious ramifications of bankruptcy; or
  • allow you to recoup some of your debts through the actions of a trustee.

However, there can be no guarantee that you will receive payment in full, or at all. If you need advice about bankrupting your debtor, contact LegalVision’s bankruptcy lawyers on 1300 544 755 or fill out the form on this page.


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