In Short
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Bankruptcy applies only to individuals: Companies cannot declare bankruptcy but may enter insolvency procedures like liquidation or administration.
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Consequences are significant: Bankruptcy can affect your credit, employment, and ability to travel.
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Not all debts are covered: Certain obligations, such as child support and student loans, remain payable.
Bankruptcy provides individuals and sole traders who are unable to pay their debts with a way to discharge financial obligations. While it offers relief, including protection from creditors and the opportunity for a fresh start, it also comes with significant consequences that can impact your assets, credit, and employment opportunities. This article outlines the various consequences of bankruptcy.
What is Bankruptcy?
Bankruptcy is the legal process where individuals (or sole trader businesses) who can no longer pay their debts are freed from financial obligations for debts incurred prior to becoming bankrupt. A Trustee in Bankruptcy will assume control of your assets and finances once you have been made bankrupt. The Bankruptcy Act 1966 (Cth) governs the bankruptcy procedure. You can only apply for bankruptcy if you are an individual, as it is not applicable to companies.
How Long Does Bankruptcy Last?
Bankruptcy normally lasts for 3 years and 1 day, starting from either:
- the day your Debtor’s Petition is accepted by AFSA; or
- if you are declared bankrupt as a result of a Creditor’s Petition, from the date your statement of affairs is accepted by AFSA.
In some cases, your Trustee in Bankruptcy can seek to extend the bankruptcy for up to eight years.
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Two Ways Bankruptcy May Occur
There are two main ways you can become bankrupt:
1. voluntarily entering bankruptcy; or
2. by order of the Court.
Voluntary Bankruptcy – Debtor’s Petition
If you cannot pay your debts, you may choose to become bankrupt voluntarily.
To do this, you will need to complete and lodge a debtor’s petition with the Australian Financial Security Authority (AFSA), and they will assess your petition. Once your petition has been accepted, a trustee will be appointed to manage your finances and debts.
Court-Ordered Bankruptcy – Creditor’s Petition
A creditor who is owed more than $10,000 and has a court judgment against you may take steps to bankrupt you.
The Court will be asked to make Sequestration Orders against you. Once sequestration orders are made, a trustee in bankruptcy will be appointed to administer your estate and your assets will typically vest with that trustee. The Trustee’s role is to realise and sell your assets to the benefit of creditors.
Bankruptcy Relief
If you cannot pay your debts, declaring bankruptcy can provide several forms of relief.
- Debt Relief: Individuals and sole trader businesses will be released from most unsecured debts and will not have to repay them anymore. This provides relief from overwhelming debts like:
- credit card debts;
- tax liabilities;
- money owed to suppliers;
- debts from personal loans and ongoing services (e.g. telephone plans, electricity, motor vehicle registration, internet, child care, etc.); and
- medical bills.
- Protection from Creditors and Legal Proceedings: Bankruptcy will generally prevent harassment from unsecured creditors and provide relief from ongoing threats and demands. Once you declare yourself bankrupt, an automatic stay is put in place, preventing unsecured creditors from taking legal action or pursuing debt collection efforts against you.
- Asset Protection: Certain assets are protected under bankruptcy laws in Australia. These include:
- superannuation in your super fund;
- tools of trade up to the prescribed amount ($4,350 as at October 2024);
- necessary household items, including appliances and furniture;
- payments from life insurance or superannuation received on or after the date of bankruptcy;
- compensation received directly by you from a personal injury claim;
- ordinary clothing; and
- a motor vehicle up to an indexed limit ($9,400 as at October 2024).
Consequences of Bankruptcy
However, bankruptcy is not merely a ‘get out of debt free’ card. Once you declare bankruptcy, there are several lasting consequences:
- Loss of Assets: Bankruptcy may require you to surrender certain assets, which can be sold by the trustee to repay your creditors. These include real property or assets that exceed limits set by the Bankruptcy Act. Any cash or money you have in a bank account will also be taken to pay your debts, and you will only be left with a minimum prescribed amount to live on.
- Trustee investigations: The trustee can investigate your financial affairs going back many years. They can reclaim assets you have given away or sold for less than the true value.
- Public Record: Your name will be permanently listed on the National Personal Insolvency Index (NPII), a searchable public register that records insolvency proceedings in Australia.
- Credit Rating: Bankruptcy can significantly affect your ability to obtain future credit, as it remains on your credit file for up to five years or longer, depending on the credit reporting agency. This may make it difficult to obtain credit and result in higher interest rates on loans. You will also be required to disclose your recent financial history to lenders, which may hinder your ability to rebuild after bankruptcy.
- Employment and Business Limitations: Bankruptcy may affect your income, employment or business, including that:
- Certain professions, such as lawyers, accountants and licensed builders, may have restrictions on practising whilst bankrupt.
- While you are an undischarged bankrupt, you are also disqualified from acting as a director or managing a company. However, you may apply to the Court for permission to do so.
- If you earn over a predetermined threshold ($71,826.30 after tax, base amount as at October 2024), you may need to make some compulsory payments to your trustee; and
- There may also be some restrictions on your employment and running a business. A court can impose restrictions on the classes of jobs, roles or sectors where you may be able to seek employment.
- Travel Restrictions: Bankruptcy will affect your ability to travel overseas. You will need to request and obtain written consent from your trustee to travel overseas. Failure to do so can lead to criminal charges. If you have complied with your obligations and the trustee does not consider you a flight risk, they will generally give consent. In some instances, you may be requested to deliver your passport to your Trustee.
Exceptions to Debt Relief
Secured Debts and/or Assets
If you have secured debts, which are tied to specific property, such as a mortgage, car loan or hire purchase arrangements, secured creditors have rights to retake possession of the property if the debt is not paid in accordance with the terms of your agreement.
If you have significant equity in an asset, for example, you have paid off a portion of your mortgage, which is enough to cover the costs of the sale and pay out something to your creditors, the trustee will likely sell the asset.
Unsecured Debts and Other Not Extinguished Debts
Additionally, there are some exceptions to debts that are covered by bankruptcy, including:
- court-imposed penalties and fines;
- debts incurred by fraud;
- child support and spousal maintenance payments;
- student loans (HECS and Fee-Help);
- unliquidated debts (whereby you and a creditor have not yet agreed on the amount of your debt); and
- newly incurred debts after declaring bankruptcy.
Key Takeaways
While bankruptcy can offer much-needed debt relief and protection, it is not without its challenges. Understanding the full scope of its effects, from asset loss to restrictions on employment and travel, is crucial before making the decision to declare bankruptcy. It is important to seek professional advice to navigate the process effectively.
Frequently Asked Questions
If you are unable to pay your debts, whether it be in your personal capacity or for your sole trader business, bankruptcy can offer relief from most creditors. Bankruptcy, however, is generally a last resort as it requires you to give up your assets and control of your own finances to a trustee. You should carefully consider whether bankruptcy is the right option for you.
Upon bankruptcy, unsecured creditors are not permitted to take action to recover debts owed to them; instead, they will have the right to lodge claims in the bankruptcy and, if there are sufficient funds, receive payment of distribution from the Trustee. Creditors can only make a claim for debts that were owed prior to you being made bankrupt. For more detailed information on debt treatment, please visit the AFSA website here.
Creditors will be paid from a bankrupt estate in a certain order under section 109 of the Bankruptcy Act and section 25 of the Bankruptcy Regulations 2021. This information is summarised here.
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