Part 1: A Broad Overview of Bankruptcy

‘As privileged professionals, who live by the words of the English language, lawyers have a special duty to be clear in what they say and write’[1]

When discussing any area of law, precision is essential.

A common source of confusion amongst both lawyers and the public generally is the difference between insolvency and bankruptcy. Though you may see the terms being used interchangeably (especially in legal dramas), the two concepts are distinct.

Insolvency and Bankruptcy: A Distinction

Insolvency is defined by the Corporations Act 2001 (Cth) as the inability to pay one’s debts as and when they fall due.[2]

There are two types of insolvency: personal and corporate insolvency. Whilst it may appear arbitrary, this classification is important as the two areas are governed by different legislative requirements.

Personal insolvency refers to individuals who become insolvent. Insolvent individuals may be declared bankrupt and must comply with the provisions of the Bankruptcy Act 1966 (Cth).

Corporate insolvency refers to insolvent companies. Insolvent companies may enter liquidation and are required to comply with the Corporations Act 2001 (Cth).

Insolvency and Bankruptcy: Jurisdictional Requirements

Bankruptcy:

As mentioned, personal insolvency is governed by the Bankruptcy Act, which includes both the Bankruptcy Schedule 2 rules and the Bankruptcy Regulations 1996 (Cth).

This regime is administered by the Australian Financial Security Authority (AFSA).

Some important key players in bankruptcy include:

  • The government trustee;
  • The Official Trustee in Bankruptcy;
  • The Official Receiver; and
  • The Inspector-General in Bankruptcy.

The key courts for bankruptcy matters are:

  • The Federal Court of Australia; and
  • The Federal Circuit Court of Australia; and
  • The Family Court of Australia (which has some jurisdiction).

Insolvency:

Insolvency is governed by the Corporations Act 2001 (Cth) which includes both the Corporations Schedule 2 rules and the Corporations Regulations 2001 (Cth).

This regime is primarily overseen by ASIC, although the Court has considerable jurisdiction under s 57AA of the Corporations Act.

Key Takeaway:

Whilst this distinction between personal and corporate insolvency may initially appear arbitrary, it is indeed important. This distinction determines both the jurisdiction and legislative requirements applicants will need consider and adhere to in their claim. Moreover, an understanding of this distinction will make reading any case law or media release far easier.

 

Part 2: Voluntary Bankruptcy

‘Insolvency is not a very thrilling or amusing subject’,[3] but ‘uninteresting as it may be, it is nevertheless a very important subject area’[4]

Having discussed the differences between corporate and personal insolvency, it is useful to now consider how a person can become bankrupt. There are two ways this can happen.

First, by a debtor’s petition, also referred to as voluntary bankruptcy.

Second, by a creditor’s petition, also referred to as involuntary bankruptcy.

For simplicity, this article will only consider the former type.

Voluntary Bankruptcy

Debtors may voluntarily choose to go bankrupt. In practice, this is a common course of action with 90% of all bankruptcies being voluntary.[5]

Debtors who are unable to pay their debts essentially have two options: present a ‘debtor’s petition’ or file a ‘debtor’s intention to present a debtor’s petition’.

Debtor’s Petition

A debtor’s petition is presented to the Official Receiver. This can be done by an individual debtor,[6] joined debtors,[7] or by partnership debtors.

Assuming an individual debtor’s petition, the debtor needs to provide the following documentation:

  • A debtor’s petition (s 55(1), AFSA Form 6);
  • Identity documentation; and
  • A ‘statement of affairs’ form detailing the debtor’s assets, liabilities and other relevant financial information (s 55(2), AFSA Form 3).

In practice, debtor’s petitions are ordinarily uncontroversial and typically accepted. However, the Official Receiver does have discretion under s 55(3) to reject a petition albeit usually for non-compliance with the administrative requirements.

Upon acceptance of a debtor’s petition, the debtor is formally bankrupted.

Declaration to Present a Debtor’s Petition:

The Bankruptcy Act has provisions which grant debtors breathing space to consider their options in dealing with bankruptcy, including a 21-day moratorium against civil debt recovery processes.[8] Not all debtors are permitted to complete this declaration, with certain classes of debtors specifically precluded from doing so, for example, debtors against whom a creditor’s petition is pending.[9]

However, to access these protections, debtors must provide the Official Receiver with:

  1. A completed ‘declaration of intention to present a debtor’s petition’; and
  2. A statement of the debtor’s affairs (s 54A, AFSA Form 5).

Debtors who complete this declaration should receive information on the consequences of being declared bankrupt as well as alternatives they can pursue.[10]  Despite the clear benefits of completing this declaration, in practice debtors often do not take advantage of this scheme, with only 511 declarations made between 2014-15 (out of a total of 17,000 bankruptcies).[11]

Key Takeaway:

Voluntary bankruptcy is commenced by the debtor themselves. There are two ways this can be achieved: through a debtor’s petition or through a declaration of intention to present a debtor’s petition. Both ways have their own respective advantages and limitations. To achieve the best outcome in any bankruptcy matter, it is essential to consult a professional who can tailor their advice to your unique financial position and desired outcomes.

 

Part 3: Involuntary Bankruptcy

Many, and possibly most, of the petitions in the bankruptcy lists of this country seek the bankruptcy of honest, albeit unbusinesslike or naïve, people whose indebtedness springs from causes which evoke sympathy rather than indignation.’[12]

In the previous article we discussed voluntary bankruptcy (through a debtor’s petition). This article will discuss the second type of bankruptcy: involuntary bankruptcy through a creditor’s petition.

Creditor’s Petition

An unpaid creditor may ‘petition’ (apply) the court for a sequestration order against the debtor. The effect of this order is that the debtor will be declared bankrupt and a trustee will be appointed to their estate.

Approaching the Court:

Only the Federal Circuit Court and the Federal Court can make sequestration orders. However, the other courts do have a general ‘sequestration’ power to enforce contempt orders for example, under r 55.13 Supreme Court Rules 1970 (NSW).

Which Creditors Can Present a Petition?

Any creditor, be it an individual, corporate, or joint creditor may present a petition to the courts.[13] This petition can be against an individual debtor,[14] a limited partnership,[15] or against joint debtors.[16]

Petition Formal Requirements:

Creditors must satisfy the following three criteria in their petition:

  1. The debt owed to the creditor must be at least $5,000.[17] Creditors entitled to debt less than this may join with other creditors in their petition.
  2. The debtor must be connected to Australia in some manner. This includes residing in Australia, being personally present, or having a dwelling/residence in Australia.[18]
  3. The debtor must have committed an act of bankruptcy within the 6 months preceding the creditor’s petition.

What are the acts of bankruptcy?

Conceptually, the acts of bankruptcy provide evidence that the debtor is in fact insolvent.

There are 14 acts of bankruptcy under s 40 Bankruptcy Act 1966. A creditor only needs to establish one of these acts their petition.

Two of the more common acts of bankruptcy include:

  1. Failing to comply with bankruptcy notices (s 40(1)(g); and
  2. Departing Australia with the intention of delaying creditors (s 40(1)(c)

The Effect of a Sequestration Order

It is important to remember that the making of a sequestration order is a matter for the court’s discretion.[19] Given the seriousness of bankruptcy and its legal ramifications for the debtor, the courts do not make sequestration orders lightly.[20]

If a sequestration order is made, then the debtor is formally bankrupted, and a trustee will be appointed to manage their estate for the benefit of creditors. Attached to a finding of bankruptcy are several legal and personal repercussions which will be considered in the next article.

 

Part 4: Life Post-Bankruptcy

In season 4 of The Office (US), the show’s protagonist, Michael Scott, encounters financial difficulties and receives questionable legal advice from his colleague, the illusive Creed Bratton:

Creed Bratton: Bankruptcy, Michael, is nature’s do-over. It’s a fresh start. It’s a clean slate.

Michael Scott: Like the Witness Protection Program.

Creed Bratton: Exactly.

Whilst clearly satirical and purposely exaggerated for comedic effect, this exchange does reflect the misconception that declaring bankruptcy is a ‘cure-all’, absolving debtors of all their liabilities. Unfortunately, this is simply untrue.

Declaring bankruptcy is a significant decision. Indeed, it is a decision carrying profound legal and financial consequences which may be irreversible. These consequences are extracted below.

1. Employment Restrictions:

A bankrupt is prohibited from managing a corporation or serving as a direct without the court’s approval.[21]

2. Travel Restrictions:

A bankrupt must relinquish their passport to the trustee and is unable to travel without their consent. It is an offence to travel overseas (or even do preparatory acts such as purchasing a ticket) without consent. Breach of this offence carries a maximum penalty of three years’ imprisonment.[22]

3. Credit Restrictions:

During the bankruptcy period, a bankrupt cannot obtain credit above the prescribed amount (presently $6,017)[23] without disclosing their bankrupt status to the lender. Once bankrupted, your name will permanently appear on the National Personal Insolvency Index (NPII) and credit reporting agencies will keep a record of your bankruptcy for either:

  • 5 years since you became bankrupt; or
  • 2 years from the date your bankruptcy ends (which ever period is later).

4. Obligation to Assist Trustee:

A bankrupt must, unless excused by the trustee or prevented by illness, provide all books (including those of bankrupt’s associated entity) relating to their examinable affairs to the trustee.[24] Further, a general obligation exists requiring the bankrupt to ‘aid to the utmost of his or her power in the administration of his or her estate‘.[25]

5. Obligation to Make Contribution Payments:

If your income exceeds the prescribed amount (currently, $60,515.00 after-tax, no dependents), you are be required to make compulsory payments to the trustee. These payments can be then used to pay off your debts. The amount to be paid is determined by the trustee.

6. Relinquishing Assets

A trustee can sell your assets to pay off your debt. Certain assets are not available to the trustee (referred to as ‘exempt property’) and include:

  • Necessary working apparel and household property;
  • Ordinary trade tools and equipment (up to a certain value);
  • Motor vehicles/motorbikes used primarily for transport (up to a certain value); and
  • Income below a certain amount (see above re compulsory payments).

An interesting example of what constitutes ‘tools of the trade’ is Vaughn v Official Receiver,[26] where a bankrupted wine presenter attempted to argue that his 115 wine bottles were trade tools. Unsurprisingly, the Federal Court dismissed this and concluded that trade tools were an ‘instrument of manual operation’.

Key Takeaway:

The period before declaring bankruptcy has been aptly referred to as a ‘financial sweatbox’.[27] Whilst it is true that bankruptcy can offer respite from this sweatbox, it is by no means a cure all. The aim of this article was to demonstrate the consequences that flow from bankruptcy and emphasise the importance of carefully considering whether bankruptcy is the best solution to your financial situation.

The Bankruptcy Bible – List of Sources