What is Bankruptcy?
Bankruptcy is a legal process where an individual relinquishes control of their financial affairs to a third party as a result of becoming insolvent (i.e. unable to repay their debts when they are due).
The third party who takes over the insolvent person’s financial affairs is either an appropriately qualified trustee or the Official Receiver appointed either by the Federal Court or the Australian Financial Security Authority (AFSA).
There are two ways in which a party may become bankrupt:
- Debtor’s Petition: the debtor (the insolvent person) voluntarily lodges a debtor’s petition and statement of affairs with AFSA declaring themselves bankrupt.
- Creditor’s Petition: a creditor who is owed money by the debtor files a creditor’s petition in the Federal Court seeking an order that the debtor be declared bankrupt (a sequestration order).
What is a Statement of Affairs?
Once a sequestration order has been made, the debtor has 14 days to file a Statement of Affairs with AFSA. The three-year period of bankruptcy does not begin until this is done.
A Statement of Affairs sets out the debtor’s personal information and assets and liabilities.
The appointed bankruptcy trustee uses this information to begin administering the debtor’s financial affairs.
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Once the bankruptcy trustee receives the Statement of Affairs, the trustee will begin investigating the debtor’s financial affairs. The trustee will notify all known creditors that the debtor has been declared bankrupt, that a bankruptcy trustee has been appointed, and that the trustee is in the process of determining how best to deal with the debtor’s outstanding debts given the information they have and their own investigations regarding the debtor’s assets and liabilities.
Once a debtor becomes bankrupt, the majority of the debtor’s assets ‘vest in’ (i.e. are under the control of) the bankruptcy trustee so they may determine how best to manage the assets to satisfy the claims by creditors of the debtor. This will usually involve the sale of assets able to be realised to meet those claims (divisible property).
Some assets may, in certain circumstances, be entirely exempt from being categorised as divisible property under the trustee’s control. These may include:
· Necessary clothing and household items
· Cars (up to a certain value)
· Tools required to work (up to a certain value)
· Life insurance policies
· Certain damages and compensation payments
It is important to note that a debtor may face strict penalties if they do not declare all assets in their possession at the time they are declared bankrupt.
Bankruptcy discharges the balance owing for most secured and unsecured debts. However, a debtor will still be liable to pay certain debts despite being declared bankrupt.
What is a Secured Debt?
A secured debt is tied to a specific asset. The debtor has agreed to provide the asset as collateral to the creditor to secure repayment of the debt. In the event the debtor is unable to pay the debt, the creditor will have the right to take possession of the asset and sell it to satisfy all or part of the debt despite the debtor’s bankruptcy. The creditor with a secured debt (secured creditor) can make a claim in the debtor’s bankruptcy for any unpaid balance after the asset has been sold.
Examples of secured debts are:
- Hire purchase agreements
- Car loans
- Rent to own agreements
What is an Unsecured Debt?
Conversely, an unsecured debt is a debt owed without the debtor having been required to offer any asset as collateral to secure payment of the debt. Therefore, an unsecured creditor is unable to pursue a specific asset directly in the event that the debtor fails to pay the debt.
Examples of unsecured debts are:
- Credit cards
- Unsecured personal loans
- Legal, medical and accounting fees
- Gas, electricity and internet bills
- Unpaid rent
- Overdrawn bank account fees
What debts will not be covered under bankruptcy?
It is important to note that bankruptcy does not cover all debts. A bankrupt debtor will still be liable to pay certain debts. In Australia, such debts include:
- Student assistance or supplement loans (HECs, HELP or SFSS)
- Court imposed fines and penalties
- Child support and maintenance agreements
- Miscellaneous debts you incur after you become bankrupt
- Debts incurred by fraud
- Child support and maintenance agreements
Bankruptcy will normally last for a period of three years after the day the debtor’s petition was accepted by the Official Receiver. In the case of bankruptcy due to the making of a sequestration order, the three-year period of bankruptcy begins after the Statement of Affairs is filed with AFSA.
An objection to automatic discharge from bankruptcy after three years can be lodged by the bankruptcy trustee or creditors when it is shown that the debtor has failed to cooperate with the trustee or has not disclosed assets.
Discharge from bankruptcy is an automatic process managed by AFSA. As such, there is no need for a debtor to apply to be discharged once the prescribed bankruptcy period is over.
The trustee may seek to extend the period of bankruptcy for up to eight years in circumstances where the debtor has failed to co-operate with the trustee or has otherwise failed to comply with their obligations under applicable laws and regulations.
There are three ways in which you may be able to cancel or ‘annul’ your bankruptcy:
- You can pay your debts in full (including interest);
- Your creditors accept an arrangement or composition (part payment) of the debt owed (e.g. repayment of a specified percentage of the full debt); or
- You successfully apply to the Court for an order annulling your bankruptcy.
An order to annul a bankruptcy (the third option above) will only be made where the Court is satisfied that the sequestration order should not have been made, or the bankruptcy appointment should not have been accepted by the trustee.
Declaring bankruptcy is not a decision that should be made lightly. Although it may be a way to avoid legal action from creditors, there are a number of serious consequences that will flow from bankruptcy.
If you are considering declaring bankruptcy, the following are some examples of the benefits and consequences to be aware of:
Do I need a Lawyer?
Being declared bankrupt, or thinking about voluntarily declaring bankruptcy, is a serious and stressful situation to be in, and it can be extremely difficult to navigate all the different aspects involved in a bankruptcy proceeding.
Call Gibbs Wright Litigation Lawyers today for a free initial consultation with one of our experienced litigation lawyers to discuss bankruptcy in more detail and explore your options.