Not being able to pay your debts as and when they fall due is a position many individuals find themselves in. While some are able to trade their way out of such situations many are not able to do so. This article discusses the options available to individuals that are unable to pay their personal debts and the implications of those options.
Personal insolvency is a situation where an individual is unable to pay their debts as and when they fall due.
In Australia, there are two primary ways to address personal insolvency:
- Bankruptcy; and
- Debt Agreements/Personal Insolvency Agreements.
What is Bankruptcy?
Bankruptcy is a legal process that is initiated either by a debtor or by a creditor. The process involves transferring the control of your assets to a trustee, who is responsible for managing the sale of your assets to repay your creditors.
Bankruptcy usually lasts for three years, during which time you are required to comply with certain obligations, such as providing financial information to your trustee and making contributions from your income (a failure by a person to comply with their obligations can result in the period of bankruptcy being extended to up to 8 years). After this period, you will be discharged from bankruptcy, and most (but not all) of your debts will be written off.
How does bankruptcy commence?
A person may become bankrupt either:
- Voluntarily, by that person presenting a 'debtor's petition' to the Official Receiver; or
- By a creditor presenting an application to the court called a 'creditor's petition'.
Advantages of voluntary bankruptcy
A voluntary bankruptcy will commence once the Official Receiver accepts a personal debtor's petition.
There can be several advantages to a person voluntarily declaring bankruptcy. These may include that:
- Any legal action being taken by unsecured creditors is put on hold immediately;
- Creditors will be required to deal directly with your bankruptcy trustee, rather than contacting you seeking to recover debts; and
- You may nominate a registered trustee to administer your estate (rather than a creditor nominating a trustee in the case of a compulsory bankruptcy).
The most common process for a compulsory bankruptcy is:
- A creditor obtains a judgement against a debtor for a debt of at least $10,000;
- The creditor applies to the 'Official Receiver' for the issue of a bankruptcy notice to the debtor;
- Within 21 days of the issue of a bankruptcy notice the debtor does not either comply with the bankruptcy notice (by making payment to the creditor), or successfully apply to the court to have the bankruptcy notice set aside;
- The creditor relies on the non-compliance with the bankruptcy notice as an 'act of bankruptcy' to present a creditor's petition to the court within 6 months of the non-compliance; and
- The court makes a 'sequestration order' against the debtor's estate which causes the debtor to become bankrupt.
Disadvantages of bankruptcy
Some of the disadvantages of bankruptcy may include:
- Most of your assets will 'vest' in your bankruptcy trustee, and will usually be sold to satisfy debts;
- Your bankruptcy trustee might take steps to 'unwind' certain transactions that you have entered into prior to your bankruptcy - this can result in legal proceedings being commenced against related parties or other creditors who might have benefited from such transactions;
- You will be required to co-operate with your bankruptcy trustee, and to provide certain information about your financial affairs;
- Your bankruptcy will be noted on a public record which is available to anyone; and
- It will become significantly more difficult to obtain credit.
Alternatives to bankruptcy - personal insolvency agreements
In some circumstances, it can be more beneficial for an insolvent debtor to consider proposing a 'personal insolvency agreement' to creditors as an alternative to bankruptcy.
A personal insolvency agreement, if accepted by creditors, becomes a legally binding contract between you and your creditors. It may allow you to come to a formal arrangement to discharge your debts without the more extensive and restrictive consequences of bankruptcy.
A debtor and his or her creditors may come to a more flexible arrangement under such an agreement that suits the particular circumstances of the debtor, and which may result in creditors receiving more than what they would have received if the debtor is made bankrupt.
These agreements may allow a debtor to avoid the stigma and legal consequences of bankruptcy and allows the debtor to be released from their debts and certain legal responsibilities more quickly.
Entering into a personal insolvency agreement
To start the process for a personal insolvency agreement a debtor must:
- Nominate a controlling trustee (usually a registered trustee in bankruptcy); and
- Provide the following documents to the trustee:
(a) An authority under section 188 of the Bankruptcy Act 1966 (Cth), giving control over the debtor's assets to the trustee;
(b) A statement of affairs, which provides information about the debtor's assets and liabilities; and
(c) A draft personal insolvency agreement outlining the terms proposed to be put to creditors.
For a proposal to be accepted, there must be agreement by both:
- A majority of creditors (by reference to the total number of creditors); and
- Creditors that, in combination, are owed more than 75% of the total debts.
If the proposal is accepted by creditors, it will become legally binding.
If the proposal is not accepted by the required majority, the creditors can resolve that the assets be released from the control of the trustee. This allows the creditors to commence recovery action or bankruptcy proceedings.
Making the right decision
Becoming bankrupt or entering into a personal insolvency agreement can have significant legal and financial consequences.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.