Bankruptcy

Bankruptcy is a legal process through which individuals or businesses who are unable to repay their outstanding debts can seek relief from some or all of their financial obligations. In Australia, bankruptcy is governed by the Bankruptcy Act 1966 and is administered by the Australian Financial Security Authority (AFSA). The process aims to provide a fair resolution for both debtors and creditors, allowing debtors to make a fresh start while ensuring creditors receive a fair distribution of the debtor’s available assets.

Why is bankruptcy important?

Bankruptcy is an essential mechanism for addressing severe financial distress. It serves several critical functions:

• Debt relief: It offers a way for individuals and businesses overwhelmed by debt to gain relief and start anew.
• Creditor protection: It ensures that creditors receive an equitable share of the debtor’s available assets.
• Financial stability: It helps maintain financial stability by providing a structured process for managing insolvency.

Types of bankruptcy in Australia

Personal bankruptcy

Personal bankruptcy applies to individuals who cannot meet their debt obligations. It typically lasts for three years and one day, during which time the bankrupt person must adhere to specific obligations and restrictions. After this period, the individual is discharged from bankruptcy, meaning they are released from most debts.

Business bankruptcy

Business bankruptcy can apply to sole traders, partnerships, or companies that are unable to pay their debts. For companies, this process is known as liquidation, which involves winding up the company’s affairs, selling its assets, and distributing the proceeds to creditors.

The bankruptcy process

Filing for bankruptcy

An individual can voluntarily file for bankruptcy by submitting a debtor’s petition to the AFSA. Alternatively, a creditor can apply to the court to make an individual bankrupt through a creditor’s petition if they are owed more than $10,000.

Assessment

Upon filing for bankruptcy, the AFSA assesses the debtor’s financial situation. If the application is accepted, the debtor is declared bankrupt, and a trustee is appointed to manage the bankruptcy.

Role of the trustee

The trustee, who may be a representative from the AFSA or a registered trustee, is responsible for:

• Assessing the debtor’s assets: Identifying and valuing the debtor’s assets.
• Realising assets: Selling the debtor’s non-exempt assets to generate funds.
• Distributing funds: Distributing the proceeds to creditors in accordance with the Bankruptcy Act.
• Ensuring compliance: Ensuring the debtor complies with their obligations during the bankruptcy period.

Obligations of a bankrupt person

During bankruptcy, the individual must:

• Disclose assets: Fully disclose all assets, income, and debts to the trustee.
• Contribute income: Make contributions from their income if it exceeds a certain threshold.
• Seek approval: Obtain the trustee’s permission before traveling overseas.
• Comply with restrictions: Adhere to restrictions on obtaining credit and managing businesses.

Discharge from bankruptcy

Most bankruptcies last for three years and one day. After this period, the individual is automatically discharged, meaning they are released from most debts incurred before bankruptcy. However, some debts, such as child support, fines, and HECS-HELP debts, are not discharged.

Pros and cons of bankruptcy

Pros

• Debt relief: Bankruptcy provides a way to eliminate or reduce unmanageable debts.
• Fresh start: It allows individuals to make a fresh start financially.
• Protection from creditors: It stops most creditors from taking legal action to recover debts.

Cons

• Asset loss: Bankrupt individuals may lose non-exempt assets, such as property or vehicles.
• Credit impact: Bankruptcy negatively affects credit ratings and remains on credit reports for up to five years, making it difficult to obtain credit in the future.
• Employment restrictions: Certain professions and positions may have restrictions or disqualifications for bankrupt individuals.
• Public record: Bankruptcy is recorded on the National Personal Insolvency Index, which is publicly accessible.

Example of bankruptcy in practice

Consider an individual who has accumulated significant debt due to unexpected medical expenses and job loss. Unable to meet their debt obligations, they decide to file for bankruptcy. They submit a debtor’s petition to the AFSA, and a trustee is appointed to manage their bankruptcy. Over the next three years, the trustee sells their non-exempt assets, and the proceeds are distributed to creditors. During this time, the individual makes contributions from their income, if applicable, and complies with other obligations. After three years and one day, they are discharged from bankruptcy, allowing them to start afresh without the burden of overwhelming debt.

Conclusion

Bankruptcy is a vital legal process that provides relief for individuals and businesses facing insurmountable debt. While it offers a pathway to a fresh financial start, it also involves significant consequences, including the loss of assets and long-term impacts on credit and employment opportunities. Understanding the bankruptcy process, its benefits, and its drawbacks is crucial for anyone considering this option.

For more information on bankruptcy and financial management, you can visit the Australian Financial Security Authority’s website.