Personal Insolvency – A Potted Summary
In Australia the Personal Insolvency regime is governed by the Bankruptcy Act 1966. This is a Federal Act of Parliament and contrary to popular mythology the aim of bankruptcy is not to blame or punishes insolvent debtors but to afford them a process by which they can become financially rehabilitated. A secondary aim is to ensure that creditors receive a fair distribution of the available assets and finally, that so far as the community is concerned; justice is seen to be done.
Like all acts of parliament, the Bankruptcy Act is divided into a number of parts
Part IV is the main operational part of bankruptcy. Alternatives to bankruptcy are found in Part X and these are known as Personal Insolvency Arrangements. Debtors who have relatively small debts can use Part IX; however the financial limits are restrictive. In very rare cases the Bankruptcy Act also has provisions dealing with insolvency deceased estates and these are found in Part XI.
The most widely used area of the Bankruptcy Act is in fact IV and most bankruptcies are voluntary. These are known as Debtor Petitions. A debtor who finds himself/herself in a hopeless financial situation is able to complete various forms and file these documents with the Insolvency Trustee Services Australia (ITSA). Once the documents are filed and accepted, the individual is bankrupt and a bankruptcy number and a certificate of bankruptcy issued. This is a relatively easy process, although some debtors may need assistance in completing the Statement of Affairs. It is important that this form must be completed carefully as ITSA is in the habit to rejecting forms even if minor details are omitted.
Whilst the process of becoming bankrupt on a voluntary basis (debtors petition) is inexpensive and quick, the opposite is true for creditors who are trying to force a debtor into bankruptcy. (Creditors Petition). The process is drawn out and expensive and creditors and their legal representatives are required to take great care in the way in which their application is made. The Courts appear to be quite lenient towards the debtor, particularly in relation to requests to grant adjournments.
The process usually starts with the creditor obtaining a judgement debt against the individual. Following the successful judgement, the creditor issues a Bankruptcy notices requiring the debtor to pay the debt within twenty one days. Failure to comply with the bankruptcy notice is an act of bankruptcy as defined in the Act and the primary evidence required for the Creditor Petition. Once the twenty one days has expired, the creditor is able to make an application to the Court for a Sequestration Order and in this process, the creditor can obtain Consent to Act from a Trustee whose job is to administer the bankrupt estate.
Consequences of Bankruptcy
Irrespective of how the individual becomes bankrupt, the consequences are virtually the same. All property owned by the bankrupt, defined as divisible property vests in the Trustee for realisation and distribution to the creditors. This property not only includes all the property presently owned by the bankrupt but any property the bankrupt acquires in the future, that is during the period of the bankruptcy, which is usually three years. The definition of property also extends to property once owned by the bankrupt, but now divested. The Act gives the Trustee power to undo certain transactions usually designed to defeat the creditors. In this regard, certain transactions can be reversed within a six month period, others go back two years and yet others go back five years depending on the nature of the transaction. In general, these “antecedent transaction” rules are designed to ensure that all the creditors get a fair distribution and no particular creditor is favoured over other creditors, and that the bankrupts are not seeking to hide property that would otherwise be available to their creditors.
Certain property is of course specifically protected under the Bankruptcy Act. Necessary household property, a motor vehicle, tools of trade and superannuation are examples of protected property. There are financial limits on these items.
Another consequence of bankruptcy is that during the period of the bankruptcy, the bankrupt’s income is monitored and if the bankrupt’s income exceeds the threshold, he or she is required to make a contribution. These contributions are based on a statutory formula which broadly is 50% of the bankrupt’s income above and beyond the threshold and after income tax. There are a number of other issues that are taken into account in calculating the Income Contributions.
In most cases the income contribution regime is not particularly onerous for individuals and of course is limited to the period of the bankruptcy.
A bankrupt needs permission from the Trustee to travel overseas. Permission should not be unreasonable withheld. A “request to travel overseas” should be made in accordance with the guidelines.
Superannuation is protected property, that is to say that superannuation benefits are not normally available to the Trustee for distribution to creditors. A problem however does occur when a bankrupt has a self-managed superannuation fund. Superannuation rules prevent the bankrupt being the trustee of a Superfund and the Corporations Act prevents the bankrupt from being a company director, thus ruling out the bankrupt’s ability to be a director of a trustee company. This unfortunately leaves a bankrupt really only three options. 1 if eligible, wind up the Superfund, 2 roll the fund into a retail or industry fund or, 3 appoint a new trustee known an RSE a Registered Superannuation Entity.
Discharge from bankruptcy is normally automatic however, a trustee can object to the discharge in certain circumstances, although it is important to note that reasons must be given. The bankrupt of course has various appeal provisions in relation to these objections.
Conversely, a bankrupt can obtain an early annulment from bankruptcy. Annulments can be obtained if a bankrupt either pays all creditors in full, or pursuant to Section 73 is able to be obtain the consent of creditors for a composition or a scheme of arrangement. In practice, the Section 73 arrangements are extremely useful, primarily because there is little creditor resistance.
In general any tax debt owed by the bankrupt is treated in the same way as all of the other unsecured creditors. That is to say the Australian Taxation Office (ATO) simply lodges a Proof of Debt with the trustee and receives a dividend as an ordinary unsecured creditor. In addition, as with all of the unsecured creditors, the bankrupt is released from this on discharge from bankruptcy. A small complication does occur in relation to income tax in that the amount provable relates only to the income generated by the bankrupt up until the date of the bankruptcy. Income generated after this date is not a provable debt and the bankrupt’s obligations to pay income tax on this income continues. This necessitates the lodgement of two income tax returns for the relevant period. One up to the date of the bankruptcy and the next one from that date to the 30th June of that year.
Capital Gains Tax
A property sold by the Trustee; may trigger a Capital Gains Tax Event. As this event occurs after the date of bankruptcy, it is not a provable debt. The Courts have held that it is not a cost of the administration and therefore the debt becomes a new debt of the bankrupt. This is an inelegant result and the only practical solution is for the debtor to file a second and subsequent petition as soon as the debt becomes provable.
There are alternatives to bankruptcy and these are found in Part X of the Bankruptcy Act. These alternatives are known as Personal Insolvency Arrangements. These arrangements are no longer as popular or as useful as they once were having regard to significant legislative amendments that took place in the early 1990’s. In addition because the arrangements require the creditors to vote in favour of a debtor’s proposal, they are becoming increasingly difficult to have approved primarily because of creditor resistance. As indicated earlier, this resistance does not appear as evident when similar proposals are being put pursuant to Section 73. In addition the cost of the Personal Insolvency Arrangement in many cases make them prohibitive for most debtors and having regard to the fact that the Personal Insolvency Arrangements still appears on the National Personal Insolvency Index (NPII), and other credit rating agencies there is little incentive for debtors to embark on this course of action. In special circumstances however, they are still worth considering.