Chapter 16: Bankruptcy and debt agreements

16.1 What is bankruptcy?

Formal debt arrangement

If you don’t have enough assets or income to pay your debts as they fall due (insolvency), you may consider taking formal action to help manage your creditor(s). The Bankruptcy Act 1966 (Cth) provides four ‘formal’ options for dealing with unmanageable debt, namely:

declaration of intention to present a debtor’s petition (interim relief)
debt agreement (also known as a Part 9 (IX) agreement)
personal insolvency agreement (also known as a Part 10 (X) agreement), and
bankruptcy.

Bankruptcy

Bankruptcy is the most extreme measure available under the Bankruptcy Act. It is a legal process whereby the debtor essentially hands over control of their property and finances to a trustee, who tries to repay as much debt as possible and protects the debtor from further action by creditors. The Australian Financial Security Authority (AFSA) regulates bankruptcy, including processing applications and acting as trustee in some bankruptcies. Bankruptcy usually lasts for three years and, when bankruptcy ends, debtors are released from most, but not all, debts.

Entering bankruptcy

There are two ways you can become bankrupt:

voluntarily (where a debtor applies to make themselves bankrupt)
involuntarily (where a creditor forces bankruptcy upon a debtor, due to unpaid judgment debt).

Where a person enters bankruptcy voluntarily, there is no minimum debt threshold. However, where a creditor seeks to make a debtor bankrupt, there must be a minimum debt of $10,000. Creditors can only apply to make you bankrupt after they have obtained a judgment against you (see Chapters 9–15).

Understanding your options

Debtors should only consider bankruptcy as an option of last resort because it can have serious consequences which extend beyond the term of actual bankruptcy. This chapter explores bankruptcy in detail and briefly outlines other formal debt arrangements. There are advantages and disadvantages to each arrangement, so you must consider all consequences before making your choice. When considering bankruptcy, you need to think about your current situation and the future. If you don’t own a home or any significant assets and debt is crushing you, then bankruptcy may be the best way to make a fresh start. Each person will have differing circumstances.

16.2 Voluntary bankruptcy

You can lodge a voluntary ‘debtor’s petition’ if you’re unable to pay your debts as they fall due and are unable to negotiate suitable repayment arrangements with creditors.

Before voluntarily entering bankruptcy, we urge you to obtain formal legal and debt management advice. You can get information and advice from financial counsellors, solicitors, AFSA or registered trustees. Financial counsellors work in non-profit community organisations. Their services are free, independent and confidential. They can help you manage a short-term crisis and plan to prevent a future one.

Application for bankruptcy

There is no minimum amount of debt for debtors who choose to enter bankruptcy voluntarily. Still, the Official Receiver reserves the right to reject a petition if they believe that:

the debtor could pay their debts in a reasonable time
the debtor demonstrates an unwillingness to pay a debt
the debtor has been bankrupt three or more times, or
the debtor has been bankrupt within the past five years.

To become bankrupt, you will need to fill in two forms:

debtor’s petition form — the application for bankruptcy; and
statement of affairs form — on which you must show all your debts, including debts owing to relatives and debts which are not provable in bankruptcy. You must provide the name, address and amount you owe each creditor. You must also show full details of your income and your property, including your house, car, bank account, shares and any money owed to you.

You can get these forms from the AFSA website, or a financial counsellor. Be careful when preparing the forms, as AFSA may reject incorrect forms. Furthermore, there are severe penalties if you do not disclose all your property, or conceal it, or dispose of it unlawfully.

You must lodge your completed forms with AFSA within 28 days of signing. AFSA usually takes 1–2 days to process voluntary bankruptcy. If accepted, you will receive a letter containing your bankruptcy number and outlining your duties and obligations, while bankrupt.

Fees and charges

It does not cost anything to lodge a debtor’s petition. However, the appointed trustee is entitled to a fee for administering your bankruptcy. Where AFSA is the trustee, the fee is regulated by legislation. Where a registered trustee is appointed, the fee is based on an hourly rate. If you are unhappy with the fees charged by your trustee, you can seek independent review, by the Inspector-General in Bankruptcy (see the AFSA website for further details). The trustee takes their fees from your compulsory income payments and the sale of your assets. Funds realised by a trustee are subject to a ‘realisations charge’, which is paid by the trustee directly to the government. Any interest earned on funds recovered by a trustee is also payable to the government. Some applications may also incur fees (for example, an ‘overseas travel application’).

For current information about fees, visit the AFSA website.

16.3 Involuntary bankruptcy

Bankruptcy notices

A creditor may try to force you into bankruptcy, as a way of obtaining money from you, where they have court judgment(s) against you amounting to $10,000 or more. A creditor will usually only do this if you have substantial assets, such as a house or expensive car, that can go towards repaying your debts. The judgment against you must be less than six years old.

In these cases, a creditor can apply to AFSA for a bankruptcy notice. A bankruptcy notice is essentially a final demand for payment. Generally, the bankruptcy notice will give you 21 days to pay the judgment debt (or have the court set aside the notice or give you an extension of time to pay). If you do not pay in time or obtain a relevant court order, you commit an ‘act of bankruptcy’.

Creditor’s petition and sequestration orders

After you commit an ‘act of bankruptcy’, by not responding to a bankruptcy notice in the required time frame, a creditor can file a creditor’s petition with the Federal Court to have you declared bankrupt. The court will allow you to be heard before making this order, but if the court is satisfied that you should be made bankrupt, it will make a sequestration order declaring you bankrupt. The creditor is not required to prove that you are insolvent. A trustee is then appointed, and you have 14 days to file a ‘statement of affairs’ with AFSA. Failure to lodge your statement of affairs within 14 days of notice of the sequestration order is an offence.

Responding to a bankruptcy notice

If you receive a bankruptcy notice and do not want to be made bankrupt, you must act quickly. Your options are:

pay the amount owed within the notice period
lodge a court application to set aside the notice, or extend the time for payment
make an arrangement with the creditor (for example, part payment with the balance to be paid by instalment).

If you ignore the notice and are declared bankrupt, there will be additional administrative fees that apply (even if you later choose to pay out your bankruptcy and have it annulled). If you agree that you owe the debt and can pay, we recommend that you pay the amount owing within 21 days of being served with the notice.

You may also have other options for responding — for example, where the notice is incorrect or defective, or where you have a counterclaim and so on. If you are served with a bankruptcy notice and dispute the matter, we urge you to get independent legal advice immediately. You should also visit the AFSA and Federal Court websites for detailed information about the necessary court forms and processes needed to set aside or extend a bankruptcy notice.

16.4 Consequences of bankruptcy

Once you are made bankrupt, a trustee from AFSA, or a registered trustee, is appointed to administer your property/assets until you are discharged. The trustee becomes the owner of your share of any house or property you own and can sell all your property/assets except for exempt (protected) property to pay your debts. The trustee can sell your house, land, boat, trailer, caravan, mobile home, shares, investments and jewellery for the benefit of your creditors.

WARNING — your home may be taken and sold by the trustee even after you have been discharged from bankruptcy (see 16.14 below).

During and after bankruptcy you will face certain restrictions, and have obligations placed on you. You must consider all the pros and cons of bankruptcy before making any decisions.

You will usually remain bankrupt for three years. After the period of bankruptcy, you are automatically discharged, provided you have co-operated with the trustee. If the trustee objects to discharge, bankruptcy can be extended to five or eight years.

16.5 Advantages of bankruptcy

There are some distinct advantages of bankruptcy, including:

Creditors will stop harassing you — once you become bankrupt unsecured creditors are required to contact you via your trustee. The only thing you must tell an unsecured creditor is your bankruptcy number and the date you became bankrupt. Secured creditors, who hold security over property, are still entitled to seize secured property and sell it if you fall behind in payments, so they may contact you to discuss this (see 16.10 Secured debts above).
After bankruptcy, you are released from most debts.
Essential household items are protected, and you can maintain a modest car and your essential tools of trade (valued up to a prescribed amount).

16.6 Disadvantages of bankruptcy

Bankruptcy can also have serious adverse consequences, including:

Your assets will be sold.
You are required to disclose your bankruptcy if applying for any form of credit above a prescribed amount. If you are bankrupt it is a criminal offence to obtain credit in certain circumstances. Severe penalties may apply to these offences.
A record of your bankruptcy remains on the public record forever. This record is called the National Personal Insolvency Index (NPII), which is a computerised database kept by AFSA.
A record of your bankruptcy will also be listed on credit records kept by commercial credit reporting agencies for five years from the date of bankruptcy or two years from the date of discharge, whichever is longer. So, a bankruptcy listing will make it difficult for you to get credit, during and after bankruptcy.
You may not be able to work in some trades or professions or be a company director while you are bankrupt.
You will not be able to commence or continue legal proceedings without the permission of your trustee (except for personal injury to yourself or your family).
It may be difficult to rent a house or unit as a bankrupt.
You might find you feel stigmatised by being bankrupt.
Not all debts are discharged after bankruptcy and remain payable.
You may need to make contributions from your income to your creditors. The contribution amount is based on a formula which considers your income above a prescribed amount and any dependents.
The trustee will take any windfall gains (such as inheritances, gifts, gambling wins etc.) obtained during the bankruptcy period.
You will need the permission of the trustee to travel overseas (failure to obtain permission is an offence).

16.7 What happens to my assets?

What assets am I allowed to keep?

The Bankruptcy Act allows bankrupts to keep certain assets, including:

clothing and basic household furniture — including cutlery, crockery, kitchen appliances, food, heaters and air-conditioners, a television, a personal computer, computer games, a DVD, a radio and stereo, beds for all members of the household, children’s toys and so on
a car worth no more than the prescribed amount — if your car is worth more than this, the trustee will sell the car and give the bankrupt the prescribed amount to purchase a cheaper car
tools of trade worth no more than the prescribed amount
compensation received directly by you for personal injuries to yourself or your family (or property purchased almost entirely with such compensation money)
payments for life insurance or superannuation received on or after the date of bankruptcy (payments received before the date of the bankruptcy are not protected).

The trustee may also allow a bankrupt to retain other household property if, for example:

members of the household have special needs
the costs of seizure, storage and sale of the property would exceed the sale price obtained at auction
the creditors agree to let you keep certain goods.

What assets will my trustee sell?

Apart from the assets you can keep, your trustee may recover any asset, even if they are overseas or in someone else’s possession. Examples include:

houses, apartments, land, farms and business premises (including leases)
motor vehicles that are not protected
household contents that are not protected
shares and other investments (including shares held in an employer’s business)
tax refunds for income earned before you became bankrupt
proceeds of a deceased estate where the person dies before or during bankruptcy
lottery winnings and other competition prizes.

16.8 What happens to my income?

The Bankruptcy Act does not restrict you from working and earning an income during your bankruptcy. However, if your after-tax income exceeds a prescribed amount, you will have to pay contributions from your income to your trustee. You will have to pay half of what you earn above the minimum threshold to the trustee. Your trustee will calculate what you must pay, based on your income and dependents and will send you a yearly notice of assessment that outlines the amount due, instalments and how to make payments.

16.9 What happens to my debts after bankruptcy?

The Bankruptcy Act intends to free a person who becomes bankrupt from most debts arising before bankruptcy. These debts are called ‘provable debts’. However, there are some debts which are not provable in bankruptcy and will not be discharged after bankruptcy (called ‘non-provable’ debts).

There are also some debts which are technically ‘provable’ in bankruptcy but will not be released on discharge (see Unsecured debts below).

16.10 Secured debts

Creditors who hold security over your assets (mortgages, bills of sale) and creditors for consumer credit contracts or lease agreement items can recover the secured asset(s) and sell them if you are in breach of the agreement (non-payment of monthly payments on due date). Bankruptcy makes no difference. Creditors can then lodge a claim with your trustee for any shortfall remaining after sale of the secured goods. If you wish to retain these assets, you must negotiate with the secured creditors and make regular payments. Your bankruptcy trustee may also decide to sell the asset, where its value exceeds the debt amount and it is not a protected asset.

16.11 Unsecured debts

Provable debt

Once you become bankrupt, you are released from having to pay most ‘provable’ debts, and they will be fully extinguished after your bankruptcy ends. Your creditors can’t take direct legal action against you anymore, but they can claim against the bankrupt estate during bankruptcy. That is, where your trustee has been able to recover money from the sale of goods, wages, and so on, the creditor can claim a share.

Provable debts include:

credit cards, personal loans, goods purchased on credit, and unpaid rent
debts which you owe a creditor under an order or judgment of a court
tax debts owing for financial years before the date of bankruptcy
During the period of bankruptcy, the ATO can keep any tax refund due to you and pay it towards any taxation debt you owe and then to any other Commonwealth debt (for example, Child Support Agency or Centrelink debts). If any amount of your tax refund is left after these repayments, the balance will go to the trustee in bankruptcy to be included as an asset of the bankrupt estate (if the tax refund relates to a year before the year of bankruptcy). Otherwise, you will receive the balance, and it will be included as a contribution to your income if the tax refund relates to a year after the year you became bankrupt). After discharge from bankruptcy the ATO will stop deducting money from your tax refunds that are for tax years ending before you became bankrupt.
the assessed portion of a HECS-HELP debt
For example, after finishing her university degree, Jenny had a total HECS-HELP debt of $34,000. She earned $59,000 in 2020 and received an assessment from the ATO advising her that because her income was over the threshold, she is required to repay an amount of $2400 for HECS-HELP for the year 2019–20. If Jenny goes bankrupt in that financial year, the assessed amount of $2400 will be a provable debt in bankruptcy. The remaining $31,600 of Jenny’s HECS-HELP debt is a non-provable debt which Jenny is still required to repay even after discharge from bankruptcy.
debts for child support and maintenance*
parking and traffic infringements not imposed by a court*
unpaid debts for the provision of gas, electricity or telephone services at a previous address*
debts incurred by fraud*.

* Note: There are exceptions to these last four which are explained in the following sections.

Provable debts with other consequences

Some debts in the list above are technically provable debts in bankruptcy (so the creditors can share in any distribution from your estate to go towards repaying them) but continue to have consequences after bankruptcy ends.

Child support and maintenance debts

These debts are provable in your bankruptcy; however, you are not released from the principal debt or balance upon discharge. You are, however, released from any interest owing to child support debts at the date of bankruptcy. However, interest starts accruing on the unpaid principal debt from the date of bankruptcy onwards. Also, you must still pay your ongoing liability for maintenance and child support during the period of bankruptcy.

Fines and infringements

Currently in NSW, any fines that you owe (for example, parking fines, public transport offences, speeding fines) that are not court-imposed are technically provable debts for bankruptcy. For example, a fine issued by Transport for NSW for ‘travel without a valid ticket’ would be a provable debt which is technically cleared by bankruptcy.

Where fines have already been referred to Revenue NSW at the time you enter bankruptcy, you may still be subject to their standard recovery processes (until the fine is paid). This may include suspending or cancelling your driver’s license and motor vehicle registration (see Chapter 4, Fines, for further information about dealing with these issues).

Unpaid utility bills

Unpaid electricity, gas and telephone accounts are provable debts which are cleared by bankruptcy. However, service providers may still disconnect services where current bills remain unpaid. So, if you want to continue to access these services at your current address, you will need to pay any current outstanding accounts.

You should contact your service provider directly, or a financial counsellor, to arrange an instalment plan. A history of non-payment of such accounts may mean that you’ll be required to pay a substantial security deposit to have services connected at a new address (see Utilities, 8.2 in Chapter 8 for further information about your bill payment options).

Debts incurred by fraud

Debts incurred by fraud (for example, Centrelink payments obtained by fraud) are provable in bankruptcy so that the Commonwealth can claim a share from the sale of your assets, but you are not released from these debts when you are discharged from bankruptcy. That is, after discharge from bankruptcy, you will still have to repay the debt.

Non-provable debts

There are a few ‘non-provable’ debts, which remain payable after bankruptcy ends. These include:

penalties or fines imposed by a court with respect to an offence against the law
accumulated HECS–HELP debts
unliquidated damages other than those arising from a contract, promise or breach of trust.

16.12 Ending bankruptcy

Discharge

If you become bankrupt by presenting your own debtor’s petition, you will be due for discharge three years and one day after you filed your petition and statement of affairs. If your bankruptcy was involuntary and forced by a creditor via a sequestration order, your bankruptcy will be discharged three years and one day after AFSA accepted your statement of affairs.

In some cases, your bankruptcy can be extended to five or eight years. This happens when your trustee objects to discharge. Common grounds for objection include failure to:

provide information or assist the trustee
disclose all your income
explain how you spent money
reveal all assets to creditors.

More than one objection can be lodged. However, you have a right to seek review of an objection by the Inspector-General.

You will not be notified of discharge. However, you can ask your trustee for confirmation or obtain a National Personal Insolvency Index (NPII) extract to show your date of discharge.

After discharge, your name will remain on the NPII index forever and on commercial credit records for up to five years or longer. Administration may continue after bankruptcy, where the trustee has yet to finalise the sale of assets and so on.

Annulment

Annulment is effectively the cancellation of bankruptcy. There are three ways to annul bankruptcy:

annulment by payment in full — you pay all your debts in full, including interest, the realisation charges and your trustee’s fees and expenses
annulment by composition or arrangement — your creditors accept a composition or arrangement, which is an offer of something less than full payment
annulment by court order — you successfully apply to the court for an order annulling your bankruptcy.

If annulment is successful, your name will remain on the NPII forever; however, the record will show that your bankruptcy was annulled. Credit reporting organisations will also keep records for up to five years, or longer. Other consequences of annulment are:

assets not needed by the trustee to pay the trustee’s fees and expenses will be returned
secured creditors will retain the rights to secured assets
you are still liable for debts not provable in bankruptcy.

16.13 Alternatives to bankruptcy

Informal arrangements with creditors

If you have debts mounting up and no possibility to pay them, discuss your difficulties with your creditors. If a creditor knows that you are seriously considering bankruptcy, they might be more willing to accept a smaller figure in settlement of your debt. A financial counsellor can help you to do this.

However, you should be aware that informal agreements with creditors are not binding and will not prevent a creditor from pursuing their legal options to get the money from you as discussed elsewhere in this book.

There are also some ‘formal’ alternatives to bankruptcy which you may consider (see below).

Part IX debt agreements

A Part IX debt agreement is a legally binding agreement introduced as a simple, low-cost alternative to bankruptcy for people on relatively low incomes. You must also meet the following criteria:

you must be insolvent (can’t pay your debts when they fall due)
have not been bankrupt within the last 10 years
have unsecured debts, assets and after-tax income, which are below prescribed limits (see the AFSA website for more information).

A debt agreement is a binding agreement between the debtor and creditor(s) which sets out a proposal of repayment for all or part of the debt. Debt agreements are suitable for debtors who can make reasonable repayment offers and want to avoid the adverse consequences of bankruptcy.

For example, debt agreements may provide for:

weekly or monthly payments from your income
deferral of payments for an agreed period
the sale of an asset to creditors
a lump-sum payment to be divided by creditors.

The process for entering a debt agreement is as follows:

obtain information about your options and eligibility (talking to a free, independent, financial counsellor is an excellent place to start)
appoint an administrator (see AFSA for a list of registered debt agreement administrators)
your debt agreement proposal is prepared by your administrator and lodged with AFSA
AFSA sends the proposal to your creditors to assess and vote on
AFSA checks and counts the votes
if the proposal is accepted, it becomes a Part IX debt agreement (the National Personal Insolvency Index is updated to reflect the agreement)
if the proposal is rejected, creditors can commence/ continue debt recovery action (the National Personal Insolvency Index is updated to reflect voting outcome).

Note: Part IX debt agreements can be administered by any person — including you, a family friend or relative. Many financial counsellors can assist you in entering into a debt agreement for no fee.

Many organisations now also administer debt agreements as a business venture. If you are considering engaging an organisation to administer your debt agreement, look very carefully at the costs they are going to charge you. Their costs usually comprise:

a fee for setting up the agreement; and (if accepted)
a fee for administering the arrangement.

The debt agreement proposal must mention the return that creditors can expect to receive on their debts and the cost for administration of the scheme. The proposal should also state that the administrator can only charge fees as work is performed.

A Part IX debt agreement is effectively an ‘act of bankruptcy’ made under the Bankruptcy Act and a record of the agreement, once accepted, will also be entered on the National Personal Insolvency Index database. However, it is an alternative to actual bankruptcy that does not have all the adverse consequences of bankruptcy.

The consequences of a Part IX debt agreement are:

all unsecured creditors are bound by the debt agreement and are paid in proportion to their debts
you are released from most unsecured debts when you complete all your obligations and payments
secured creditors may still seize and sell assets (for example, your house and car) if you are in default
creditors cannot take any other action against you, providing you abide by the agreement
the agreement does not relieve joint debtors of their obligations under loan agreements (for example, if you entered a joint loan agreement with an ex-partner, the creditor could still try to recover the entire debt from your ex-partner, despite your agreements with the creditor).

Part X debt agreements

A personal insolvency agreement (PIA) is another option available to help you deal with unmanageable debt. These are also known as ‘Part X debt agreements’. A PIA is a flexible way for you to come to an arrangement with creditors to settle your debts without going bankrupt. It is a legally binding agreement between you and your creditors. You can only propose a PIA if you are insolvent (that is, you cannot pay your debts as and when they fall due).

The general process for entering a PIA is as follows:

the debtor appoints a controlling trustee (see the AFSA website for a list of registered trustees to contact)
your trustee considers your proposal, consults with creditors and develops an offer to pay part or all your debts by instalments or a lump sum
a creditors’ meeting is held within 25 days of the trustee’s appointment
your PIA proposal is either accepted or rejected by creditors
if the proposal is accepted, creditors are bound by the terms of the PIA
a trustee (either a registered trustee or AFSA) is then appointed to administer the agreement.

A PIA may involve one or more of the following, which will result in creditors being paid in part or in full:

a lump-sum payment to creditors (from your own money or a third party’s)
transfer of assets to creditors or the payment of sale proceeds of assets to creditors
a payment arrangement with creditors (for example a deferral of repayments).

Some significant consequences of a PIA (or Part X debt agreement) include:

the appointment of a controlling trustee in these matters is considered an ‘act of bankruptcy’, and creditors can still use this to apply to a court to make you bankrupt
the PIA is recorded on the National Personal Insolvency Index forever
credit reporting bodies will hold details for five years or more
after you execute a PIA, you cannot manage any corporation until you fully comply with the terms of the agreement
secured creditors’ rights are not affected by a PIA (so they can still repossess secured property to satisfy debts).

A PIA will come to an end when your obligations under the agreement have been satisfied.

Interim relief

Do not rush into bankruptcy. If creditors are at your door, you can obtain interim relief (and time to think) by filling out a simple form called a declaration of intention to present a debtor’s petition (DOI). Filling out the form does not mean you have to proceed with bankruptcy, but it gives you 21 days to decide whether to proceed with bankruptcy or another option.

During these 21 days, unsecured creditors cannot take any action to recover debts, including recovering money or seizing unsecured assets. There is no fee for filing a DOI, and your application is not recorded on the National Personal Insolvency Index. After you lodge a DOI, your creditors are notified of stay on enforcement and receive a copy of your statement of financial affairs.

You can use the 21 days to think through your options and negotiate payment plans. If there is no resolution after 21 days, your creditors may resume enforcement action against you, including making an application for bankruptcy.

See the AFSA website for further details.

16.14 Other important considerations

Minimising additional fees

What happens if you are already considering voluntary bankruptcy and receive a bankruptcy notice or creditor’s petition from a creditor? In that case, you can still file your debtor’s petition before the creditor’s petition is heard by the court. This option helps you avoid a court-ordered bankruptcy and should reduce administration fees.

Residential property

The trustee will only sell an asset which will result in sufficient funds being received from the sale to pay a dividend to your unsecured creditors. So, if there is little or no equity after deducting the mortgage debt and selling expenses from the value of the property, the trustee will not sell the house. However, the trustee will lodge a caveat on the title to record the trustee’s interest in the property and review the value of the equity from time to time, and when the value of the equity is sufficient to provide a return to your creditors, the trustee will sell it.

Therefore, you may continue to live in your house during the intervening period but on the understanding that you are only really ‘renting’ the property and that eventually the trustee will sell it. Sale can even occur after discharge from bankruptcy.

Jointly owned residential property

It is the trustee’s responsibility to convert your valuable property into cash to repay your creditors. This may include the sale of your share of the family home. If your home is owned jointly, the trustee will give the non-bankrupt joint owner first option to purchase your interest in the property or join the trustee in a sale of the property. If neither option is adopted, then the trustee can force a sale of the property by way of a court order, and legal costs will be paid from the sale proceeds. This process may significantly reduce the amount that the non-bankrupt joint owner receives from the sale. Therefore, every effort should be made to avoid such a situation. In these cases, the joint owner should seek independent legal advice about the best option for them.

Legislation and further information

Fifteenth Chapter

Stopping enforcement

Seventeenth Chapter

Sample templates and letters