Bankruptcy was originally designed to stop people who could not pay their debts being put in gaol. It is a method by which some control can be taken over a debtor's affairs, so that the entire financial disaster can be brought to an end and the debtor can make a fresh start.

When a debtor becomes bankrupt, the bankrupt's property and any property acquired during his or her bankruptcy comes under a trustee's control [Bankruptcy Act 1966 s 58(1)]. A bankrupt is required to assist the trustee in the administration of his or her financial affairs [s 77]. The money received from the sale of a bankrupt's property is distributed by the trustee to creditors on a pro rata (or percentage of overall debts) basis. With some exceptions, from the date the bankruptcy begins, creditors are prevented from taking any further debt recovery action against the bankrupt or his or her property.

Probably the best way to understand bankruptcy is to see it as a swap. In return for protection from further legal action by creditors and for a total release from debts at the end of the bankruptcy period, the debtor agrees to give up to the trustee certain assets and (for a while) a large degree of control over his or her financial affairs. However, for people who do not have any valuable assets and who have a low income, there is no real change in their control over their financial affairs because there is nothing for the trustee to take.

There are many restrictions on the bankrupt's life. A bankrupt may not be able to practise certain occupations and is unable to obtain credit of more than $3000 (indexed) without informing the potential creditor of his or her bankruptcy. A bankrupt may not be able to travel overseas, while business bankrupts must hand over all relevant books, documents and property as directed by the trustee and must supply any other relevant information that is requested.

Bankruptcy generally continues until discharge (whether the debts have been paid in full or not). A bankrupt can apply for early discharge six months after filing their statement of affairs with the Official Receiver [s.149T-ZE] but only where their bankruptcy occurred prior to 5 May 2003. The legislation has since been amended so that an early discharge is no longer available for any bankruptcy entered into as of 5 May 2003. Usually discharge occurs automatically after three years unless an objection has been lodged by the trustee [s 149D]. In certain circumstances it can last longer, see ending bankruptcy. After discharge all a bankrupt's remaining debts that were incurred before the bankruptcy are cancelled. For certain exceptions to this rule, see debts.

See also our pamphlet Bankruptcy.