The effects of entering bankruptcy will be different for different people. In this section the legal effects of going bankrupt on a person's property, income and rights are explained.
It is important to understand the effects of going bankrupt and as well as reading through this, you should seek specific advice about your own circumstances.
With some exceptions (see property a bankrupt can keep), a bankrupt's real estate and personal property vests in the Trustee. This is so whether the property is situated in Australia or elsewhere [Bankruptcy Act 1966 (Cth) s 116, Bankruptcy Regulations 1996 regs 6.03 and 6.04].
Property includes the bankrupt's interest in a house (whether owned alone or jointly with someone else), cash in the bank, jewellery, stocks, shares and debentures, fixtures and fittings, gifts and legacies received under a will, crops and more. Any money owed to the bankrupt can be recovered by the trustee unless it is protected (exempt).
The vesting of property in real estate that is owned as a joint tenant with another has the effect of severing the joint tenancy in the property. So, the automatic protection for the non-bankrupt joint owner on the death of the bankrupt is therefore lost.
If a bankrupt owns, or is purchasing, a home which is in the bankrupt's name, the trustee has the right to sell the property and distribute any equity to the creditors. This does not apply to homes purchased with Defence Service Homes loans which are protected under the Defence Service Homes Act 1918 (Cth) and the Director will rarely give permission for the sale to take place.
In the case of jointly owned property, when one owner becomes bankrupt the trustee will become registered as a 'tenant in common' of the home with the non-bankrupt owner, or will lodge a caveat on the title to protect the bankrupt's interest.
- the other owner has first option to buy, either for cash or by instalments, the bankrupt's interest (or share) in the home from the trustee.
- a joint owner who cannot afford to buy the bankrupt's share may agree with the trustee to sell the home. Both the trustee and the non-bankrupt joint owner usually receive equal shares of any money left over after the mortgage and expenses are paid.
- if the joint owner refuses to co-operate, the trustee can apply to the Court under the Law of Property Act 1936 (SA), for an order that the property be sold and the proceeds divided between them. The cost of the trustee going to Court can be very high, and is taken out of the proceeds of the sale of the property. In that case, it is far better to co-operate the trustee to preserve any equity available to the non-bankrupt owner.
If the home was bought with, or substantially with compensation money for an injury it cannot be taken, see property a bankrupt can keep.
A bankrupt is allowed to keep vehicles used for personal transport up to a certain value. The amounts are indexed and can be checked on the AFSA website here.
If there is equity in the car that exceeds the indexed amount, the trustee can sell the car and the indexed amount is returned to the bankrupt to enable him or her to buy and keep a cheaper car.
If a car is under finance, and the repayments are not being maintained by the bankrupt, it is likely that the secured creditor (the lender) will take steps to repossess the car. Any shortfall after the sale of the car is an unsecured debt, and the lender will become another creditor and be asked to lodge a proof of debt in the bankruptcy.
Be careful of allowing someone else to pay out any car loan during the course of the bankruptcy. If the car is valued above the threshold amount, even if someone else has paid it out, it will vest in the trustee and most likely be sold.
If a person borrows money to buy goods, and gives the lender security over those goods, the debt owed to the lender is a secured debt or consumer mortgage. It is often a term of the consumer mortgage that the loan will be in "default" if the person is made bankrupt. Default entitles the lender to seize and sell the goods to recover the debt (see consumer credit).
A lender may agree that a bankrupt can keep goods over which security is held during the course of the bankruptcy, as long as payments are being maintained. This of course depends on whether or not the trustee also agrees, particularly if there is significant equity in the goods.
Certain goods are exempt from seizure by the trustee under the Bankruptcy Act 1966 (Cth). This means that the goods are not available to sell by the trustee to repay creditors. Such goods are household items, cars under a certain value and tools of trade under a certain value. Any other goods are available to the trustee to take, even if the goods are subject to security in favour of a lender.
If goods are paid for in full during the period of bankruptcy (whether the payments are made by the bankrupt or by a family member or friend), and are not exempt (ie not household goods or motor vehicles valued under the threshold amounts which can be found here) the trustee can seize the property and sell it to pay creditors.
At any time during the bankruptcy, the trustee may take any money or other items the bankrupt receives, such as gifts, lottery winnings or money inherited. If the bankrupt does save money and buys some possessions, they may also be taken by the trustee [s 58(1)].
Some debtors, seeing the threat of bankruptcy, try to get rid of their property first by transferring it to others, often to family members. Under the 'clawback' provisions of the Bankruptcy Act 1966 (Cth) a trustee can take back some property that no longer belongs to the bankrupt, such as property that was sold, or given away, with intent to defraud creditors and not for its real value. Trustees have greater powers to set aside certain transactions entered into up to five years before the bankruptcy where the market value was not paid.
A transaction is not void:
- in the case of a transfer to a related entity of the transferor: if the transfer took place more than 4 years before the commencement of the bankruptcy and the transferee proves that, at the time of transfer, the transferor was solvent; OR
- in any other case: the transfer took place more than 2 years before the commencement of the bankruptcy and the transferee proves that, at the time of transfer, the transferor was solvent.
[Bankruptcy Act 1966 ss 120, 121]
Where a payment was made to a creditor the Official Receiver may, on behalf of the trustee, issue a notice requiring repayment of the sum [s 139ZQ]. A person disobeying a notice faces up to six months gaol [s 139ZT]. A person can apply to the court to set aside a notice [s 139ZS]. Where the transaction concerns property a charge can be registered over the property [s 139ZR]. The charge has priority over any other mortgage, lien, charge, or encumbrance unless it was a genuine transaction at 'arms length' (i.e. no favours were made as a result of a family relationship or friendship) for valuable and adequate consideration.
Exceptions to this include [s 120]:
- payments for tax payable to either State or Commonwealth governments
- payments made under maintenance agreements or orders
- transfer of property under a debt agreement
- where the cost of recovery of the transferred property would be likely to exceed its value
Similarly, where a bankrupt (transferor) transfers property to another party (transferee) and the transferee then gives money (or anything else of value) in consideration of this transfer to a third party, these transactions can also be set aside [Bankruptcy Act 1966 s 121A]. The Act allows a trustee to treat the transaction as if it had occurred between the transferor and the third party directly.
All bankrupts must hand over their passports when requested by their trustee (although not all trustees ask for the passport to be handed over), but may ask for the return of the passport during the bankruptcy and the trustee must have a good reason for refusing the request. A bankrupt whether they are a compulsory contributor or not may not leave Australia during the bankruptcy without the trustee's written consent [Bankruptcy Act 1966 (Cth) s 272]. Where the bankrupt is a compulsory contributor, the trustee may impose conditions including payment of the contribution liability [s 272(2)].
Where a bankrupt leaves Australia without the trustee's written consent or contravenes any of the conditions imposed, an offence is committed and the bankruptcy may be extended for eight years commencing on the bankrupt's return to Australia and/or upon conviction face up to one year in gaol.
- ordinary clothing
- necessary household goods (such as lounge suite, kitchen furniture, ordinary domestic refrigerator, washing machine, educational material, television set, stereo, video recorder)
- tools of trade, plant and equipment that are used to earn income, and that are up to a certain value (indexed). For more information about the indexed value, see Australian Financial Security Authority (formerly ITSA)
- certain policies of life assurance, endowment assurance, policies of insurance
- the bankrupt's interest in certain superannuation funds or approved
- money received as damages or compensation for personal injury to the bankrupt, his or her spouse or family (including death). Also any property (such as a house or car) bought with, or mostly with, that money. Where those assets have been purchased partly but not substantially with compensation for injuries, for example 10%, on the sale of that asset the bankrupt is entitled to receive that same percentage from the proceeds of the sale
- amounts paid by the State to the bankrupt under certain rural assistance agreements between the Commonwealth and the States
- the separate property of a non-bankrupt spouse or held on trust for another person
- motor vehicles with a net equity of less than $7 200 or $14 400 (indexed) for a jointly owned vehicle may not be taken by the trustee. Where a vehicle of higher value is sold the bankrupt will be given $7 200 (or $14 400) (indexed) in order to buy a cheaper vehicle which he or she can keep, see motor vehicles.
In determining what household goods can be retained, the trustee must regard:
- the number and age of members of the bankrupt's household
- any special health or medical needs
- any special climatic, geographical isolation factors
- whether the assets are reasonably necessary for the household to run properly
- whether the cost of storage and sale would exceed the sale price
Bankrupts receiving over a certain income must pay contributions to their trustee. Income includes wages, fees, commission, and the value of fringe benefits (for example, the provision of a motor vehicle or school fees for the bankrupt's children). The contribution is half the bankrupt's income above the threshold. The threshold amount is adjusted to take into account the number of dependents, income tax and child support payments. It is adjusted twice a year in line with movements in the pension rate and is set out on the website of the Australian Financial Security Authority (formerly ITSA). If the bankrupt suffers hardship the contributions may be varied upon a written application [Bankruptcy Act 1966 s 139T].
If a bankrupt does not pay the contributions the trustee can demand payment from a person who owes money or property to the bankrupt (for example, the bankrupt's employer or bank) [s 139ZL]. A person can be gaoled for failing to comply with a demand [s 139ZO]. The trustee can also recover the amount not paid as a debt by taking action against the person in court even after they have been discharged from bankruptcy [s 139ZL(10)].
The Family Law Courts have jurisdiction in any matter arising out of a property settlement under the Family Law Act where one of the parties is a bankrupt. This means that a trustee of a bankrupt can apply to become a party in Family Law proceedings if they can show the Court that the creditors’ interests will be affected.
When this occurs the bankrupt party is not entitled to make any submissions to the Court about property already vested in the trustee, other than with the permission of the Court and this is only granted in exceptional circumstances.
No priority is given to the creditors of the bankrupt party over the non-bankrupt spouse and similarly, no priority is given to the non-bankrupt spouse over the creditors of the bankrupt party. In making any decision the Court must attempt to balance the interests of both parties.
Where property has been vested in the trustee for the bankrupt party, the Court has the power to order the transfer of this property to the non-bankrupt spouse. Once transferred the property is not available to creditors of the bankrupt party.
There are a number of serious offences under the Bankruptcy Act 1966 (Cth) for which a bankrupt person could be prosecuted. The Act has been strengthened in recent years to ensure that there are significant penalties for bankrupts who attempt to dispose of or conceal property in an effort to defeat creditors. The time period in which such actions are viewed as criminal often precedes the commencement date of bankruptcy.
Examples of offences under the Act include:
- Concealment of property [s 263] — maximum penalty of 5 years imprisonment.
- Giving a false affidavit [s 263A] — maximum penalty of $200 or 6 months imprisonment for a summary offence; for an indictable offence the maximum penalty is 4 years imprisonment.
- Failure of person to attend court [s 264A] - maximum penalty of 6 months imprisonment.
- Failure to disclose property [s 265(1)] — this includes the disposition of property for a period of 2 years immediately preceding the date the bankruptcy commenced — maximum penalty of 1 year imprisonment.
- Making false representations or fraud on creditors [Bankruptcy Act 1966 s 265(3)] — maximum penalty of 5 years imprisonment.
- Concealing property after bankruptcy commenced — [s 265(4)] — maximum penalty of 1 year imprisonment.
- Making a false declaration [s 267] — maximum penalty of 12 months imprisonment.
- Obtaining credit of $3 000 or more without disclosing debt agreement or bankruptcy [s 269] — maximum penalty of 3 years imprisonment.
- Gambling or hazardous speculations [s 271] — if a bankrupt materially contributes to or increases their insolvency due to gambling or hazardous speculations even 2 years prior to their bankruptcy they may be guilty of this offence. The behaviour must have been rash or hazardous in light of their financial position at the time and any speculations made must not have been connected to their trade or business — maximum penalty of 1 year imprisonment.
- Leaving Australia with intent to defeat creditors within 6 months before bankruptcy [s 272] — maximum penalty of 5 years imprisonment.
The following is a short list of some of the more important rights of bankrupts.
- Where a trustee objects to a discharge or sets a contribution payable, a bankrupt can write, enclosing appropriate documents, to have the matter reviewed. Decisions are reviewed by the Inspector General (if considered justified) or the Commonwealth Ombudsman. Reviews can also be made to the Administrative Appeals Tribunal (an application fee is payable unless hardship can be proven [Reg 19 of the Regulations to the Administrative Appeals Tribunal Act 1975 (Cth)], and will be refunded if the bankrupt is successful). A bankrupt, creditor or other person affected by an action or omission of the trustee may apply to the court for an order that it thinks just and equitable in the circumstances [Bankruptcy Act 1966 (Cth) s 178].
- Only debts that are legally enforceable against the bankrupt can be proved in bankruptcy. For example, debts that are not enforceable under State laws (for example, statute barred) are not provable debts and, where appropriate, that fact ought to be drawn to the trustee's attention. Most debts become statute barred six years after the date of the last repayment or other acknowledgment of the debt by the debtor. After that time the lender loses the right to sue.
- Bankrupts are automatically discharged after three years and one day unless the trustee files an objection.
- The bankrupt, or his or her estate, has the right to continue any legal or court proceedings begun before the bankruptcy in relation to injury to, or death of the bankrupt, the bankrupt's spouse or a member of the bankrupt's family, or in relation to any compensation or damages received. Any property bought with, or substantially with, those funds is not divisible among the creditors.
- Bankruptcy operates automatically to stop legal or court proceedings (other than those in relation to injury) already begun by the bankrupt. The trustee’s permission is needed to begin or continue with any legal proceedings. The trustee must however, act reasonably at all times and has a duty to consider whether the legal proceedings have merit. A trustee who believes that the action has merit, 'steps into the bankrupt's' shoes and may start or continue the proceedings. This depends on the type of proceedings and advice should be sought from the trustee.
- A bankrupt is entitled to operate a savings bank account.
- A bankrupt has the right to travel freely throughout Australia, although the trustee must be notified of any change in name, address, or employment. This includes simply using a different name or an additional name [s 80].
- A bankrupt can be the executor of a deceased estate and may even apply to be appointed the administrator of an estate if there is no will but in this situation may be required to pay a bond, see obtaining letters of administration. However, property inherited by an undischarged bankrupt will probably be taken by the trustee depending on the type of bequest.
A bankrupt can request from their trustee information that they reasonably require concerning their property or affairs [s 170]. The file will probably contain the trustee's reports, copies of any relevant court transcripts, general correspondence and a list of proofs of debt lodged by creditors. Copies of all relevant documents are obtainable under the Freedom of Information Act 1982 (Cth) although charges were recently introduced under that Act. It may now be preferable simply to seek permission to obtain specific information from the trustee’s file.
The content of the Law Handbook is made available as a public service for information purposes only and should not be relied upon as a substitute for legal advice. See Disclaimer for details. For free and confidential legal advice in South Australia call 1300 366 424.