Lecture Fundamentals of business law (7/e): Chapter 20 - M.L Barron

Chapter 20 - Bankruptcy law. At the end of this chapter you should understand: the objectives of bankruptcy law, the advantages and disadvantages of bankruptcy from the perspective of the creditor and the debtor, how the Bankruptcy Act 1966 (Cwlth) is administered,...

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Bankruptcy law

Chapter 20

Learning objectives

At the end of this chapter you should

understand:

• the objectives of bankruptcy law

• the advantages and disadvantages of bankruptcy from the perspective of the creditor and the debtor

• how the Bankruptcy Act 1966 (Cwlth) is administered

• the difference between a debtor’s petition and a

creditor’s petition

• the term ‘acts of bankruptcy’ and give examples

• the steps involved in obtaining a sequestration order

• the property of a bankrupt that is available for distribution

to creditors

Learning objectives (cont.)

• the order in which creditors’ debts are paid

• the powers of the trustee, including the power to

avoid antecedent transactions

• the procedure for discharge from bankruptcy

• the contrast between the bankruptcy of a debtor with alternative procedures under Parts IX and X of the

Bankruptcy Act.

Bankruptcy

• Where legal possession of a debtor’s

possessions is taken for the benefit of

that person’s creditors.

• Debtor’s property is sold and

distributed fairly amongst creditors,

following which the bankrupt is given a

discharge of their debts.

• May be sought by debtor or creditor

• Regulated by the Bankruptcy Act 1966

Objectives of bankruptcy Law

• To assist the debtor

– Will be entitled, once discharged, to make

a fresh start free from the demands of creditors

• To protect creditors:

– by preventing debtors from disposing of

property when bankruptcy is inevitable – by distributing the debtor’s assets among

creditors in the swiftest and most economical manner.

Objectives of bankruptcy law

(cont.)

• To benefit the community:

– by giving a debtor who is hopelessly in debt an opportunity to make a new start, rather than

remain a burden on the community.

– by imposing limits on the capacity of a person

who is an undischarged bankrupt to enter new contracts.

Advantages for creditors

• Equitable and proportionate distribution

of debtor’s assets

• Recovery of property that was

distributed prior to bankruptcy

• Possibly uncover more property

available for distribution to creditors by

public examination

Disadvantages for creditors

• Significant fees for administering the

estate, and court costs associated with

the recovery of costs, are paid before

creditors.

• Delays and complications

• Bankrupt must stop trading

Advantages for debtors

• Enables bankrupt to avoid being

sued by creditors for debts

incurred prior to the bankruptcy.

• New start in three years, with

cooperation.

• Bankrupt maintains ‘necessary

property’.

Disadvantages for debtors

• Debtor’s property available for settlement of debts

• Earnings may be used as contribution towards debts

• Stigma attached to bankruptcy

• Restrictions in obtaining credit without notifying credit

provider of bankruptcy

• Bankrupt’s passport to be surrendered

• Cannot be director of company without permission of

Distinction between

bankruptcy and insolvency

• Insolvency

– The person is unable to pay all of his or

her debts as and when they become due

and payable.

• Bankruptcy

– The person is required to provide a

trustee with specified property, to be

distributed among creditors.

Insolvency and Trustee Service

• Bankruptcy matters are administered under the umbrella of the Insolvency and Trustee

Service Australia or ITSA.

• ITSA provides bankruptcy, trustee and

related services including advice and

regulation in one location.

• Important role in countering illegal activities and protecting Australian community from

impact of financial failure

Bankruptcy Act 1966—

administration

Inspector-General in bankruptcy

(appointed by Attorney-General’s Department)

Overseas general administration of Bankruptcy Act

State Official Receiver OR Registered trustee

(appointed by Governor-General) (appointed by Federal Court)

Administration and distribution of bankrupt’s estate:

Gathering bankrupt’s estate Realising non-monetary assets Distributing dividend to creditors

Official trustee in bankruptcy

A body corporate that holds and

invests property on behalf of the

creditors prior to sale and distribution.

How a person can be made

Bankruptcy by debtor’s petition (voluntary bankruptcy)

Insolvent

• Declaration of intention s 54A

(provides stay period)

Bankruptcy by creditor’s petition

• Initiated by one or more creditors and

presented to the Federal Court.

• If satisfied, court issues a sequestration

order which results in the debtors estate

being vested in the Official Trustee or a

registered trustee for distribution to creditors.

• Process may be expensive and drawn out so it’s important to consider commercial

realities.

• Usually used when there is a large sum of

Conditions before creditors’

petition will issue

• Debt owed to creditor/s must be at least

$5000 and be capable of being quantified.

• Debtor must have committed an act of

bankruptcy within a period of six months

before the presentation of the petition.

• Generally the debtor must be resident or

have a residential or business address in

Australia at the time the act of bankruptcy

was committed.

Acts of bankruptcy

• Listed in Part IV, Division I, s 40 of the

Bankruptcy Act 1966 (Cwlth)

• One of the most common acts of

bankruptcy is a failure to comply with a

bankruptcy notice.

• The Official Receiver may issue the notice

on application of creditor/s who have

obtained a final judgement or order for an

amount of at least $5000.

• The notice requires the debtor to pay within

a prescribed time.

Failure to comply with bankruptcy notice (creditor has right against debtor decided)Final judgment made

Bankruptcy notice served

(based on final judgment order)– sum due

– deadline to be paid

Debtor complies

no act of bankruptcy

Debtor doesn't comply

commits act of bankruptcy

Pay debt

Prove debt not owed

– counterclaim– set-off– cross demand

Creditor presents petition

for bankruptcy (> $5000 owed)

Served on debtor

Court proceedings for sequestration order

Prove: debt exists

debtor committed one or more acts of bankruptcy within six months before

creditor’s

petition presented service of petition of debtor

Court makes sequestration order

Sequestration order

(on creditor’s/debtor’s petition)

• Administration of the estate:

– Debtor files statement of affairs (assets/liabilities)

within 14 days – Trustee calls creditors to meeting within 28 days

– Public examination of debtor

– Creditors prove debt exists

– Trustee realises assets

– Trustee pays dividends to proven creditors

– Debtor freed from all provable debts

Proof of debt

Secured Unsecured

Rely on Estimate Realise/surrender

security security security

Shortfall

Proof of debt

Amount How incurred Substantiation

Assets available to the trustee

• Assets of bankrupt owned on day of

bankruptcy, i.e earliest act of

bankruptcy that can be counted, within

last six months

• Assets bankrupt acquires while

bankrupt

• Income above threshold amount

(includes the value of fringe benefits

and money paid to associated entities)

Certain property excluded

from bankruptcy

• Section 116(2) of the Bankruptcy Act

1966 lists some specific exclusions,

e.g.

– clothes and necessary household furniture

– personal belongings

– vehicle (worth up to $6850)

– property used to obtain income by personal

exertion, not exceeding a prescribed value.

Property available for

payment of debts

• Doctrine of relation back (s 115):

– The bankruptcy will relate back to the earliest

act of bankruptcy committed by the debtor

within the six-month period preceding the date

of the presentation of the creditor’s petition, or

the application for the making of a sequestration

order (debtor’s petition).

– Aimed at preventing persons aware of imminent

bankruptcy from disposing of property that

should be used to satisfy creditors’ debts

Antecedent transactions: s 118

• Execution and attachments before

bankruptcy

– Money received via execution against property,

six months before or after the presentation of the petition, must be paid to trustee (less costs).

Preferential payments: s 122

• Transfer of property (within six

months of presentation of petition)

– By insolvent person

– Made from person’s own money

– Made in favour of a creditor in preference to

other creditors

• Exceptions:

– Received during normal course of business

– Received in good faith

– Purchased for at least market value

Discharge from bankruptcy

• Automatic discharge—after three

years

• Discharge—usually within three years

from filing of statement of affairs

– May be extended to five years.

– May be extended to eight years on return to

Australia

• Annulment—where all debts are paid,

or bankruptcy was not deserved

Debt agreements under Part IX

• Proposal options:

– Payment of debt over period of time

– Creditors accept less than full amount

• Available if debtor has:

– unsecured debts of less than $90 326.60

– property of less than $90 326.60

– After tax income of less than $67 744.95

– not been bankrupt or entered into a Part X

arrangement in last ten years.

Debt agreements under Part IX

(cont.)

Proposal Official Trustee 75% of creditors approve

Debt agreement Recorded on National Personal Insolvency Index (NPII)

Part X schemes—personal

insolvency agreements

• Agreement with creditors outside of bankruptcy,

avoiding consequences and stigma of bankruptcy.

• Debtor must authorise a registered trustee or

solicitor to call a meeting of the debtor's creditors.

• Within 14 days of consenting to act and meeting

with creditors, the trustee must prepare a report

summarising the affairs of the debtor.

• Trustee must state whether a personal insolvency

agreement is in the best interest of the creditors.

• Meeting of creditors seeks information from

debtor who must present statement of affairs,

assesses and votes on agreement

Reasons for bankruptcy

• Consumer debt

• Lack of business and investment skills

• Change in economic or political climate

• Unforeseen liabilities