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The Bankruptcy Process Explained

This article explains the four stages involved in the bankruptcy process.  This occurs in the most common form of bankruptcy which is involuntary where the individual finds themselves subject to a sequestration order.

What is Bankruptcy?

Bankruptcy is a situation that occurs when a person is the involuntary subject of a sequestration order or voluntarily submits a debtor’s petition pursuant to the Bankruptcy Act 1966 (Cth). It is essentially when the Court recognising that person is incapable of paying their debts and a trustee must take control over their property to realise (sell) it and pay creditors the dividends in proportionate shares.

The most common form of bankruptcy is the involuntary variety involving a sequestration order. That process can be broken down into several stages:

The stages of the Bankruptcy Process

  1. A creditor commences legal proceedings against a debtor in an Australian Court and obtains a Final Judgement in respect of a debt. 
  2. This Final Judgement is not complied with, and the creditor applies to have the debtor issued with a bankruptcy notice.
  3. The bankruptcy notice is not complied with, and the creditor applies to have the debtor rendered bankrupt.
  4. Once rendered bankrupt, the debtor’s property vests with a trustee and is realised to repay outstanding debts.

Stage 1: 

A Final Judgement (otherwise known as a Final Order) in respect of a debt is essentially an order by a Court that compels a person to pay a debt they owe. It is the first stage in the bankruptcy process. A creditor can obtain a final judgement by commencing legal proceedings in an Australian Court against a debtor to recover a debt that has not been paid.

Stage 2:

The issue of a bankruptcy notice is the second stage of the bankruptcy process. It is an official demand for payment of a debt. Once a creditor has obtained a final judgement, and if it is not complied with, a creditor may petition for the issue of a bankruptcy notice. Bankruptcy notices are issued by the Official Receiver, a position filled by the Australian Financial Security Authority (AFSA), following an application by a creditor. Bankruptcy notices state that the debtor must repay their debt within 21 days (unless the Official Receiver stipulates a different compliance period). The debt must be $10,000 or more and no more than six years old. Failure to do this will result in an act of bankruptcy, which allows creditors to commence bankruptcy proceedings in the Federal Circuit and Family Court or Federal Court of Australia

Stage 3:

The third stage in the involuntary bankruptcy process involves a creditor making an application to the Court to make the debtor bankrupt. The Court does this through a sequestration order. This can be done when a person commits an act of bankruptcy. The relevant act of bankruptcy in this case is when that person owing a debt does not repay that debt pursuant to a bankruptcy notice issued on behalf of a creditor. That creditor can then apply for a sequestration order from the Federal Circuit and Family Court or Federal Court of Australia, which renders a person bankrupt for three years and one day after the debtor’s statement of affairs was filed.  This application must include proof that the debt is still owing among other procedural requirements. 

Stage 4:

The final stage of the bankruptcy process revolves around the trustee realising the debtor’s property and repaying creditors. When a person is bankrupt, much of their property or assets vest with a trustee appointed by the Court and a trust is created to hold that property. Being a trustee means that they acquire a legal interest in that property and can dispose of it according to the terms of the trust. The trustee must be either a private registered trustee-in-bankruptcy or the government Official Trustee in Bankruptcy, a role filled by the Australian Financial Security Authority (AFSA). Their purpose is to investigate the affairs of the bankrupt person, report to creditors and realise (sell) their assets to repay the creditors the debtor owes money to. Once a debtor is rendered bankrupt, they must file a statement of their affairs with the Official Receiver and the trustee. This is a document that details a person’s assets and liabilities. The trustee will then proceed to realise the debtor’s property to repay creditors in amounts proportionate to the size of their outstanding balances, otherwise known as the pari passu principle. 

Additionally, whilst bankrupt a debtor must declare their bankruptcy any time they pay for goods or services by cheque or attempt to obtain credit from a person or financial institution. Often people and financial institutions will refuse to loan money to or take payment by cheque from a bankrupt person. Additionally, if a debtor is earning an income whilst bankrupt, they must pay a portion of that income to the trustee. Any property that a person acquires whilst bankrupt also vests with the trustee. This legal status will continue for three years and one day after the date of filing of their statement of affairs.

Concluding Remarks:

Bankruptcy is a complex legal process that has severe financial implications for individuals who find themselves subject to a sequestration order.

The bankruptcy lawyers at Brander Smith McKnight are skilled at navigating this area of law and can assist clients facing bankruptcy legal proceedings.

Call us to arrange a free 20 minute no obligation consultation that includes case evaluation and cost estimate.

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