The key consequences of bankruptcy.
Personal insolvencies are on the rise. For those of your clients who are in business and find themselves encountering challenging headwinds, it’s never been a more important time to revisit some of the consequences of bankruptcy. My colleague, Paul Nogueira, touched on this topic in his 2022 article Bankruptcy: What is it & how does it work.
Irrespective of how the bankruptcy is initiated, voluntarily by the debtor or by a creditor, it is a legal process that gives a financial fresh start to the debtor and due process to those creditors who are owned money.
The personal insolvency outlook
According to a recent report released by the Australian Financial Security Authority (AFSA) for 2024, personal insolvencies are on the rise¹.
Key findings in the report include:
"There were 11,644 new personal insolvencies in 2023-24, an increase of 17.3% from the previous year. This remains well below the ten-year average of 21,252.
AFSA has forecast personal insolvencies to rise by 15% to 13,400 in 2024–25 and by a further 12% to 14,950 in 2025–26.
While just over a quarter (25.1%) of personal insolvencies were business-related, they accounted for 75% of the personal insolvency system’s total debt ($17.3 billion), with a total value of $13.2 billion in liabilities.
Debtors with low liabilities continue to represent a significant proportion of new personal insolvencies in 2023-24, with 49% of debtors having liabilities of less than $50,000." ¹
Via https://www.afsa.gov.au/newsroom/state-personal-insolvency-report-released-2024
According to the report, AFSA is expecting annual personal insolvency volumes to rise moderately over the next two years, which highlights ongoing costs of living pressures having an impact on Australia households.
With this expected rise, it’s important to understand the fundamental consequence of personal insolvency and impact of a bankruptcy.
What is the effect on creditors?
When a person is made bankrupt, creditors rights to enforce their claims are removed and replaced with the right to prove for a dividend in the bankrupt estate. All creditors with a provable debt at the date of bankruptcy can prove for a dividend.
Impact of bankruptcy on the individual
During the period of bankruptcy an individual:
Is automatically disqualified from acting as a company officer (director)
cannot trade under a registered business name without advising people that they are bankrupt; however, they can trade under their own name
must make all of their divisible assets available to the trustee
cannot incur credit over an indexed amount (at time of writing, currently indexed by AFSA at $7,060) without disclosing to the lender that they are bankrupt
must obtain permission to travel overseas
must make all books, records and financial statements available, including those of associated entities (e.g. companies and trusts)
will likely see an immediate drop in their credit score / rating, which may have consequences for some time following the bankruptcy.
Whilst bankruptcy does not generally impose any restrictions on employment in any profession, various state and national associations/governing bodies do provide certain restrictions. Further information on this can be found here.
Bankruptcy impact on an individual’s property
A bankruptcy trustee controls all of a bankrupt’s divisible property. This includes all property owned at the time of bankruptcy, and all property received after the date of bankruptcy, but before discharge.
Certain property is not divisible, which in general terms means that is not available to the trustee to realise for the benefit of the bankrupt’s creditors.
The property which is not ‘divisible’, includes²:
necessary clothing and household items
tools of trade to an indexed amount ($4,350)
a motor vehicle to an indexed amount ($9,400)
life assurance or endowment policies (subject to some limitations)
certain damages and compensation payments
sentimental property (as defined in the Bankruptcy Act)
superannuation payments (subject to certain limitations).
Impact of bankruptcy on income
A bankrupt is entitled to earn income however, if that income exceeds income threshold limits, a contribution from this income must be paid by the bankrupt to the estate. The total income to be assessed is reduced by the income tax payable, appropriate business expenses, and any child support payments. Further information regarding the income thresholds can be found in the Worrells Guide to Personal Insolvency.
Understanding the impacts – seek advice early
With personal insolvency events increasing, it is important that you seek appropriate trustworthy professional advice and act on that advice. Seeking this advice early may mean you have more options to deal with the debts. For further information for particular advice on your circumstances, contact the team at Worrells who are here to help.
¹ https://www.afsa.gov.au/newsroom/state-personal-insolvency-report-released-2024
² Many of the dollar amounts in bankruptcy law are indexed. This means they regularly change to keep up with the Consumer Price Index or the base pension rate: https://www.afsa.gov.au/professionals/resource-hub/indexed-amounts
