How bankruptcy supports struggling individuals

Next time you hear someone talk about a company that’s become bankrupt, tell them that’s impossible. Here’s why – and when bankruptcy is possible.

We often read in the media about companies becoming bankrupt. But this is incorrect. Bankruptcy only applies to individuals. The confusion is exacerbated when discussing the United States, as in that country, the term bankruptcy applies to both businesses and individuals. In Australia, there are clear differences between corporate and personal insolvency, and where bankruptcy fits in.

Corporate and personal insolvency: what’s the difference?

There’s a difference between corporate and personal insolvency and the available solutions for both. Corporate insolvency happens when a company is unable to pay all its debts as and when they fall due. If this occurs, an external administrator is generally appointed who will seek strategies to either save, sell or wind down – liquidate – the business to try and repay its debts (see breakout).

Similarly, personal insolvency also occurs when individuals are unable to pay their debts as and when they fall due. But the solutions available to someone in this situation differ. With personal insolvency, there are two main options available: bankruptcy and a personal insolvency agreement (also known as a Part X agreement).

Personal insolvencies are not rare, and with these tough economic times we’re currently experiencing, they’re on the rise. It is important to address the situation as soon as possible to find the best solution.

What is bankruptcy?

A person who cannot pay their debts as and when they fall due, is insolvent, and bankruptcy is a legal process for those in this situation. You might want to think of it as personal insolvency being an individual’s financial state, while bankruptcy is an individual’s legal state.

Bankruptcy tends to be the most common of the two main solutions taken by individuals who are insolvent, and it can be either voluntary or involuntary. Voluntary bankruptcy is when the insolvent person declares themselves bankrupt, and involuntary bankruptcy is when an insolvent person’s creditor takes action to declare the individual bankrupt – which can happen if the creditor is owed more than $10,000.

Once declared bankrupt, a Bankruptcy Trustee is appointed to control the insolvent individual’s property and financial affairs, with a view to releasing them from almost all their debts, providing relief and ultimately allowing them to make a fresh start.

What is a personal insolvency agreement?

A personal insolvency or Part X agreement is an alternative to bankruptcy. It’s a legally binding agreement that takes its name from Part X of the Bankruptcy Act and enables the insolvent individual to appoint a Controlling Trustee. The Trustee will call a meeting of creditors and negotiate a binding formal agreement for debt repayment that is tailored to the person’s individual financial circumstances – usually by paying the debt in full by instalments or by paying an agreed lump sum.

When does bankruptcy end?

Bankruptcy usually lasts for three years and one day from when the statement of affairs is lodged. This period can be extended if the trustee lodges an objection to discharge based on any failure to comply with the bankruptcy’s conditions. Bankruptcy can also be annulled if the debt, plus the associated costs, are paid in full.

While it can be overwhelming for an individual to declare themselves bankrupt and hand over control of their assets to a trustee, it can also reduce the stress and emotional impact of trying to negotiate with potentially hostile creditors themselves. Taking early action when facing financial challenges ensures solutions can be found quickly, which means getting finances – and life – back on track.

Corporate insolvency solutions

The tough economic trading conditions are fuelling a rise in corporate insolvencies but there are strategies that can help. The most important thing, however, is to take early action as it’s an offence for a director to continue operating a business and incur more debts when the director is aware the business is insolvent. Also, they may be personally liable for any unpaid debts incurred after the business becomes insolvent.

Liquidation is not always the end for an insolvent company. A Voluntary Administration and Deed of Company Arrangement (DOCA), or the Small Business Restructuring (SBR) process may be able to assist restructure and revive the company.

To enter into a DOCA, a company will need to be placed under a Voluntary Administration (VAs) process. The VA process allows insolvent companies to continue to operate whilst the company explores plans to put forward to its creditors providing for a greater return to creditors than they would otherwise receive if the business was liquidated. A VA appointment immediately suspends most creditors claims against the company. It provides vital ‘breathing space’.

If a company has less than $1 million in debt and satisfies all other requirements, the SBR process is a potential strategy. It is a simple and cost-effective solution involving a Restructuring Practitioner developing a plan with the director and advisors to compromise the debt owing to creditors. Similar to a VA / DOCA, the plan is circulated to creditors who then vote whether to accept it.

Hanzel Hizola

Jirsch Sutherland

Jirsch Sutherland