How does bankruptcy work?

No-one ever wants go declare bankruptcy – particularly when you are running a small business. So, how does it work exactly?`

When a person is in debt, they can be declared bankrupt. There are two ways this can happen: a person can declare themselves bankrupt or a person’s creditors can apply to court to have the person declared bankrupt.

When a person is bankrupted they have a sequestration order made against their estate. This sequestration order has the effect of taking all of the assets of the person, which are then sold and used to pay the debts of the individual. Most of the debts that the person owes are compromised and the person will be bankrupted for a mandatory period of time (in Australia that time is three years).

If a person becomes bankrupt what debts form part of their bankrupt estate?When a person is declared bankrupt, they are obliged to complete a ‘Statement of Affairs’. The majority of debts are proved as valid (provable debts) in bankruptcy; however, a number of government-imposed expenses are not provable such as:

Penalties and fines imposed by a court such as a fine for a breach of legislation such as a breach of the laws relating to not sending out SPAM text messages
Debts that a person incurs after the date of bankruptcy
Spousal maintenance
Child support
Debts incurred by fraud

When a bankrupt is discharged from bankruptcy, they will be released from provable debts; however, the debts listed above will still be owed by the bankrupt. Any debts of secured creditors (this means that the creditor has a right to recover a person’s physical asset such as a mortgage of a person’s home) are not affected by a person’s bankruptcy.

Unsecured creditors generally do not have the right to repossess goods to sell them, but may receive a partial payment based on the debts that the bankrupt person owes. Any debts that a bankrupt person incurs after they are declared bankrupt are debts that the bankrupt person is personally responsible to repay and do not form part of the estate.

What assets can a bankrupt person keep?
A bankrupt person will generally be entitled to retain their personal belongings but not assets. An asset is anything that can be owned that is not a personal belonging and includes real property, chattels or possessions. Generally, a bankrupt person’s household items, furniture and personal effects, life insurance and superannuation policies are not assets that form part of the bankrupt estate.

A person’s residence forms part of their bankrupt estate and is not protected property. If the house is mortgaged there are a variety of options that can be used to protect the house but usually the mortgagee of the property will sell it to settle the mortgage owed by the bankrupt person.

Does bankruptcy affect a person’s employment?
Generally, bankruptcy does not prevent a person from working but a number of industries may be affected by a person being declared bankrupt. If the bankrupt person is engaged in particular trades or professions, there may be certain restrictions imposed by their professional organisation or government legislation and rules.

More advice:
Click here for advice for managing debts
Click here for a guide to closing your business
Click here to find out what you need to tell the tax office
Click here to find out if you can be personally liable for debts of a business or company
Click here for what to do if you are struggling financially and worried about your employees

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This is an edited extract from The Business Legal Lifecycle by Jeremy Streten – designed to guide and empower you with the knowledge you need to successfully navigate your business journey.