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Alternatives to bankruptcy

Notice of Intention to Declare a Debtor's Petition

Subject to certain exceptions a debtor may present to the Official Receiver a declaration to present a debtor's petition [Bankruptcy Act 1966 s 54A]. Once accepted this has the effect of freezing action against the debtor by a creditor for a period of 21 days. This allows a debtor time to seek advice or make arrangements with creditors and prevent the need to become bankrupt. These arrangements have no effect on the rights of secured creditors to deal with their security. A declaration is not available to business partners and can only be filed once in any twelve month period.

Informal Agreements

It is possible to negotiate arrangements with creditors to repay certain debts over a period of time. Dealing with debt in this way requires some skill, and it is best to consult a financial counsellor, or lawyer or accountant to put a realistic and manageable proposal to persuade creditors to accept something like a reduced lump sum or a long term instalment arrangement. Creditors may ask to be informed of your complete financial position, including other creditors, to ensure that any proposal is fair. Clearly entering into such an arrangement avoids the stigma and consequences of bankruptcy, although it is likely that creditors may make an adverse credit report which will remain on your credit file for a period of 5 years.

The Bankruptcy Act offers other alternatives that are legally binding, but do not have some of the same effects as bankruptcy.

Debt agreements - see Debt Agreements

Personal Insolvency Agreements

A Personal Insolvency Agreement is similar to a Debt Agreement, except that there are no limits on income and assets owned by the debtor, and no limits on the total debt owed. The PIA is managed by a controlling trustee, and involves investigation of a debtor's financial position by the trustee, who then calls a creditors meeting to allow the creditors to vote on any proposal. If the proposal is rejected, any creditor is free to make the debtor bankrupt (through a creditors petition) or let the debtor lodge their own petition.

This alternative is more suitable for people with unmanageable debts, but a high income and a number of assets.

The effect of a PIA is similar to a debt agreement:

  • It is an act of bankruptcy which allows a person to apply to a Court for a sequestration order if the PIA fails;
  • It is recorded on a person's credit report and on the NPII
  • Requires co-operation with the controlling trustee

Further detailed information about PIAs can be found on the AFSA website.

Debt Agreements

Debt agreements are regulated under Part IX of the Bankruptcy Act 1966 (Cth). This part describes the debt agreement process, and includes changes that commenced on 27 June 2019.

A debt agreement is a legally binding agreement between a debtor and their creditors to reach a compromise about how debts can be paid, without the debtor going bankrupt. Creditors must agree to accept a lower amount in instalments over a period of time to ensure that they receive some of the amount owed, rather than nothing which is the case when a debtor is bankrupt.

However, entry into a debt agreement is considered an act of bankruptcy which can later be the basis for a creditor to make the debtor bankrupt.

From 27 June 2019, a debt agreement will have a maximum duration of three years where the debtor does not have an interest in their home. It may be five years if the debtor has an interest in their home.

A debt agreement is not a consolidation loan and will not necessarily cover all debts. More information about what debts are covered can be found on the Australian Financial Security Authority (AFSA) website.

Debt agreement administrators

A debt agreement must be administered by a debt agreement administrator, who receives a fee for this service. Debt agreement administrators gather the required information including information about a debtor’s financial situation, and creditors. Provided the necessary criteria are met, the administrator can prepare the necessary forms and submit the proposal to AFSA.

Debt agreement administrators must be registered, regardless of the number of debt agreements they are managing at one time. To be registered, an administrator must have the appropriate knowledge, skills and attributes to professionally undertake their role, and hold the required insurance.

Debt agreement administrators and related entities are also prevented from voting on a proposed debt agreement for their own fees. In addition, administrators must disclose in the proposal the types of expenses that can be recovered (and these are limited) for consideration by creditors.

Debt agreements commenced prior to 27 June 2019 are not subject to the requirement for the administrator to be registered.

Entry into a debt agreement

To be eligible to give AFSA a debt agreement proposal, the debtor must meet the criteria set out in section 185C.

The debtor must be insolvent (unable to pay debts as and when they fall due).

The debtor’s unsecured debts, property and income must all be below a certain threshold. The limit for unsecured debts and unsecured property is currently approximately $115,800, and the limit for income is approximately $87,000. These amounts are indexed and published every 6 months by AFSA on its website.

AFSA may require information regarding the debtor’s financial circumstances or assets to ensure that the monetary limits are complied with. AFSA has no discretion to vary the monetary limits, even by a small amount.

A person who has been in a debt agreement or been bankrupt in the past 10 years is also prohibited from proposing a debt agreement.

Other requirements

A debt agreement administrator must make reasonable enquiries about and verify the debtor’s financial circumstances. Prior to submitting the proposal, the administrator is required to certify that the debtor can discharge the obligations under the agreement.

Payments cannot exceed the debtor’s income by a certain percentage, which is determined by the Minister. The formula used to calculate the prescribed percentage includes a low income debtor amount to protect vulnerable debtors.

Formula

Total of the payments that the debtor would be required to make + Low income debtor amount

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Debtor's after tax income in the year beginning at the proposed time

The total income to payment ratio is set to ensure that a person can realistically complete the debt agreement within 3 years (or 5 years in limited circumstances).

AFSA may also refuse to accept a debt agreement on the basis that it would cause undue hardship to the debtor, in accordance with section 185E. This is an added protection for debtors, and is in addition to an administrator’s certification of the debtor’s financial circumstances.

Other circumstances that may result in rejection of the proposal by AFSA include:

  • The creditors interest are not served by the agreement, for example where the debtor's financial affairs are very complex and unclear to creditors;
  • The debtor has only one creditor;
  • A resubmitted debt agreement that does not address any concern raised by major creditors.

Creditors must approve the proposal

Once the fee is paid and the proposal is approved by AFSA, it is sent to creditors for a vote. A proposal is accepted if a majority of creditors (by reference to the value of the debts) vote in favour of the debtor's proposal.

All creditors with provable debts at the time the debtor's details are entered into the National Personal Insolvency Index (NPII) are bound by the agreement, even those who voted against the proposal. It is therefore very important to ensure that all debts are included.

For debt agreements proposed after 27 June 2019, a debt agreement administrator or related entity cannot vote on the proposal.

Effect of a debt agreement

Creditor's debts are fixed at the date the proposal was entered on the NPII. Interest does not accrue and creditors cannot take or continue action against the debtor to collect their debts.

After all payments are made, the debtor is released from debts owed to the creditors covered by the agreement. Debts incurred after the commencement of the debt agreement can still be recovered, and there are also certain types of debts that cannot form part of a debt agreement.

The debt agreement information about a debtor remains on the NPII for up to 5 years from the date the agreement is completed. If an agreement is proposed but is withdrawn, rejected or otherwise does not go ahead, the information remains on the NPII for one year. A terminated debt agreement is also recorded for a period of up to two years after the agreement terminates.

The information is also recorded on a person’s credit report and remains for similar time periods as the NPII.

Termination of a debt agreement

If a debtor misses payments on a debt agreement for six months, the agreement terminates automatically. Another reason to terminate the agreement is if the debtor wants to submit a debtor’s petition (go bankrupt).

Debtors can propose to vary an agreement but this requires a vote by the affected creditors and the payments must not exceed the income to payment ratio. In addition, the total length of the agreement must not exceed three years.

If a debt agreement is terminated, affected creditors are free to continue to recover the balance of any amounts owing, unless the debtor is made bankrupt.

    Alternatives to bankruptcy  :  Last Revised: Wed Jun 26th 2019
    The content of the Law Handbook is made available as a public service for information purposes only and should not be relied upon as a substitute for legal advice. See Disclaimer for details. For free and confidential legal advice in South Australia call 1300 366 424.