Dane Grauf

Where an individual is insolvent it is possible for their estate to be dealt with under the Bankruptcy Act. The bankruptcy may be entered voluntarily under what is known as a debtor’s petition or it may be made by order of the Federal Court which is what is usually termed a sequestration order based upon a creditors’ petition. Under a debtor’s petition an individual is required to also file a statement of affairs. For a creditor’s petition it is necessary to show not only that the debtor is insolvent but also that the debtor had committed an act of bankruptcy (see our earlier blog article on Bankruptcy Notices and Creditors Petitions) within six months of the presentation of the petition.

On the commencement of bankruptcy, all of the individual’s property vests in a trustee in bankruptcy. The trustee then gains control over the property and in some situations the income of the debtor. There is some property that is exempted from this control, like superannuation (in most circumstances). Once a person is made bankrupt certain obligations rest upon the debtor to provide information and generally assist the trustee who is controlling the debtor’s property.

Unlike corporations that may be liquidated and deregistered so that they will cease to exist as a separate legal entity, individuals will eventually emerge from bankruptcy. Currently, the general rule is that a person will be discharged from bankruptcy three years from the date that he or she filed their statement of affairs. However, the period of bankruptcy may be extended to 5 years or even 8 years for non-compliance with the obligations imposed on a bankrupt. The bankruptcy may also be annulled (ended) prior to discharge in some situations.

Test for Insolvency

A company is insolvent under section 95A of the Corporations Act 2001 (the ‘Corporations Act’) if it is unable to pay its debts as and when they fall due.

This is a question of fact to be considered on a case by case basis.

There are two tests for insolvency.

Firstly, the balance sheet test.

The balance sheet test is that a company will be insolvent if liabilities exceed assets- in other words the liabilities of the company would not be met if all the assets of the company were liquidated and used to meet those liabilities. This test is difficult to apply when there is not an obvious market for assets of the debtor, and/or a value cannot easily be ascribed to those assets.

Finally, the cash flow test.

This is the preferred test and is, in effective, enshrined in section 95A of the Corporations Act above.

The cash flow test holds that the extent to which assets exceed liability is irrelevant. The basis is that the company is technically insolvent if it cannot meet its day to day commitments, and creditors should not be forced to wait while the debtor realises some of its assets to pay them, particularly if those assets cannot be easily liquidated. The view taken by the court is that (Southern Cross Interiors Pty Ltd v DCT(2001) 39 ACR 305):

“in considering the company’s financial position as a whole, the Court must have regard to commercial realities. Commercial realities will be relevant in considering what resources are available to the company to meet its liabilities as they fall due, whether resources other than cash are realisable by sale or borrowing upon security, and when such realisations are achievable.”

What Indicates Insolvency

ASIC v Plymin (No. 1)(2003) 46 ACSR 126 gives some considerations that may indicate insolvency in the context of director liability for insolvent trading:

1. Continuing losses.

2. Liquidity ratios under 1.

3. Overdue taxes.

4. Poor relationship with a bank resulting in inability to borrow further.

5. No access to alternative finance.

6. No ability to raise more capital.

7. Suppliers only providing goods ‘cash on delivery’.

8. Creditors unpaid outside trading terms.

9. Issuing post-dated cheques.

10. Dishonoured cheques.

11. Special arrangements for selected creditors.

12. Judgments, solicitors letters and similar issued against the company.

13. Payments to creditors of rounded amounts rather than payments of specific invoices.

14. Inability to produce timely and accurate financial statements.

Test for Insolvency

A company is insolvent under section 95A of the Corporations Act 2001 (the ‘Corporations Act’) if it is unable to pay its debts as and when they fall due.

This is a question of fact to be considered on a case by case basis.

There are two tests for insolvency.

Firstly, the balance sheet test.

The balance sheet test is that a company will be insolvent if liabilities exceed assets- in other words the liabilities of the company would not be met if all the assets of the company were liquidated and used to meet those liabilities. This test is difficult to apply when there is not an obvious market for assets of the debtor, and/or a value cannot easily be ascribed to those assets.

Finally, the cash flow test.

This is the preferred test and is, in effective, enshrined in section 95A of the Corporations Act above.

The cash flow test holds that the extent to which assets exceed liability is irrelevant. The basis is that the company is technically insolvent if it cannot meet its day to day commitments, and creditors should not be forced to wait while the debtor realises some of its assets to pay them, particularly if those assets cannot be easily liquidated. The view taken by the court is that (Southern Cross Interiors Pty Ltd v DCT(2001) 39 ACR 305):

“in considering the company’s financial position as a whole, the Court must have regard to commercial realities. Commercial realities will be relevant in considering what resources are available to the company to meet its liabilities as they fall due, whether resources other than cash are realisable by sale or borrowing upon security, and when such realisations are achievable.”

Insolvent Trading

Insolvent trading occurs when a company incurs a debt when it is unable to pay its debts as and when they fall due pursuant with section 588G of the Corporations Act.

The following is summarised from the ASIC regulatory guide 217 (RG217). Resolv Lawyers strongly recommends that directors, irrespective of whether they are concerned as to the solvency of their company, review this document as it details their duties quite succinctly.

It is availablehere.

The Claim

Section 588G of the Corporations Act places a duty on directors of an insolvent company to prevent the company incurring debts where a director has grounds for suspecting that it is insolvent, or does actually suspect the company is insolvent.

An Insolvent Trading claim has the following elements:

1. The person is a director at the time when the company incurs that debt.

2. The company was insolvent at the time or became insolvent by incurring that debt, or by incurring at that time debts including that debt.

3. At that time there were reasonable grounds for suspecting the company was insolvent or would become insolvent.

By failing to prevent the debt from being incurred, a director contravenes section 588G(2) of the Corporations Act where, at the time the director was aware that there are such grounds for suspecting, or a reasonable person in a like position in the company, would have been aware that the company was insolvent.

The Evidence Required to Raise the Insolvent Trading Claim Against a Director

Before a director becomes liable it must be established that there were reasonable grounds to suspect that the company was insolvent or would become insolvent, to successfully invoke section 588G of the Corporations Act. The test requires that suspicion be based on reasonable grounds, thus making the test not only subjective, but also objective.

What Indicates Insolvency

ASIC v Plymin (No. 1)(2003) 46 ACSR 126 gives some considerations that may indicate insolvency in the context of director liability for insolvent trading:

1. Continuing losses.

2. Liquidity ratios under 1.

3. Overdue taxes.

4. Poor relationship with a bank resulting in inability to borrow further.

5. No access to alternative finance.

6. No ability to raise more capital.

7. Suppliers only providing goods ‘cash on delivery’.

8. Creditors unpaid outside trading terms.

9. Issuing post-dated cheques.

10. Dishonoured cheques.

11. Special arrangements for selected creditors.

12. Judgments, solicitors letters and similar issued against the company.

13. Payments to creditors of rounded amounts rather than payments of specific invoices.

14. Inability to produce timely and accurate financial statements.

The Penalties and/or Compensation for Insolvent Trading

The court has the power to disqualify a person from managing a corporation (ie, being a director) or imposing a fine up to $200,000.

However, a court may not order the disqualification if it is satisfied that, despite the contravention, the person is fit and proper to manage a corporation nor order a pecuniary penalty where it considers a contravention not to be a serious one.

The most common outcome of an insolvent trading claim is an award for damages against the director to creditors who suffered because the director ‘traded’ with them whilst insolvent.

For example, if the company was insolvent and a director incurred debts totalling $500,000 during the period it was insolvent, then the liquidator can sue the director for $500,000. The funds will go towards ordinary unsecured creditors and the costs of the liquidation pursuant with section 556 of the Corporations Act.

Defences

A director can avail themselves of a number of statutory defences contained in section 588H of the Corporations Act and will not be liable if:

1. There were reasonable grounds to expect the company was solvent;

2. There were reasonable grounds to rely on the information provided by another (for example, an accountant);

3. At the time debts were incurred the director can establish illness or other good reason; or

4. The director took all reasonable steps to prevent incurring the debt.

Alternatively, relief from liability may be granted in circumstances where the director has acted honestly or ought fairly to be excused from the contravention.

Absolutely not. Although, if you are seeking advice from someone, I'd recommend a lawyer or account over a 'pre-insolvency expert' any day!

You can simply go to the AFSA website and download the forms to declare bankruptcy. AFSA are the regulators of Bankruptcy in Australia. Then, you simply send them off to be processed and you become bankrupt.

You should note you can seek to appoint a private trustee to administer your bankrupt estate. This will usually require an upfront fee. Some people prefer knowing the person administering their bankruptcy and take this option notwithstanding the costs (It is often around $5,000). If you take this option, you will need to lodge a signed consent from the trustee with you AFSA documents. If you don't, the the offical trustee is appointed to administer your estate automatically.

Hi there,

In Australia, when a company becomes insolvent, it is generally placed into liquidation (as opposed to bankruptcy, which applies to individuals). Upon the completion of the liquidation, which can take years as there is no statutory timeframe, the company is deregistered with ASIC. It cannot start fresh after liquidation. With that said, an alternative to liquidation is to appoint voluntary administrators. The function of this form of insolvency appointment is to enable the directors (or anyone for that matter) to present a deed of company arrangement (DOCA). This is effectively a formal arrangement with creditors to pay them a percentage of their debts in exchange for the return of the company.

Hi there,

Yes, you can with the permission of your trustee. Technically, a trustee is entitled to retain your passport upon their appointment.

You will need to put the trustee on notice of your intention to travel, notifying them on when, where, why, and how much it costs (estimated) and who is paying. You will also need to provide your contact details for duration of the trip. Most private trustee's have a form you can complete to satisfy this. The Offical trust also has a process, with an application fee attached (see the AFSA website). A trustee can object to you travelling, but rarely do. Reasons for objection include previous non-compliance with a bankrupts obligations or outstanding income contributions.

Hi there,

Presently, a bankruptcy lasts for 3 years from the date the statement of affairs is submitted. There is currently legislation not yet in force which will reduce this to 1yr, though maintaining other obligations for the full 3yr period. Whether this will apply retrospectively is yet to be seen.

To answer your second question, if you inherit money or win the lotto, it is technically property that vests in the trustee (and therefore, available to your creditors) if this occurs during the period of your bankruptcy. If it pays your debts in full, including the trustee's fees/costs, then your bankruptcy can end through this process.

Alternatively, to end a bankruptcy early (generally speaking) you can propose a composition to creditors (often called a s73 Composition). The affect of this would be to annul the bankruptcy (as though it never occurred). You might propose to creditor to pay them 20 cents in the dollar to annul your bankruptcy, if a majority in number and value agree, then your annulment is put into effect (provided you pay). Often making a s73 Composition will cost further amounts to pay for the trustee's fees in dealing with the proposal.

Hi there,

You can continue to trade whilst a bankrupt (please note we are not taking about companies and a liquidation here). The purpose of bankruptcy is to provide a fresh start not to prevent you from earning money. Your bankruptcy only relates to debts accrued prior to the date you were declared a bankrupt. There are a few technicalities you need to comply with though. Obviously, you will need to disclose your income to the Trustee in Bankruptcy (this goes for all bankrupts though). If you are carrying on in business using a business name, you will need to disclose the fact that you are a bankrupt. This is usually done by simply mentioning it in brackets after you name for example, John Smith (A Bankrupt) trading as Smith & Co Plumbing (ABN 123 etc). If you are just issuing invoices in your own name (e.g. John Smith (ABN 123 etc), then this is not required. You should also, as a matter of convenience rather than law, contact the ATO to let them know you are continuing to trade just in case the ATO cancels your ABN upon notice of your insolvency.

Hi there,

Bankruptcy, in Australia, is the legal position of individuals who have declared that they cannot pay their debts as and when they fall due. Technically, Bankrupts are insolvent because of this. They become subject to certain obligations for the period of the bankruptcy, being 3 years.

Liquidation is the equivalent for companies, with the variation that at the end of the liquidation (not set time frame), the company is deregistered.

Insolvency, is a term used for the financial position of a personal or company. They are insolvent when they cannot pay debts as an when they fall due for payment. Generally speaking, this is both a subjective (case by case basis) and objective (legal/accounting definitions) test.

Hi there,

You can simply complete a number of forms supplied, for free, from the Australian Financial Security Authority (AFSA) who regulate bankruptcy.

They are available here.

You may wish to consider appointing a private trustee. These professionals often work for accounting firms and are licenced to take bankruptcy appointments. You should note that they will likely charge an upfront fee for the period of your bankruptcy (3yrs). If this is the case, then they will assist your with the AFSA forms and lodgement.

Alternatively, you can simply complete the AFSA forms and send them, with the requisiteidentification (listed on the forms), to AFSA directly. If this occurs, the Official Trustee will become your trustee in bankruptcy. There is no upfront cost with this options, however, the official trustee will charge for interim things like considering whether to let you travel overseas. You pay per request in this regard.

Hi there,

There are a few potential issues here.

Firstly, is the business of the new company the same as the business previously being run by your husband? If so, creditors of your husband's bankrupt estate may have a claim in income. It may be the case that the transfer of the business to the new structure was a transfer to defeat creditors per the Bankruptcy Act. Such transfers can be made void by a trustee in bankruptcy.

Secondly, a trustee may take issue if your husband is the sole income earner for the new entity, as opposed to the main income earner for similar reasons as set out above.

Thirdly, your husband, as a bankrupt, is prohibited under the Corporations Act from managing a company. Whilst he may not technically be a director of the company registered with ASIC, he could still be deemed to be managing a corporation if he undertakes day to day management of the company's business. He may be deemed to be a shadow director or defacto director.

Finally, It may be the case that you are already aware of this, but note there are income thresholds in bankruptcy (subject to dependants). Your husband will be required to pay a portion of his income over the threshold amount applicable to the trustee in bankruptcy.