28Jul

Proposed Reduced Default Bankruptcy Period – Sledgehammer Syndrome?

Posted by: Alice Ruhe | Date: July 28, 2016 | 

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As many of you are aware, the Federal Government, via its National Innovation and Science Agenda has proposed “Reducing the default bankruptcy period” to one year (instead of the existing default period of three years).  However, on review of the proposals suggested, it appears that the amended “bankruptcy period” may not be as significant a change as the title suggests.  I wonder whether the same effect could be achieved by less severe amendments to the legislation, which may perhaps not be as misleading than the “reduced period” adjustments suggest.

The proposals paper (which can be found here) also deals with proposals around Safe Harbour Provisions and Ipso Facto Clauses, however for the purposes of this piece I am only referring to the section on Reducing the bankruptcy period.

Reasons for Proposed Reduction in Bankruptcy Period

In the paper, it is suggested that the existing default period of three years for bankruptcy administrations may discourage innovation and business start-ups and that this may be as a result of:

  • overseas travel restrictions;
  • the restrictions on incurring further debts; and
  • the prohibition on being a company director.

In relation to the above, I note the following:

Overseas Travel

 Section 272(1) of the Bankruptcy Act 1966 (“Act”) prescribes that it is an offence for a person to leave (or do an act preparatory to leaving) Australia with the intent to defeat creditors or without consent of their Trustee.  This applies not only to the bankruptcy period, but also “within six months before the presentation of the petition” if there exists the intent to defeat or delay the payment of creditors.

Accordingly, the restrictions relate not only to the bankruptcy period, but to a period prior to bankruptcy as well.

Section 77(1)(ii) of the Act notes that it is the obligation of the bankrupt to, unless excused by the trustee or prevented by illness or some other cause, to give to the trustee the bankrupt’s passport, if any.

It has been my experience, as a Trustee in Bankruptcy, that it is uncomplicated for bankrupts to apply for permission to travel and that in the main, provided certain conditions are met, the application to travel is generally granted.  There are many cases where bankrupts are required to travel overseas for work purposes and, provided information is provided and conditions met, it can be desirable to the bankrupt estate for the trustee to allow travel as it may lead to increased income contributions payable by the bankrupt by virtue of the work he/she is able to do.

To that end, it is a little difficult to see how a reduced bankruptcy period to alleviate overseas travel restrictions for business purposes is a major issue, especially considering the proposal allows for the income contribution regime to continue for at least three years, notwithstanding the proposed reduction in default bankruptcy period.

Restrictions on Incurring Further Debt

The restrictions on bankrupts incurring debt are set out in Section 269 of the Act.  In summary, a bankrupt is not permitted to incur debt over a certain amount (currently $5,485) unless they disclose to the lending party that they are an undischarged bankrupt.  Section 269 also precludes a bankrupt from carrying on a business under an assumed name, in the name of another person or either alone or in a partnership under a firm name without disclosing to every person with whom they deal their true name and the fact that they are an undischarged bankrupt.

This appears to be a section that protects creditors from unwittingly providing debt to undischarged bankrupts without the full ability to consider their risk, which seems quite reasonable.

It is proposed that by reducing the default bankruptcy period to one year, after this time (and unless an Objection to Discharge is filed) the debtor will be able to incur credit without regard to this section.  Notwithstanding the proposed reduction in the default bankruptcy period, the debtor’s bankruptcy will still remain on their credit report for a significant period following discharge and as such debtors may still have practical issues with obtaining credit.

If the Government wants to promote debtors’ ability to incur credit, perhaps it would be more appropriate to detail that the debt restrictions imposed by Section 269 only relate to the first year of bankruptcy, instead of having the entire default bankruptcy period reduced.

Prohibition on Acting as a Company Director

The restriction of an undischarged bankrupt acting as a company director is prescribed not by the Bankruptcy Act, but rather Section 206 of the Corporations Act 2001(Corporations Act) which states that a person is disqualified from managing corporations if the person is an undischarged bankrupt under the law of Australia, its external territories or another country.

Again, perhaps instead of attempting to reduce the default bankruptcy period, an amendment could be made to this section of the Corporations Act whereby the restriction only applies to the first year of a bankruptcy period (unless an Objection to Discharge is filed).   It is interesting that this section does not only relate to Australian bankruptcies but also those under other jurisdictions.  Whilst an amendment to the Bankruptcy Act would result in debtors who have been made bankrupt in Australia being able to again become directors of Australian Corporations within the reduced period, it doesn’t appear as though there would be any effect on persons bankrupt in other Countries.

What Will Not Change

It is important to note that, at least on my reading, other than the above three issues, there will be very little change to the current bankruptcy regime, notwithstanding the proposed introduction of the reduced default bankruptcy period.

Income Contributions

It is proposed that the income contribution regime period would exist separately to the default bankruptcy period.  That means that although it is proposed that the default bankruptcy period is reduced to one year, bankrupts/debtors will still be required to pay contributions to their estate for a three-year period.

Currently, if a bankrupt does not provide the requisite information to enable the calculation of their income assessments or refuses to pay their income assessments, the Trustee can lodge an Objection to Discharge which has the effect of extending the bankruptcy period up to eight years.  If the bankrupt is already discharged when he/she becomes non-compliant, it is going to be more difficult to encourage them to comply with their obligations in this regard.

Objections to Discharge

Currently, Section 149 of the Act provides that a bankrupt is automatically discharged at the end of three years from the date on which they file their Statement of Affairs.  Section 149A notes that if an Objection to Discharge is lodged during the period of bankruptcy, the term of bankruptcy can be extended to either five or eight years (depending on the ground).  It is important to note that, where appropriate, an Objection to Discharge can be withdrawn or cancelled before the extended period has expired which has the effect of either:

  • Bringing the automatic discharge date back to three years (if that period had not yet expired); or
  • Immediately discharging the bankrupt (if the three-year period has already expired).

The suggested amendments are proposing to keep the Objection to Discharge regime, however it is noted in the paper that it might be more difficult for a Trustee to gather sufficient evidence to lodge an Objection throughout the reduced default bankruptcy period.

A good example of how this would be difficult is in relation to the Income Contribution regime.  At present, pursuant to Section 139U of the Act, a bankrupt is required as soon as practicable (and in any event not later than 21 days after the end of a contribution assessment period) to give to their trustee information and documentation regarding their income for that period.

Section 149D(1)(e) notes that non-compliance with Section 139U is a ground upon which an Objection to Discharge may be lodged.  An Objection lodged pursuant to this ground would lead to an extension of the bankruptcy period to eight years.

In the event that the reduced default period is enacted, a debtor who has become bankrupt on their own petition (which requires the filing of their Statement of Affairs at the time of lodgement), or one who files their Statement of Affairs within the prescribed period of 14 days after being notified of their bankruptcy in the event of a creditors petition, would be discharged before the obligation imposed by Section 139U would have come into force.  Therefore, it would be seemingly impossible for a Trustee to object on this ground under the proposed regime.  Practically speaking, in my experience in any event, this ground is one of the more regularly used grounds upon which Objections to Discharge are based.

Ongoing Obligations for Bankrupts

It is proposed that, although discharged, the bankrupt would potentially still have ongoing obligations to:

  • Assist their Trustee to realise and distribute property; and
  • Pay any outstanding income contributions.

Given that these requirements already exist for discharged bankrupts there does not appear to be any real change here.  The issue with ongoing obligations in relation to a reduced default period come with how to enforce same once a bankrupt has been discharged.  Although the Offence Referral Regime through the Australian Financial Security Authority is active, it appears, in many instances at least, to be more difficult to obtain co-operation from a bankrupt or debtor through this measure than it has historically been to obtain compliance following the lodgement of an Objection.

Objections to Discharge are a mechanism that is available to the Trustee to encourage compliance by the bankrupt, and this is detailed in Section 149B(2) which states that a Trustee must file a notice of objection to discharge if the trustee believes:

  1. That doing so will help make the bankrupt discharge a duty that the bankrupt has not discharged; and
  2. That there is no other way for the trustee to induce the bankrupt to discharge any duties that the bankrupt has not discharged.

Given the investigations required, and the time frames that exist within the Act it would be quite difficult for the Objection to Discharge Regime to have the same effect as it currently has.

In light of the above, given that the Government’s desire is to make changes with respect to the bankruptcy regime in relation to overseas travel, restrictions on credit and prohibition on undischarged bankrupts becoming company directors, whilst attempting to keep all other obligations and duties as they stand, it would appear to me that proposing a reduced bankruptcy period would be akin to using a sledgehammer to crack a nut.

Should you have any queries, require anything further or wish to discuss a potential engagement, please contact me either on 03 9600 2100 or by email to aruhe@smbvic.com.au

This article is intended to provide general information only in summary format on relevant issues.  It does not constitute legal or financial advice and should not be relied on as such.