2013/14 GUIDE TO PERSONAL INSOLVENCY INDICATORS OF INSOLVENCY PLAIN TALK. STRAIGHT ANSWERS. FAST RESULTS. WORRELLS ARE A TEAM OF FULL TIME SPECIALISTS. OLVENCY MANAGEMENT, RESTRUCTURE OR INSOLVENCY S ADMINISTRATION CAN BE A PERIOD OF GREAT STRESS. N EXPERIENCED AND SPECIALIST TEAM CAN EASE THE PROCESS, A ENSURING A FAIR OUTCOME FOR ALL PARTIES CONCERNED. EDITORS Chris Cook, Partner Worrells Brisbane Kate Lee, Marketing Coordinator DISCLAIMER The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission within this brochure. Liability limited by a scheme approved under Professional Standards Legislation. 1 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS INDICATORS OF INSOLVENCY PERSONAL INSOLVENCY 1 BANKRUPTCY18 DIVISIBLE PROPERTY IN BANKRUPTCY 22 BANKRUPTCY AND THE FAMILY HOME 28 GETTING OUT OF BANKRUPTCY 32 INCOME CONTRIBUTIONS IN BANKRUPTCY 34 VOID TRANSACTIONS IN BANKRUPTCY 37 PREFERENCES IN BANKRUPTCY 41 PART X PERSONAL INSOLVENCY AGREEMENTS 44 SECTION 73 PROPOSALS 46 DISCHARGE & ANNULMENT 48 RELATED TOPICS 2 5 PHASES OF FAILURE 58 PROOFS OF DEBT AND SECURED CREDITORS 63 MEETINGS OF CREDITORS 65 DIVIDENDS68 CGT AND INSOLVENCY 73 GST AND INSOLVENCY 77 OBJECTIONS TO DISCHARGE 85 VOIDING SUPERANNUATION CONTRIBUTIONS 87 WORRELLS ARTICLES WHAT’S IN A NAME? IT’S MY MONEY, ISN’T IT? ARE SUPERANNUATION MONIES WITHIN THE TAXMAN’S REACH? 100 101 3 102 WORRELLS.NET.AU 2 WORRELLS PARTNERS IT’S OUR PEOPLE THAT DELIVER “‘PLAIN TALK, STRAIGHT ANSWERS AND FAST RESULTS.” At Worrells we’re specialists Solvency and Forensic Accounting is all we do. • 19 Partners, • 18 Registered & Official Liquidators, • 13 Registered Trustees, • 3 Certified Fraud examiners, • 5 east coast major metro locations, Quick decisive action by a highly skilled team acting in a caring, respectful and fair manner does make all the difference. Established over 40 years ago, Worrells draws upon over 200 years of partner experience. …w e can have experienced staff at any location, quickly. WORRELLS QLD IVOR WORRELL BRISBANE CA (Fellow) Liquidator Registered Trustee Justice of the Peace 07 3225 4310 [email protected] RAJ KHATRI BRISBANE CA (Fellow) Liquidator Registered Trustee Commissioner of Declarations 07 3225 4320 [email protected] 3 Ivor is a leading Queensland insolvency practitioner. In a career spanning 40 years he has developed extensive experience in corporate and personal insolvency, receivership and litigation support. Ivor is often called upon as an expert witness and has experience as receiver of property. Raj’s area of expertise is corporate and personal insolvency and has nearly three decades of experience in the field. He has extensive experience in viability analysis and administration of corporate continued trade, resulting in more going concern sales. WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS Using proprietary technology, our team have successfully completed over 26,000 assignments. Specialist accounting services, delivered by dedicated full time specialists, on time, on budget every time. MORGAN LANE BRISBANE CA CPA (Fellow) Liquidator Registered Trustee 07 3225 4330 [email protected] MICHAEL GRIFFIN BRISBANE CA Liquidator Registered Trustee Commissioner of Declarations 07 3225 4360 [email protected] MICHAEL PELDAN BRISBANE CA (Fellow) Liquidator Registered Trustee Certified Fraud Examiner Commissioner of Declarations Justice of the Peace 07 3225 4370 [email protected] CHRIS COOK BRISBANE CA CPA Liquidator Commissioner of Declarations 07 3225 4386 [email protected] Morgan Lane joined the firm in 1992 and became a full partner in 1996. He is a member of the Institute of Chartered Accountants in Australia, a member of Insolvency Practitioners Association of Australia and a fellow of CPA Australia (specialist in insolvency & reconstruction). Michael is a member of the Institute of Chartered Accountants in Australia, an associate of the Insolvency Practitioners Association of Australia, and a member of the Association of Certified Fraud Examiners. He oversees a team in Brisbane and works closely in consultation with the Ipswich and Toowoomba offices. Michael has been in public practice since 1991. He is a fellow of Institute of Chartered Accountants in Australia and a member of the Association of Certified Fraud Examiners. Michael oversees a personal and corporate insolvency team in the Brisbane office. Chris has in excess of a decade of experience in both the corporate and personal insolvency fields. He has significant involvement in numerous personal insolvency appointments at Worrells including bankruptcies and personal insolvency arrangements. Chris also has experience as a receiver of partnership property by court order and by private agreement. WORRELLS.NET.AU 4 WORRELLS QLD ADAM WARD IPSWICH/TOOWOOMBA CPA Liquidator Registered Trustee Commissioner for Declarations 07 3280 6201 – Ipswich 07 4637 6501 – Toowoomba [email protected] JASON BETTLES GOLD COAST CA Liquidator Registered Trustee Justice of the Peace 07 5553 3405 [email protected] PAUL NOGUEIRA SUNSHINE COAST CA CPA Liquidator Registered Trustee Commissioner of Declarations Adam spent 10 years in the Worrells Brisbane office and subsequently spearheaded the Ipswich and Toowoomba offices. His experience is in managing distressed businesses and is adept in the manufacturing, building and construction, mining, hospitality and retail sectors. He specialises in conducting independent financial capacity assessments. Jason is the managing partner of Worrells Gold Coast and is a Chartered Accountant and a member of the Insolvency Practitioners Association of Australia. With extensive experience in investigating and analysing corporate and personal insolvency matters, he presents appropriate informal and formal solutions to clients. Paul joined Worrells in 1999 and became a partner in 2006. He is experienced in all forms of corporate and personal insolvency administrations across numerous industry sectors. He specialises in the SME sector in business turnaround management and insolvency solutions. 07 5459 1002 [email protected] JOHN CUNNINGHAM SUNSHINE COAST CPA Liquidator Registered Trustee 07 5459 1001 [email protected] 5 John has over 23 years experience in insolvency, starting out with the then Official Receivers Office in Melbourne in 1989. John joined Worrells as part of the Ramsay Clout merger in 2012. He has developed a particular expertise in the areas of building, retail and hospitality. WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS NSW/ACT NICHOLAS MALANOS SYDNEY CPA Liquidator Registered Trustee Certified Fraud Examiner Member IPA Graduate Diploma in Administration Nick is a senior partner in Worrells Sydney and has over 28 years experience in all aspects of corporate and personal insolvency. His vast knowledge in the areas of voluntary administration and deeds of company arrangement, has allowed numerous companies to successfully continue over the years. 02 9249 1200 [email protected] CHRISTOPHER DARIN SYDNEY CA Liquidator Justice of the Peace 02 9249 1200 [email protected] AARON LUCAN SYDNEY CA 02 9249 1200 [email protected] STEPHEN HUNDY CANBERRA CA Liquidator Registered Trustee Member of IPA 02 6287 6000 [email protected] Chris became partner of Worrells Sydney in 2008, after having been in practice on his own since 1996. His solid understanding of corporate insolvency and advocacy appointments allows him to explore all financial avenues available and to assist companies to effectively deal with all stakeholders. Aaron joined Worrells Sydney in January 2006 and became a partner of the firm in July 2013. Aaron has over 10 years experience in all forms of corporate and personal insolvency administrations. In addition to servicing clients and referrers in Sydney and surrounding areas, Aaron manages Worrells’ Central West NSW practice. Stephen joined Worrells in 2011 as a partner of Worrells Canberra. He has worked exclusively in the insolvency industry since 1995 and provides practical, commercial advice on business issues. He also provides fraud and financial investigation reports, financial viability reviews and assists in shareholder/partnership disputes. WORRELLS.NET.AU 6 WORRELLS VIC PAUL BURNESS MELBOURNE CPA Liquidator Registered Trustee Certified Fraud Examiner Member IPA 03 9613 5510 [email protected] MATTHEW JESS MELBOURNE CPA Liquidator Registered Trustee Member IPA 03 9613 5513 [email protected] CON KOKKINOS MELBOURNE CPA Liquidator 03 9613 5502 [email protected] IVAN GLAVAS MELBOURNE CA Liquidator Member IPA 03 9613 5517 [email protected] 7 Paul is the managing partner of Worrells Melbourne, having established the practice in 2002. He has extensive knowledge in all forms of corporate and personal insolvency and reconstruction. His experience extends to liquidations of both large and small entities, across many industries including, manufacturing, construction, agricultural, retail, and professional practices. Matthew joined Worrells in 2004 and became partner in 2006. He is an official liquidator and certified practising accountant, who has considerable experience in the insolvency, commercial accounting and corporate finance fields. He also has experience includes due diligence investigations, sale of business transactions, corporate reconstructions and financial turnarounds. Con Kokkinos became a partner in Worrells Melbourne in 2009. With over 15 years in public practice, Con is experienced in all forms of corporate and personal insolvency administrations and specialises in small to medium business turnaround management and solvency solutions. Ivan Glavas became a partner of Worrells Melbourne in January 2013. Ivan is a Chartered Accountant with over 18 years experience in dealing with corporate and personal insolvency related matters across numerous industries. Ivan’s experience also includes litigation support, fraud investigation and business reconstruction advice. WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS NATHAN DEPPELER BALLARAT/BENDIGO CA Liquidator 03 5338 4694 [email protected] In July 2013, Nathan Deppeler was appointed a Partner of Worrells Solvency & Forensic Accountants and operates from offices in Ballarat and Bendigo servicing the Western and North/ Western Victoria region. Nathan has a broad range of experience in all forms of Corporate and Personal Insolvency having specialised in insolvency since graduating and became a registered and official liquidator in May 2012. FORENSIC PARTNERS Our Worrells Forensic arm naturally complements our core insolvency capability. A Forensic Accountant is often retained to analyse, interpret, ANITA OWENS SUNSHINE COAST CPA (Fellow) Liquidator Commissioner of Declarations Forensic Accountant 07 5459 1003 [email protected] SHARLENE ANDERSON MELBOURNE CPA Chartered Accountant Certified Fraud Examiner Forensic Accountant 03 9613 5500 [email protected] summarize and present complex financial and business related issues in a manner which is both understandable and properly supported. Each of our Forensic Partners brings a wealth of practical experience and knowledge to the application of a full range of forensic services. Anita joined Worrells in 2012 as part of the Ramsay Clout merger. Anita commenced her insolvency career in Noosa in 1989. She completed a Bachelor of Business at the University of Southern Queensland in 1995 and a Graduate Certificate of Forensic Studies (Accounting) at Monash University in 2005. Anita has experience in forensic accounting and all aspects of insolvency. Sharlene is a forensic accountant and registered company auditor. Sharlene joined Worrells in 2013 as a Partner specialising in Forensic Accounting. Sharlene has considerable experience across various areas of forensic accounting including financial statement fraud, embezzlement, litigation support and valuations. WORRELLS.NET.AU 8 WORRELLS IS HERE TO ASSIST YOU INSOLVENCY SETS UP LARGE PRACTICAL AND EMOTIONAL HURDLES TO THOSE FACING THE CHALLENGE FOR THE FIRST TIME. THIS IS TRUE OF THE PROFESSIONAL ADVISOR OFFERING GUIDANCE TO HIS OR HER CLIENT, IT’S TRUE FOR THE DIRECTOR FACING THE LOSS OF A COMPANY AND IT’S TRUE FOR EACH INDIVIDUAL CONTEMPLATING THE POSSIBLE LOSS OF MUCH THAT THEY HAVE WORKED LONG AND HARD FOR. The insolvent client’s level of dependence on his or her professional advisor is often both misunderstood and understated. It is the client’s accountant or solicitor, or perhaps both working together, who commonly has the onerous task of discovering and demonstrating the true financial position. Frequently they must persuade the client that specialist insolvency help is necessary, and it is they who must find and nominate a suitable insolvency practitioner who they trust and can work with. It is true that many insolvencies are invested with strong emotions; creditors may be angry to learn of their loss, employees may suffer the stress of being thrown out of work without adequate notice, customers face the frustration of lost deposits and incomplete jobs, bankrupts and directors face crises of confidence in themselves, and marriage breakdowns are sometimes the bedfellows of financial difficulties. The company director and the insolvent debtor, for their part, are faced with both emotional and practical problems. It is never easy to admit that a business venture has been unsuccessful, and added to this the need to understand new and confusing insolvency terms, processes and options is no easy feat. For our professional advisor colleagues, Worrells provides an independent, objective and knowledgeable resource that can be called upon to help the professional advisor help their clients. Fear that labels such as “bankruptcy”, “insolvency” and “liquidation” will conjure up in the minds of the minority suggestions of wrong doing, or financial profligacy, have to be overcome. The partners of Worrells know from regular contact with those facing impossible financial difficulties that an exaggerated sense of the perceived stigma can lead to delay in seeking the protection and assistance of insolvency legislation, and can add greatly and needlessly to the client’s distress. Worrells have now been providing high quality insolvency and related service for over 40 years. We pride ourselves on offering reliable and practical solutions to those burdened with debt. Our large investment in state of the art proprietary software streamlines all functions leading to savings which are passed on by way of competitive pricing. Personal bankruptcy and each of the forms of company insolvency are not about punishing business owners for making mistakes. And they are not about penalising people for taking risks, because risk is at the very essence of our market economy. They are about removing impossible financial obligations in a way which is transparent and fair to all. They are about financial recovery and financial equity. 9 That is why we exist. For those facing insolvency we provide a service which is transparent, equitable and respectful. Worrells 2013/14 Guide to Personal Insolvency is an up to date, one volume, easy to understand explanation of the law and practice of personal insolvency in Australia and it draws together in a form convenient to all, the combined experience of Worrells 19 partners. We offer this Guide to help assist and inform in any role that you may find yourself in, when contemplating insolvency administration. Our advice is always made available on a complimentary and confidential basis with respect and openness as the cornerstone of all that we do. WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS “‘FOCUSED LOCALLY, RESOURCED NATIONALLY – WORRELLS IS THE FIRM OF CHOICE FOR ALL INSOLVENCY APPOINTMENTS.“‘ NOOSA MAROOCHYDORE BRISBANE IPSWICH TOOWOOMBA GOLD COAST BALLINA CENTRAL COAST SYDNEY CANBERRA BENDIGO BALLARAT MELBOURNE WORRELLS.NET.AU 10 LATEST PERSONAL INSOLVENCY STATISTICS INSOLVENCY FIGURES AS RELEASED BY AUSTRALIAN FINANCIAL SECURITY AUTHORITY (AFSA). NEW ADMINISTRATIONS UNDER THE BANKRUPTCY ACT 1966 STATISTICS (PROVISIONAL) JULY 2012 – JUNE 2013 RELEASE NO: 131 DATE ISSUED: 9 JULY 2013 BANKRUPTCIES (PARTS IV AND XI) DEBT AGREEMENTS (PART IX) TOTAL PERSONAL INSOLVENCY ACTIVITY PERSONAL INSOLVENCY AGREEMENTS (PART X) 11/12 12/13 % CHANGE 11/12 12/13 % CHANGE 11/12 12/13 % CHANGE 11/12 12/13 % CHANGE NSW 7,627 6,799 -10.86% 3,089 3,235 4.73% 118 88 -25.42% 10,834 10,122 -6.57% ACT 172 206 19.77% 146 173 18.49% 6 1 -83.33% 324 380 17.28% VIC 4,249 4,180 -1.62% 1,755 1,846 5.19% 98 79 -19.39% 6,102 6,105 0.05% QLD 6,251 6,052 -3.18% 2,485 2,706 8.89% 80 54 -32.50% 8,816 8,812 -0.05% SA 1,523 1,493 -1.97% 360 484 34.44% 16 17 6.25% 1,899 1,994 5.00% NT 80 102 27.50% 56 102 82.14% 2 3 50.00% 138 207 50.00% WA 1,567 1,469 -6.25% 773 772 -0.13% 63 47 -25.40% 2,403 2,288 -4.79% TAS 694 575 -17.15% 291 334 14.78% 5 5 0.00% 990 914 -7.68% 22,163 20,876 -5.81% 8,955 9,652 7.78% 388 294 -24.23% 31,506 30,822 -2.17% TOTAL Note 1:All the above figures refer to personal administrations under the Bankruptcy Act only (and not corporate insolvency). Note 2:Provisional statistics are correct at the date of compilation. Verified annual figures for all types of personal insolvency administrations are available from our Annual Report. These figures, together with some historical data, may be found on the Australian Financial Security Authority homepage at www.afsa.gov.au For further information on these statistics, please read the Guide to provisional personal insolvency statistics. 11 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS BANKRUPTCY 2010/11 2011/12 2012/13 9000 NSW 8127 7,627 6799 8000 ACT 186 172 206 7000 VIC 4521 4,249 4180 QLD 6145 6,251 6052 SA 1603 1,523 1493 NT 106 80 102 WA 1701 1,567 1469 1000 TAS 713 694 575 0 BANKRUPTCY 2010/11 BANKRUPTCY 2011/12 BANKRUPTCY 2012/13 6000 5000 4000 3000 2000 NSW ACT VIC QLD SA PERSONAL INSOLVENCY AGREEMENTS (PART X) 2010/11 2011/12 2012/13 126 118 88 120 ACT 1 6 1 100 VIC 106 98 79 QLD 74 80 54 SA 7 16 17 NT 0 2 3 WA 55 63 47 20 TAS 6 5 5 0 WA TAS P ERSONAL INSOLVENCY AGREEMENTS (PART X) 2010/11 140 NSW NT P ERSONAL INSOLVENCY AGREEMENTS (PART X) 2011/12 P ERSONAL INSOLVENCY AGREEMENTS (PART X) 2012/13 80 60 40 NSW ACT VIC QLD SA NT WA TAS TOTAL INSOLVENCY ACTIVITY NSW 2010/11 2011/12 2012/13 12000 T OTAL INSOLVENCY ACTIVITY 2010/11 10914 10,834 10122 10000 T OTAL INSOLVENCY ACTIVITY 2011/12 8000 T OTAL INSOLVENCY ACTIVITY 2012/13 ACT 285 324 380 VIC 6360 6,102 6105 QLD 8463 8,816 8812 6000 SA 1948 1,899 1994 4000 NT 160 138 207 WA 2381 2,403 2288 TAS 1020 990 914 2000 0 NSW ACT VIC QLD SA NT WA TAS WORRELLS.NET.AU 12 PERSONAL INSOLVENCY THRESHOLDS The following information outlines both the monetary thresholds and time limits that apply in relevant insolvency practices. INCOME CONTRIBUTION THRESHOLD Income Thresholds before Income Contributions become Payable (after tax & s139N deductions): PRIORITY EMPLOYEE ENTITLEMENT THRESHOLD Priority Claim for Employee: A maximum priority dividend (including superannuation) of $4,200.00 The balance paid as a non-priority debt. BANKRUPTCY NOTICES $50,332.10 - No Dependents $59,391.88 - 1 Dependent $63,921.77 - 2 Dependents $66,438.37 - 3 Dependents $67,445.01 - 4 Dependents $68,451.66 - 5+ Dependents Maximum Dependant Income - $3,277.00 Minimum amount for issuance of a Bankruptcy Notice: $5,000.00 PART IX THRESHOLDS For current figures please visit our website via the QR code below. To be eligible to proposal a Part IX Agreement: Time period for compliance: The debtor has 21 days to pay the debt or be deemed insolvent. These figures are correct as at 31 July 2013. $75,498.15 - Income (after tax) $100,664.20 - Available Assets (after secured debts) $100,664.20 - Unsecured Creditors ASSET ALLOWANCES $3,600.00 - Tools of Trade allowance $7,350.00 - Motor Vehicle Allowance $5,176.00 - Obtaining Credit without Disclosure GENERAL DIVIDENDS Notice to be given to creditors to lodge Proofs of Debt: at least 21 days before Declaration Minimum time after Declaration before payment of Dividend: at least 21 days after the end of the lodgement period. Minimum Dividend: Liquidators are not required to pay a dividend under $25.00 to any creditor. 13 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS STAY CONNECTED WITH WORRELLS ENSURE YOU’RE COVERED ENCY TO INSOLV 2013 GUIDE SUMMER UIDE TO 2013/14 GINSOLVENCY TE A R O P R CO DOWNLOAD A COPY OF OUR 2013/14 GUIDE TO CORPORATE INSOLVENCY. STAY CONNECTED WITH WORRELLS JOIN US ON FACEBOOK OR STAY CONNECTED WITH OUR E-UPDATE FOR ALL THE LATEST INFORMATION AND UPCOMING EVENTS. VISIT WORRELLS.NET.AU FOR MORE DETAILS. WORRELLS.NET.AU 14 INDICATORS OF INSOLVENCY 15 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS INDICATORS OF INSOLVENCY 1 PERSONAL INSOLVENCY BANKRUPTCY DIVISIBLE PROPERTY IN BANKRUPTCY BANKRUPTCY AND THE FAMILY HOME GETTING OUT OF BANKRUPTCY INCOME CONTRIBUTIONS IN BANKRUPTCY VOID TRANSACTIONS IN BANKRUPTCY PREFERENCES IN BANKRUPTCY PART X PERSONAL INSOLVENCY AGREEMENTS SECTION 73 PROPOSALS DISCHARGE & ANNULMENT 18 22 28 32 34 37 41 44 46 48 WORRELLS.NET.AU 16 PERSONAL INSOLVENCY INDICATORS OF INSOLVENCY PERSONAL INSOLVENCY NUMBERS APPEAR TO BE ON THE DECLINE, HOWEVER THE NEED FOR AN UNDERSTANDING IN THIS AREA HAS NOT LESSENED. 17 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS INDICATORS OFBANKRUPTCY INSOLVENCY Bankruptcy is a legal process where a trustee is appointed to administer an insolvent person’s affairs in order to provide a fair distribution of that person’s assets to their creditors. Bankruptcy is a legitimate and just way for a debtor to solve their debt problems, and is one way for creditors to take action against someone for unpaid debts. WHY CHOOSE BANKRUPTCY? The Bankruptcy Act has been developed for the protection of both debtors (the bankrupt) and creditors. The debtor is protected from being pursued by his or her creditors and, with limited exceptions, is released from his or her debts at the end of the bankruptcy. It provides a debtor with a fresh start. Bankruptcy protects the interests of creditors by having an independent, qualified professional control and investigate the affairs of the bankrupt and oversee the collection and distribution of the bankrupt’s assets. HOW DOES A PERSON BECOME BANKRUPT? A person may become bankrupt in one of two ways. They may bankrupt themselves by filing a debtor’s petition and a Statement of Affairs with the Official Receiver. This process is referred to as lodging a ‘debtor’s petition’. A person is made bankrupt when the Official Receiver processes the debtor’s petition and issues an estate number. A person may also be made bankrupt by the Federal Court on the application of one of their creditors through a ‘creditor’s petition’. In most instances, a creditor must have obtained a judgment on their debt and have served a ‘bankruptcy notice’ on the debtor. If the debtor does not pay the debt before the expiry of the bankruptcy notice, the creditor may file a creditor’s petition with the Federal Court seeking a sequestration order bankrupting the debtor. CAN A DEBTOR BE MADE BANKRUPT IF THEIR ASSETS EXCEED THEIR DEBTS? Yes. A person is legally insolvent if they are unable to pay their debts as and when they fall due. If a debtor owns sufficient assets to cover their debts but is unable to liquidate them (sell them or borrow against them) to actually pay the debts, they may be bankrupted. Technically a debtor is legally insolvent if they do not satisfy a bankruptcy notice, regardless of whether they can pay the debt or not. But, the Official Receiver has the discretion not to accept a debtor’s petition if they believe that the debtor is solvent and could satisfy their debts. PERSONAL INSOLVENCY WHAT IS BANKRUPTCY? 1 WHAT IS A STATEMENT OF AFFAIRS? A Statement of Affairs is a document that must be completed by all bankrupts that sets out their personal and financial information. This is an important document for two reasons: 1.It is the financial disclosure of a bankrupt’s assets and debts and this information is used by the trustee in conducting the estate. 2.The date of lodgement of the Statement of Affairs will determine when the bankruptcy ends (the date of discharge). HOW DOES BANKRUPTCY AFFECT SOMEONE? A person is an ‘undischarged bankrupt’ from the date of bankruptcy until they are either discharged or annulled. During this period they: > Can’t act as a company officer; > Can’t trade under a registered business name without advising people that they are bankrupt (they can trade under their own name); > Must make all of their divisible assets available to the trustee; > Can’t incur credit over an indexed amount without advising the lender that they are bankrupt; > Must surrender their passport(s) and must seek permission for overseas travel; and >Must make all books and records and financial statements available, including those of associated entities such as companies and trusts. WORRELLS.NET.AU 18 INDICATORS OF INSOLVENCY BANKRUPTCY CONTINUED CAN A BANKRUPT CONTINUE TO EARN INCOME? CAN THE TRUSTEE RECOVER PROPERTY THAT WAS SOLD BEFORE BANKRUPTCY? Yes, a bankrupt may continue to earn income and is encouraged to do so. Maybe. The trustee will look at any sales or transfers of property that occurred within the five years before the bankruptcy. If these transactions appear improper, undervalued, or to have had the purpose of attempting to defeat creditors, that property or its value may be recovered from the recipient. If income earned during the bankruptcy exceeds certain indexed threshold limits, the bankrupt will have to pay a contribution from that income to the estate. Income under these provisions includes personal income, certain benefits provided by third parties and income from superannuation or trusts. Income is then reduced by the income tax payable on the income, legitimate business expenses (where appropriate) and certain child support payments. The liability to pay this contribution to the estate survives beyond the discharge of the bankruptcy and can be enforced by the trustee. The trustee may garnishee the bankrupt’s wages or use the supervised account regime to collect contributions. The bankrupt may be re-bankrupted by the trustee for non-payment of contributions. HOW DOES BANKRUPTCY AFFECT PROPERTY? All of a bankrupt’s divisible property is controlled by their trustee. This includes all property the bankrupt owned when he or she was bankrupted and all property received after the date of bankruptcy but before discharge. This latter property is called after-acquired property. Some property is not divisible. Divisible property (i.e. property that can be divided amongst creditors) does not include the following: > Necessary clothing and household items; > Tools of trade to an indexed amount; > A motor vehicle to an indexed amount; >Life assurance or endowment policies (subject to some limitations); > Certain damages and compensation payments; > Sentimental property (as defined in the Bankruptcy Act); The trustee may also recover monies from creditors who may have received payment of their debts in the six months before the bankruptcy. Such payments are commonly referred to as preferential or preference payments. HOW DOES BANKRUPTCY AFFECT JOINTLY OWNED REAL PROPERTY? The trustee of a bankrupt estate may have his or her name placed on the title deed in place of the bankrupt. This is called entering transmission. The trustee will usually invite the co-owner of the property to either buy the bankrupt’s interest or join in selling the property. If the co-owner will not cooperate with the trustee or they cannot agree on a satisfactory arrangement, the trustee can force the sale of joint property. CAN BANKRUPTCY AFFECT A FAMILY TRUST? A trustee may recover any property that a bankrupt has given or sold to a trust at less than its true value. The trustee will also receive any monies that may be owed to the bankrupt by a trust in the form of a loan or outstanding entitlements, and receive any distribution due to the bankrupt. Usually the trustee of a discretionary trust will not make distributions to someone while they are bankrupt. Trustees of unit trusts will not have that discretion. WHAT IS THE AFFECT ON CREDITORS? When a person is made bankrupt, their creditors exchange the right to enforce their claims for a right to prove in the bankrupt estate for a dividend. All creditors with claims at the date of bankruptcy can prove for a dividend. > Superannuation payments (subject to certain limitations). 19 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS INDICATORS OFBANKRUPTCY INSOLVENCY CONTINUED The bankruptcy does not affect the rights of secured creditors in relation to their security. They can enforce their charges or securities and prove for any deficiency in the estate. There are special provisions on how secured creditors may prove for shortfalls before the secured assets have been sold. WHAT ARE NON-PROVABLE DEBTS? Certain debts cannot be claimed in the bankruptcy. Non-provable debts cannot be proved for and will not be released at the end of the bankruptcy. These debts include: > Some portion of a HECS debt; > Court imposed fines; and > The remainder of maintenance agreements under the Family Law Act; Full details of provable debts are set out in section 82 of the Bankruptcy Act. CAN THE TRUSTEE PAY DIVIDENDS? Yes. Ultimately the role of the trustee is the distribution of the bankrupt’s assets to the creditors. Obviously this can only occur if the bankrupt has assets. Section 109 of the Bankruptcy Act sets out the order of priorities under which dividends must be paid. Some payments and certain debts need to be paid before dividends are paid to unsecured creditors. WHEN DOES BANKRUPTCY END? The bankruptcy period automatically ends (the bankrupt is discharged) three years after the date on which the bankrupt files his or her Statement of Affairs. But the conduct of the estate may continue for some time thereafter. A BANKRUPT IS NORMALLY DISCHARGED THREE YEARS AFTER A COMPLETED STATEMENT OF AFFAIRS IS LODGED WITH ITSA. The period of bankruptcy may be extended for up to five years. This is done when the trustee lodges an objection to discharge. This may happen if the bankrupt fails to cooperate with the trustee, leaves Australia without permission, manages a company without the leave of the court, or engages in misleading conduct in relation to an amount over an indexed sum. WHAT IS AN ANNULMENT OF THE BANKRUPTCY? An annulment is the cancellation of the bankruptcy and reinstatement of the affairs of the debtor as if no bankruptcy had occurred. An annulment can be obtained: PERSONAL INSOLVENCY ARE THE RIGHTS OF SECURED CREDITORS AFFECTED? 1 > By an order of the court on the basis that the bankruptcy should not have occurred; > By the bankrupt’s debts and the costs of the administration being paid in full; or > By a proposal under section 73 being accepted by creditors. WHO LOOKS AFTER A BANKRUPT ESTATE? When a person is made bankrupt, a trustee in bankruptcy is appointed to administer the bankrupt’s estate. The trustee is an appropriately qualified and registered specialist accountant who is either an officer of the Federal Court (a registered trustee) or a public servant (the Official Receiver). A debtor presenting a debtor’s petition or a creditor filing a creditor’s petition can obtain consent from a registered trustee. If no consent is obtained, the Official Receiver will be the trustee. WHAT ARE THE TRUSTEE’S POWERS? The trustee has the power to sell any divisible asset of the bankrupt, investigate the affairs of the bankrupt and examine the bankrupt and others under oath, conduct and sell any business of the bankrupt, admit debts and distribute dividends. The trustee is empowered to exercise all of the rights and powers that the bankrupt would have had if they had not become bankrupt, plus has recovery powers that the bankrupt would not have. WORRELLS.NET.AU 20 BANKRUPTCY CONTINUED In summary, the trustee will: > Find and protect the assets of the bankrupt; > Realise those assets; > Conduct investigations into the financial affairs of the bankrupt and any suspicious transactions; > Make appropriate recoveries; > Report to creditors; > Report offences to ITSA; and > Distribute surplus funds to creditors. CAN A TRUSTEE BE CHANGED? Yes. The Bankruptcy Act allows the trustee to be changed. There are two ways of doing this. 1.The creditors may change the trustee by voting for a change. This may occur at any time and for any reason. 2.The court may replace a trustee if it is convinced that it is proper to do so. This usually only happens if the trustee has done something wrong, and the court forms the opinion that a new trustee needs to take over the estate. A replacement trustee is also appointed if the current trustee retires or dies. GOVERNMENT CHARGES (ARC AND IRC) Bankrupt estates attract a government charge. This charge is payable at the rate of 4.7% of gross monies received into the estate, less payments to secured creditors, trade on costs and other minor amounts. Monies held by trustees for an estate must also be held in interest bearing accounts with any interest earned being payable to the government. 21 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS DIVISIBLE PROPERTY IN BANKRUPTCY In simple terms, trustees of bankrupt estates sell the assets of the bankrupt and distribute the proceeds to the bankrupt’s creditors. This guide looks at which of the bankrupt’s assets can be sold by the trustee. It does not look at assets that may be recovered from other parties through other provisions related to void transactions under the Bankruptcy Act. Not all of the bankrupt’s assets are available to the trustee. The Bankruptcy Act defines “divisible” assets (those assets that are available to the trustee) from “non-divisible” assets (those assets that are not available to the trustee). Understandably, whether an asset is divisible or not is sometimes a contested issue. It is also important to determine what is property of the bankrupt and what is not. Items held on trust or loaned to the bankrupt, or simply do not belong to the bankrupt, do not vest in the trustee. They are not the bankrupt’s assets and therefore cannot be divisible. (b)after-acquired property of the bankrupt vests, as soon as it is acquired by, or devolves on, the bankrupt, in the Official Trustee or, if a registered trustee is the trustee of the estate of the bankrupt, in that registered trustee. After-acquired property includes any property acquired by or devolved on the bankrupt on or after the date of the bankruptcy and before discharge, being property that is also divisible amongst their creditors. Non-divisible afteracquired property does not vest in the trustee. The two important factors are: PERSONAL INSOLVENCY INTRODUCTION 1 1.The property must have been acquired during the term of the bankruptcy; and 2.It would otherwise be classified as divisible property. If existing owned property is not deemed as ‘divisible’ at the commencement of bankruptcy, it would not be divisible if acquired during bankruptcy. VESTING OF THE “PROPERTY OF THE BANKRUPT” ‘After-acquired property’, in relation to a bankrupt, means property that is acquired by, or devolves on, the bankrupt on or after the date of the bankruptcy and is property that is divisible amongst the creditors of the bankrupt. Any property of the bankrupt automatically vests in the trustee on the commencement of the bankruptcy. The trustee isn’t required to take any action for this ‘vesting’ to occur. Where applicable, legal title to some property may have to be registered in the trustee’s name, but equitable title will automatically vest (e.g. real property). Assets acquired by the bankrupt after the bankruptcy commenced and before discharge may also vest in the trustee when they are acquired. These are called ‘after-acquired property’. One of the purposes of section 58 is to provide immediate protection to assets from individual creditors who are attempting to recover their debts by enforcements against assets. As the bankrupt is no longer the legal owner of the property, nothing can be given away to creditors or taken from the estate under enforcement actions. Once the asset has vested in the trustee, only the trustee may deal with that asset. This allows for an orderly and fair distribution of the bankrupt’s assets between the proper creditors. BANKRUPTCY ACT 1966 - SECTION 58 BANKRUPTCY ACT 1966 - SECTION 58 Vesting of property upon bankruptcy-general rule Vesting of property upon bankruptcy-general rule (1)Subject to this Act, where a debtor becomes a bankrupt: (3) Except as provided by this Act, after a debtor has become a bankrupt, it is not competent for a creditor: (a)the property of the bankrupt, not being after-acquired property, vests forthwith in the Official Trustee or, if, at the time when the debtor becomes a bankrupt, a registered trustee becomes the trustee of the estate of the bankrupt by virtue of section 156A, in that registered trustee; and (a) to enforce any remedy against the person or the property of the bankrupt in respect of a provable debt; or (b) except with the leave of the Court and on such terms as the Court thinks fit, to commence any legal proceeding in respect of a provable debt or take any fresh step in such a proceeding. WORRELLS.NET.AU 22 DIVISIBLE PROPERTY IN BANKRUPTCY CONTINUED There are two exceptions that allow creditors to commence or continue action against property: documents until title to the property has been transferred into his or her name. 1.Secured creditors have a right to exercise their security over any asset covered by their security. Section 58 only provides protection to divisible assets that are not covered by a valid security. BANKRUPTCY ACT 1966 - SECTION 58 2.Creditors can exercise their rights against non-divisible property for debts under maintenance orders or agreements. Non-divisible property does not fall under the control or protection of the trustee as it does not vest in the trustee. BANKRUPTCY ACT 1966 - SECTION 58 Vesting of property upon bankruptcy-general rule (5) Nothing in this section affects the right of a secured creditor to realise or otherwise deal with his or her security. (5A)Nothing in this section shall be taken to prevent a creditor from enforcing any remedy against a bankrupt, or against any property of a bankrupt that is not vested in the trustee of the bankrupt, in respect of any liability of the bankrupt under: Vesting of property upon bankruptcy-general rule (2) Where a law of the Commonwealth or of a State or Territory of the Commonwealth requires the transmission of property to be registered and enables the trustee of the estate of a bankrupt to be registered as the owner of any such property that is part of the property of the bankrupt, that property, notwithstanding that it vests in equity in the trustee by virtue of this section, does not so vest at law until the requirements of that law have been complied with. NEW TRUSTEES Occasionally the trustee of the estate will change during the bankruptcy. The remaining property in the estate automatically vests in the new or replacement trustee as soon as the change of trustee takes effect. The same transmission rules apply so the new trustee may have to enter transmission of relevant property into their name. BANKRUPTCY ACT 1966 - SECTION 132 (a) a maintenance agreement; or Vesting and transfer of property (b) a maintenance order; whether entered into or made, as the case may be, before or after the commencement of this subsection. (1) Subject to this section, and to section 158, where a trustee is appointed by the creditors, the property of the bankrupt passes to and vests in the trustee so appointed on the day on which the appointment takes effect. All divisible property that is not secured to a particular creditor is solely under the control of the trustee. But what is and is not divisible property is not always straight forward. REGISTRATION OF INTERESTS In some cases registration is necessary to record the vesting of the property in the trustee. This is usually the case with real property where the title of the property will have to be transferred to the trustee in order for the trustee to be able to legally deal with the property. This process is known as ‘entering transmission’ - transmitting legal ownership. The equitable interest will vest in the trustee, however the legal interest will need to be transferred. In the case of real property, usually the trustee will initially protect the estate’s interest by lodging a caveat on the title - vesting of the property provides a ‘caveatable’ interest. But the trustee will not be able to sign transfer (2) Subject to this section, the property of the bankrupt passes from trustee to trustee and vests in the trustee for the time being during his or her continuance in office or, if the Official Trustee becomes the trustee, in the Official Trustee, without any conveyance, assignment or transfer. (3) Where a law of the Commonwealth or of a State or Territory of the Commonwealth requires the transmission of property to be registered, and enables the trustee to be registered as the owner of any such property that is part of the property of the bankrupt, that property, notwithstanding that it vests in equity in the trustee by virtue of this section, does not vest in the trustee at law until the requirements of that law have been complied with. 23 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS DIVISIBLE PROPERTY IN BANKRUPTCY CONTINUED WHAT IS DIVISIBLE PROPERTY? Section 58 does not define what is or is not divisible property, only that all divisible property vests in the trustee. It is easiest to think of divisible property as all of the property of the bankrupt and work backwards from there. The Bankruptcy Act has a wide definition of divisible property and broadly covers the following: > All property owned at the time of bankruptcy or acquired during the bankruptcy; > A ny rights or powers over property that existed at the date of bankruptcy or during the bankruptcy; > A ny rights to exercise powers over property; > A ny property that vests because an associated entity received the property as a result of personal services supplied by the bankrupt (section 139D); > Monies recovered from an associated entity due to an increase in the net worth of the entity as a result of personal services supplied by the bankrupt (section 139E). The relevant section lists what classes of assets are divisible amongst creditors: BANKRUPTCY ACT 1966 - SECTION 116 Property divisible among creditors (1) Subject to this Act: (a) all property that belonged to, or was vested in, a bankrupt at the commencement of the bankruptcy, or has been acquired or is acquired by him or her, or has devolved or devolves on him or her, after the commencement of the bankruptcy and before his or her discharge; and (b) the capacity to exercise, and to take proceedings for exercising all such powers in, over or in respect of property as might have been exercised by the bankrupt for his or her own benefit at the commencement of the bankruptcy or at any time after the commencement of the bankruptcy and before his or her discharge; and (c) property that is vested in the trustee of the bankrupt’s estate by or under an order under section 139D or 139DA; and (d) money that is paid to the trustee of the bankrupt’s estate under an order under section 139E or 139EA; and (e) money that is paid to the trustee of the bankrupt’s estate under an order under paragraph 128K(1)(b); and (f) money that is paid to the trustee of the bankrupt’s estate under a section 139ZQ notice that relates to a transaction that is void against the trustee under section 128C; and PERSONAL INSOLVENCY Changes in trustees are not common, but the procedural mechanism is in place to allow a smooth transfer of the rights to property to any new trustee. 1 (g) money that is paid to the trustee of the bankrupt’s estate under an order under section 139ZU; is property divisible amongst the creditors of the bankrupt. The trustee will start with all of the property and will eliminate non-divisible assets from this list. NON-DIVISIBLE PROPERTY What is not divisible property is a more difficult area. The Bankruptcy Act provides that a number of types of property will not be divisible. Section 116(2) of the Bankruptcy Act summarises what is not classified as property divisible amongst creditors. The list of what assets are non-divisible is extensive, but in most cases these assets will appear fairly rarely. Some of them are very common and are non-divisible as they are necessary for the bankrupt’s subsistence. These can be grouped roughly into the following 14 different areas: 1.Property held by the bankrupt in trust for another person, that is, property that is not owned by the bankrupt. 2.The bankrupt’s household property prescribed by Regulation 6.03 or identified by a resolution passed by the creditors before the trustee realises the property. 3.Personal property that has sentimental value for the bankrupt and is identified by a special resolution passed by the creditors before the trustee realises the property. WORRELLS.NET.AU 24 DIVISIBLE PROPERTY IN BANKRUPTCY CONTINUED or approved by the States and Northern Territory Grants (Rural Adjustment) Act 1979; the States and Northern Territory Grants (Rural Adjustment) Act 1985; the States and Northern Territory Grants (Rural Adjustment) Act 1988; amounts paid to the bankrupt for re-establishment support under the Rural Adjustment Scheme within the meaning of the Rural Adjustment Act 1992; amounts paid to the bankrupt as a re-establishment grant under the farm help re-establishment grant scheme within the meaning of the Farm Household Support Act 1992; amounts paid to the bankrupt as a dairy exit payment within the meaning of the Farm Household Support Act 1992. 4.The tools of trade that are for use by the bankrupt in earning income by personal exertion (subject to the value limit prescribed by the regulations). 5.A vehicle used by the bankrupt as a means of transport, (subject to the value limit prescribed by the regulations). 6.Policies of life assurance or endowment assurance in respect of the life of the bankrupt or the spouse of the bankrupt whether the proceeds are received on or after the date of the bankruptcy. 7.The interest of the bankrupt in a regulated superannuation fund or an approved deposit fund or an exempt public sector superannuation scheme or a payment to the bankrupt from such a fund received on or after the date of the bankruptcy and if the payment is not a pension within the meaning of the Superannuation Industry (Supervision) Act 1993 (certain conditions apply). 8.A payment to the bankrupt under a payment split under Part VIIIB of the Family Law Act 1975 where the eligible superannuation plan involved is a fund or scheme covered by the Act and the payment involved is not a pension within the meaning of the Superannuation Industry (Supervision) Act 1993. 9.The amount of money a bankrupt holds in a retirement savings account (RSA) or a payment to a bankrupt from an RSA received on or after the date of the bankruptcy, if the payment is not a pension or annuity within the meaning of the Retirement Savings Accounts Act 1997. 10.A payment to the bankrupt under a payment split under Part VIIIB of the Family Law Act 1975 where the eligible superannuation plan involved is an RSA; and the splittable payment involved is not a pension or annuity within the meaning of the Retirement Savings Accounts Act 1997. 11.Any right to recover damages or compensation for personal injury or wrong doing or in respect of the death of the spouse or member of family of the bankrupt. 12.Amounts paid under a scheme approved by the States Grants (Rural Reconstruction) Act 1971; the States Grants (Rural Adjustment) Act 1976 13.Property that was funded either wholly or substantially, with protected money (what is protected money is limited as a number of non-divisible assets lose their protection when converted into cash, particularly before bankruptcy). 14.Where, as at the time when the trustee realises particular property, the outlay in relation to the property is in part protected money, the trustee shall pay to the bankrupt so much of the proceeds of realising the property as can fairly be attributed to that protected money. EXEMPT ASSETS Some otherwise divisible property is subject to statutory value limits and property with values under those limits is exempt or non-divisible to that extent. These limits change from time to time and current amounts are listed on page 13 of this guide and on our website on the Thresholds page. These limits are designed to allow the bankrupt to maintain some standard of living (the household property limitations), and maintain some employment (the tools of trade and motor vehicle limitations). These limits and the legislation dealing with exempt values are set out in the following regulations: BANKRUPTCY REGULATIONS 1996 6.03 Household property BANKRUPTCY REGULATIONS 1996 - 6.0 Property divisible among creditors - prescribed amounts 25 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS DIVISIBLE PROPERTY IN BANKRUPTCY CONTINUED BANKRUPTCY ACT 1966 - SECTION 129AA What is sentimental property and whether it is exempt is regulated by the Bankruptcy Act. Sentimental property must be non-monetary, have real sentimental value to the bankrupt, and be an award for sporting, cultural, military or academic achievement. If it does not fall into these categories, it cannot be classified as sentimental and usually will be divisible. Time limit for realizing property SENTIMENTAL PROPERTY DOES NOT INCLUDE ITEMS SUCH AS ENGAGEMENT/WEDDING RINGS. (1) This section applies only to: (a) property (other than cash) that was disclosed in the bankrupt’s statement of affairs; and (b) after-acquired property (other than cash) that the bankrupt discloses in writing to the trustee within 14 days after the bankrupt becomes aware that the property devolved on, or was acquired by, the bankrupt. In this subsection, cash includes amounts standing to the credit of a bank account or similar account. An asset will never revest to the bankrupt if: Creditors must also resolve that this property is sentimental property by special resolution at a meeting of creditors or a virtual meeting. If the creditors do not approve it as sentimental property, it is divisible to the estate. 1.The asset was owned before the bankruptcy but was not disclosed in the bankrupt’s Statement of Affairs; or BANKRUPTCY REGULATIONS 1996 - 6.03A 3. It is cash. Personal property Otherwise property will revest six years after either the bankrupt is discharged or when the asset is disclosed to the trustee, whichever is later. (1) For subparagraph 116 (2) (ba) (ii) of the Act, sporting, cultural, military or academic awards made to the bankrupt in recognition of his or her performance are personal property to which subsection 116 (1) of the Act does not extend. (2) Subregulation (1) does not apply to a monetary award. TIME LIMITS FOR REALISATION Two provisions limit the time available to trustees to realise property. REVESTING OF PROPERTY The first is the revesting provision under section 129AA of the Bankruptcy Act. Assets will revest in the bankrupt where trustees do not realise divisible property within the statutory time period. All types of divisible assets are able to be revested, with the exception of cash. PERSONAL INSOLVENCY SENTIMENTAL PROPERTY 1 2.The acquisition of after-acquired property is not notified to the trustee within 14 days of the bankrupt’s knowledge of its acquisition; or BANKRUPTCY ACT 1966 - SECTION 129AA Time limit for realizing property (3) Initially, the revesting time for property is: (a) for property disclosed in the statement of affairs -the beginning of the day that is the sixth anniversary of the day on which the bankrupt is discharged from the bankruptcy; and (b) for after-acquired property that is disclosed before the bankrupt is discharged from the bankruptcy - the beginning of the day that is the sixth anniversary of the day on which the bankrupt is discharged; and (c) for after-acquired property that is disclosed after the bankrupt is discharged from the bankruptcy - the beginning of the day that is the sixth anniversary of the day on which the bankrupt disclosed the property to the trustee. WORRELLS.NET.AU 26 DIVISIBLE PROPERTY IN BANKRUPTCY CONTINUED When that six year time limit commences previously depended on when the estate commenced and in relation to transitional clauses. There were three possibilities for assets disclosed in the Statement of Affairs. The provisions were introduced in 2003 and the transitional clauses expired in 2009 (being six years after the introduction). That is, the earliest date that any property could have revested was 5 May 2009. This gave trustees six years after the introduction to the provision to sell any assets. Currently for estates that commenced after 5 May 2003 (which is the greater majority of current estates), the revesting date is six years after the date of discharge. Acquisition of after-acquired property must be notified to the trustee within 14 days of the bankrupt’s knowledge of the acquisition. If notification is not given within that period, the property will not be eligible to be revested. For property where proper notification is given, the revesting date will be six years after the date of discharge or date of notification, whichever is later. EXTENSION OF TIME The trustee is able to extend the revesting period for a further three years after the “current” revesting period ends or three years after some specified event. The Act does not limit the number of extensions that may be made. Therefore, in theory, the trustee can keep extending the period three years at a time indefinitely. BANKRUPTCY ACT 1966 - SECTION 129AA (5) There is no limit on the number of extension notices that the trustee may give (either generally or in relation to particular property). (6) The time specified in an extension notice must be either: (a) a specified time that is not more than 3 years after the current revesting time; or (b) a time that is reckoned by reference to a specified event (for example, the death of a life tenant), but is not more than 3 years after the happening of that event. 20 YEAR LIMIT The second time limit is imposed by section 127 and relates to divisible property not caught under the revesting provisions - property that was not properly disclosed to the trustee. This provision gives the trustee 20 years from the date of bankruptcy to make a claim to and realise any property. BANKRUPTCY ACT 1966 - SECTION 127 Limitation of time for making claims by trustee etc. (1) After the expiration of 20 years from the date on which a person became a bankrupt, a claim shall not be made by the trustee in the bankruptcy to any property of the bankrupt, and that property shall, subject to the rights, if any, of a person other than the trustee in respect of the property, be deemed to be vested in the bankrupt, or a person claiming through or under him or her, as the case may be. Time limit for realizing property (4) If the trustee, before the current revesting time, gives the bankrupt a written notice (an extension notice) stating that a later revesting time applies to particular property, then that later time becomes the revesting time for that property. 27 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS BANKRUPTCY AND THE FAMILY HOME How the Bankruptcy Act applies to a bankrupt’s family home is often misunderstood. The loss of the bankrupt’s family home is usually felt more intensely than the loss of any other asset. Understandably, many bankrupts know that the loss of the home will disrupt the family unit, not only effecting the bankrupt but also their children and partners/spouses who may be solvent. Because of these factors, trustees in bankruptcy must approach the realisation of a bankrupt’s interest in a family home with some tact and understanding, while protecting the rights and interests of creditors. THE PROSPECT OF LOSING THE FAMILY HOME IN BANKRUPTCY IS OFTEN THE MOST STRESSFUL PART OF BANKRUPTCY. IS THE FAMILY HOME PROTECTED? No. The family home is not a protected asset under the Bankruptcy Act. If there is equity in the property after paying out any proper mortgage and selling costs, the trustee is obliged to realise the property. to create a joint tenancy. This practice is long established having been mentioned in the 1862 case of Paten v Cribb. The trigger to this alienation of legal rights is the vesting of the property in the trustee and that occurs at the commencement of the bankruptcy. After the severing of the joint tenancy, those interests in the property are held as a ‘tenants in common’. This is important if a bankrupt dies after their bankruptcy. If the joint tenancy had not been severed, the bankrupt’s share of the property (and the equity attached to that share) would automatically vest in the co-owner upon the death of the bankrupt, and the value would be lost to the estate. HOW IS THE EQUITY IN A PROPERTY DETERMINED? The trustee will have the property valued. Secured debts are deducted from that value and the bankrupt’s share of the equity is calculated. WHAT IF THERE IS NO EQUITY IN THE PROPERTY? WHAT ABOUT JOINT OWNERSHIP? Sometimes there is no equity in a property when it vests in the trustee, meaning that the debts secured against the property are greater than the current value of the property. In some cases the mortgagees will exercise their rights and sell the property. The realisation process is relatively straightforward when the bankrupt is the only owner of the home, or all of the owners are bankrupt. However, often the bankrupt and his or her non-bankrupt spouse will own the family home together as ‘joint tenants’. But even if the family home is jointly owned by the bankrupt and a solvent (non bankrupt) co-owner, the trustee can still insist on the bankrupt’s share of the equity being realised. The options available to achieve this are discussed below. But sometimes the mortgagees will take no action and the bankrupt and possibly other parties will continue to service that loan. It is also a fair consideration to predict that the value of the property may increase. The property vests in the trustee at the time of bankruptcy and remains vested even where there is no equity and even if the trustee takes no immediate action to sell the property. The property will remain vested in the trustee even after the bankrupt has been discharged from bankruptcy. WHAT HAPPENS TO JOINT TENANCIES ON THE BANKRUPTCY OF ONE OR MORE OWNERS? A joint tenancy is automatically severed upon the bankruptcy of any one of the joint tenants - at least as far as it relates to the ownership interest of the bankrupt. This occurs due to the ‘involuntary alienation’ or severing of the fundamental legal rights of the parties necessary PERSONAL INSOLVENCY BANKRUPTCY AND THE FAMILY HOME 1 The trustee will generally review the equity position of the property periodically. They are able to realise any equity generated after the date of bankruptcy. This is the case even if that equity has been generated by the continued payment of the mortgage by the bankrupt or the other owner. Mortgage payments attributed to the bankrupt’s share are deemed to be rental payments for the use and occupation of the property during that time. WORRELLS.NET.AU 28 BANKRUPTCY AND THE FAMILY HOME CONTINUED HOW ARE PROPERTIES REALISED? Where the trustee is the only owner, they can put the property up for sale. Where there is a co-owner, the trustee will usually take the following steps: 1.Give the co-owner the opportunity to buy the estate’s interest in the property. 2.If that is not possible, see whether the co-owner will join with the trustee in cooperatively marketing the property on agreed terms. WHAT IF THE BANKRUPT CAN CONTINUE WITH MORTGAGE PAYMENTS? If the bankrupt has the capacity to continue making mortgage payments, the mortgagee will usually not insist upon possession of the property, preferring to allow the loan repayments to continue. The trustee should have no objection to this, provided that the bankrupt arranges for the equity in the property to be paid to the trustee of the bankrupt estate. 3.If an agreement on selling the property cannot be reached, the trustee can ask the court to appoint a ‘statutory trustee for sale’ over the co-owner’s interest to force a sale of the property. This type of arrangement benefits everyone. The bankrupt estate obtains the equity in the property, the mortgagee retains a performing loan and the bankrupt’s family avoids the sale of their home. The appointment of a statutory trustee compels the sale of the home, notwithstanding that the co-owner is solvent and has not contributed to the bankruptcy in any way. Although the court will often attempt to soften the effect of such an order by allowing the co-owner time to relocate, the ultimate result is that the property will be sold. However, the property can still be sold by the trustee at a later point, even if the mortgage payments are kept up to date. This means the estate will be able to benefit from the extra equity generated in the property because of these additional payments. WHAT IS ENTERING TRANSMISSION? The trustee will normally be required to provide vacant possession when selling a property therefore it will be necessary for the bankrupt to vacate the property before settlement. The trustee usually does not expect a bankrupt to vacate the premises immediately upon bankruptcy and will, in normal circumstances, allow for a few weeks for the alternative arrangements to be made. The sale process usually begins with the trustee ‘entering transmission’. This is the legal process to have the trustee’s name placed on the certificate of title in place of the bankrupt’s. This is necessary so that the trustee can execute a sale contract and transfer forms when selling the property. Usually the trustee will only enter transmission if satisfied that there is equity in the property. If there is doubt about the final outcome, the trustee may initially lodge a caveat over the title to protect the estate’s interests for the short term, giving them some time to determine what to do with the property. WHAT ABOUT MORTGAGEES? The vast majority of family homes are subject to a mortgage. The mortgage may be enforced during the bankruptcy, possible even when the mortgage payments are up to date as the bankruptcy itself may constitute a default in the terms the mortgage. Although mortgagees have the power to sell the bankrupt’s home, in most cases they will leave the task to the trustee. WHAT ABOUT GETTING VACANT POSSESSION? In some cases the trustee may allow the bankrupt to stay in residence during the selling period provided the bankrupt assists that process, contributes a fair rent and maintains the property, and when the trustee is satisfied that the bankrupt will continue to cooperate. HOW ARE THE PROCEEDS OF SALE DISTRIBUTED? If the property is wholly owned by the bankrupt, the estate will receive the entire surplus of the sale after any mortgagee and selling costs are paid. If the property is co-owned, the trustee will share the surplus with the non-bankrupt co-owner on the basis of the legal entitlement as shown on the title deed. 29 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS BANKRUPTCY AND THE FAMILY HOME CONTINUED 1 IS THERE A TIMEFRAME FOR THE SALE OF THE PROPERTY? WHEN DOES THE DOCTRINE OF EXONERATION APPLY? The six year rule only applies to property disclosed to the trustee. If the property is not disclosed in the bankrupt’s Statement of Affairs or as after-acquired property, the trustee will have 20 years to deal with the property. The property may be encumbered by a mortgage that secures a loan to the sole benefit of one owner, even though all owners have agreed to the mortgage. The doctrine says that the person who received the benefit of the loan should have the first obligation to repay the loan - and the co-owner should only be considered a surety (guarantor) and their share should only be used to meet any shortfall. A simple example of the doctrine would be a family home worth $400,000 owned by the bankrupt and a non-bankrupt spouse. Prior to bankruptcy they agreed with the bank taking a mortgage over their property to support an advance of $150,000 to the bankrupt’s business. On a sale of the property $250,000 would be available for distribution to the owners ($400,000 sale price less the mortgage of $150,000). Because each owner had an equal share in the legal title to the property it might be thought that they should each receive $125,000. However the doctrine of exoneration may require that the amount due under the mortgage should be deducted from the bankrupt’s equity so that the following equitable distribution would apply: Bankrupt’s share less $150,000 Spouse’s share = = = $200,000 $50,000 $200,000 The principle of the doctrine of exoneration is not applied without a full review by the trustee who must find compelling evidence that it should apply. Trustees will generally sell property in a timely fashion. Section 129AA of the Bankruptcy Act requires trustees to realise property within a period ending six years after the discharge of a bankrupt. This generally allows nine years to arrange such sales. If the trustee does not do so, the property could potentially revest in the discharged bankrupt. PERSONAL INSOLVENCY Although the title to a property may be held equally, occasions will arise where unequal contributions have been made towards the acquisition or development of the property. This may lead to one party holding the property for the other party in a constructive or resultant trust and will potentially alter the distribution. The sharing of equity may also be altered under the doctrine of exoneration if loans secured on the property were used by one party and not the other. WAR SERVICE HOMES A bankrupt or a debtor under Part X of the Bankruptcy Act cannot have a war service home taken from them, except in extraordinary circumstances. This arises from the provisions of the Defence Service Homes Act which state: DEFENCE SERVICE HOMES ACT 1918 - SECTION 45A Bankruptcy of purchaser or borrower (1) Except with the approval of the Secretary, the estate or interest of a purchaser or borrower in any land, land and dwelling-house or right of residence in a retirement village that is the subject of a contract of sale, or of a mortgage or other security securing a Corporation advance or a subsidised advance: (a) shall not be taken from the purchaser or borrower under the Bankruptcy Act 1966; and (b) shall not be sold in satisfaction of a judgment debt, otherwise than by the Bank or another mortgage in the exercise of powers under a contract of sale, or a mortgage or other security. (2) Where a husband and wife are joint purchasers or borrowers in relation to land, land and a dwellinghouse or a right or residence in a retirement village, the Secretary may give an approval under subsection (10) in relation to the estate or interest of both of them if either of them becomes bankrupt or incurs a judgment debt. WORRELLS.NET.AU 30 BANKRUPTCY AND THE FAMILY HOME CONTINUED Although the secretary of this department has discretion to allow a trustee to sell the bankrupt’s property, in reality this discretion is very seldom applied. In our experience the secretary will not exercise their discretion even when the bankrupt has incurred very substantial business debts. There can be no doubt that some bankrupts have taken business risks (which they would otherwise have avoided) in the knowledge that they would not lose their home. This is inequitable as far as creditors are concerned, but this is currently the law. SUMMARY 1.A bankrupt’s home can be sold even if the bankrupt only has a part interest in the property. 2.The trustee will normally offer the property for sale to any co-owner prior to having the property placed on the market. 3.The trustee will normally sell the interest in the property without undue delay. 4.The trustee must recover the value for the property but has a wide discretion regarding how to sell. 5.The trustee will normally allow the bankrupt a few weeks to arrange alternative accommodation. 6.The doctrine of exoneration or a constructive or resultant trust may adjust the distribution of the sale proceeds. 7. War Service homes are excluded from realisation. 31 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS GETTING OUT OF BANKRUPTCY A person’s bankruptcy usually ends with the bankrupt being discharged from bankruptcy. This signifies the end of the legal process against the bankrupt. The bankrupt or trustee need do nothing to obtain a discharge, it is purely an operation of the Bankruptcy Act three years after the Statement of Affairs is lodged. The bankrupt estate may continue after discharge while the trustee finalises the estate, and the discharged bankrupt may have some ongoing obligations, but they will no longer be ‘bankrupt’. WHEN IS A BANKRUPT DISCHARGED? A bankrupt is automatically discharged three years after their completed Statement of Affairs is filed with Insolvency and Trustee Service Australia (ITSA) - unless an ‘objection to the discharge’ has been filed by the trustee. CAN A BANKRUPT GET OUT OF BANKRUPTCY BEFORE DISCHARGE? Yes. The bankruptcy may be annulled. An annulment is a complete undoing of the bankruptcy, as if the bankruptcy never had happened. HOW IS A BANKRUPTCY ANNULLED? A bankruptcy will be annulled if: 1.The trustee obtains sufficient monies to pay all of the debts and costs of the estate; 2.A section 73 proposal is accepted by the bankrupt’s creditors; or PERSONAL INSOLVENCY HOW DOES A BANKRUPTCY NORMALLY END? 1 3.The bankrupt convinces the court that the bankruptcy should never have been commenced. WHAT ARE THE DEBTS AND COSTS OF THE ESTATE? If the bankruptcy was commenced via a debtor’s petition, the Statement of Affairs must have been filed at the same time and therefore the bankruptcy will end three years after acceptance of the debtor’s petition. The costs and debts are: If the bankruptcy was initiated by a sequestration order (an order of the court), the Statement of Affairs would not have been filed at that time. The bankrupt will have to complete a Statement of Affairs and lodge it with ITSA. As the bankruptcy ends three years after the filing of the statement, the longer the bankrupt takes to file it, the longer the bankruptcy will be protracted. If the Statement of Affairs is never filed, the bankruptcy will continue until the death of the bankrupt, however the conduct of the estate will continue until completed. > The expenses and remuneration of the trustee; and > All provable debts of the estate; > The Asset Realisation Charge (ARC) payable to ITSA under the Act; > A ny other charges or statutory costs of the estate. For a bankruptcy to be annulled by all debts and costs being paid, the trustee must have sufficient money to satisfy all the pre-bankruptcy debts, the costs of the bankruptcy and the statutory charges. This type of annulment generally happens when the sale of an asset provides enough money to pay these costs, or when a friend or relative provides these funds. AS THE BANKRUPT’S DISCHARGE DATE IS BASED ON THE FILING DATE OF THE STATEMENT OF AFFAIRS – MEANS ANY DELAY WILL IMPACT ON THE END DATE. WORRELLS.NET.AU 32 GETTING OUT OF BANKRUPTCY CONTINUED WHAT IS A SECTION 73 PROPOSAL? This is a formal proposal put to creditors under section 73 of the Bankruptcy Act. It provides a mechanism for bankrupts to put forward a proposal to their creditors as an alternative to the continuation of the bankruptcy. If the creditors accept the proposal, the bankruptcy is effectively exchanged for an obligation under the section 73 agreement. WHY WOULD THE COURT ANNUL A BANKRUPTCY? Usually the court will only annul a bankruptcy when it can be shown that the bankruptcy should never have been commenced. This may happen where the proper legal process was not followed in initially bankrupting the person, if there was no debt outstanding to that creditor at that time, or if the bankrupt is actually solvent. Bankrupts who successfully obtain an annulment through the court should be aware that the ex-trustee has the right to use the assets in their possession to pay outstanding remuneration and outlays, and if insufficient, may seek payment from the ex-bankrupt. 33 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS INCOME CONTRIBUTIONS IN BANKRUPTCY Yes. In most cases, a bankrupt will be able to earn an income during their bankruptcy. Subject to some provisions and exceptions, the bankrupt is encouraged to earn an income during this period as there is no logical reason why a bankrupt should not be entitled to earn an income and benefit from those earnings. The Bankruptcy Act states that they must also pay contributions to their estate from that income if the amount earned is over the relevant threshold. THERE IS NO REASON WHY A BANKRUPT CANNOT CONTINUE TO EARN AN INCOME. WHAT ARE INCOME CONTRIBUTIONS? A working bankrupt may be liable to make a contribution to their bankrupt estate from income earned during their bankruptcy. It is equitable that some of the rewards from the bankrupt’s efforts during the bankruptcy period be used to satisfy their past debts and this has been put into statute in the Bankruptcy Act. WHAT INCOME IS ASSESSED FOR CONTRIBUTIONS? The bankrupt’s income is assessed to determine whether contributions must be paid. The provisions of the Bankruptcy Act set out the definition of income to be assessed. Income has the same meaning as defined under the Taxation Acts, but also includes other amounts that have not been earned from physical exertion or investments, and amounts that may not even be taxable income. These other incomes include loans made to the bankrupt, items that fall under the Fringe Benefit Tax provisions, annuities, pensions and some social security or insurance payments. IS ALL MONEY EARNED INCOME? No. There are a number of amounts that are not income for contribution assessment purposes. These are set out under paragraph (b) of section 139L. (b)The following are not income in relation to a bankrupt (even if they come within the ordinary meaning of “income”): (i) An amount paid to the bankrupt: (A) From the Child Support Reserve established under the Child Support (Registration and Collection) Act 1988; or PERSONAL INSOLVENCY CAN A BANKRUPT WORK DURING THEIR BANKRUPTCY? 1 (B) From another source for the maintenance of children of whom the bankrupt has custody; or (iv) A payment to the bankrupt under: (A)A legal aid scheme or service established under a law of the Commonwealth or of a State or Territory of the Commonwealth; or (B)A legal aid scheme or service approved by the Attorney-General for the purposes of paragraph 2(4)(a) of the Federal Court of Australia Regulations; or (C) A ny other legal aid scheme or service established to provide assistance to people on low incomes; (v) A payment or amount that the regulations provide is not income of the bankrupt. ARE ANY AMOUNTS DEDUCTIBLE FROM AFTER-TAX INCOME? Yes. Deductions are available for payments to support a child, if they are paid pursuant to a maintenance agreement under the Family Law Act or under a maintenance order. Deductions are also available for certain business expenses. Section 139N of the Bankruptcy Act sets out these deductions in detail. WORRELLS.NET.AU 34 INCOME CONTRIBUTIONS IN BANKRUPTCY CONTINUED HOW DOES THE TRUSTEE OBTAIN INFORMATION ABOUT A BANKRUPT’S INCOME? It is a requirement under the Act that the bankrupt provide details of their income to their trustee. The trustee will usually send a form to be completed by the bankrupt on each anniversary of the date of bankruptcy. These forms need to be completed and returned with any documentation supporting the income earned and deductions claimed. WHAT IF THE BANKRUPT DOES NOT COMPLETE THE FORMS? It is an offence for the bankrupt not to cooperate with their trustee and complete the income assessment forms. If they don’t cooperate, the trustee may object to the bankrupt’s discharge from bankruptcy (extending their bankruptcy period) and estimate the bankrupt’s income and assess them accordingly. CAN THE TRUSTEE INVESTIGATE THE BANKRUPT’S INCOME INFORMATION? Yes. Whilst the trustee has the power to make an assessment on what they reasonably believe to be the income of the bankrupt, practically they will investigate the matter as fully as possible before making that assessment. If the information received from the bankrupt is inadequate or questionable, the trustee will seek further information. If appropriate, the trustee can conduct an examination and can request further information to be provided to clarify any matter. If the further information is not forthcoming, the trustee can make the assessment on what they reasonably believe the income is and it is then up to the bankrupt to disprove the assessment. HOW IS THE INCOME CONTRIBUTION CALCULATED? The calculation is made on assessed income, which is the surplus of income after tax the Medicare Levy and proper deductions. A contribution will be payable if that assessed income is more than the current statutory threshold. The amount of that threshold is based on the number of dependents that the bankrupt had during that assessment period - refer to page 13 of this guide and on our website on the Thresholds page. The trustee is entitled to receive one half of the balance over the threshold. That is, the ‘over threshold after tax income’ is divided equally between the bankrupt and trustee. The formula is: (Assessed Income - Actual Income Threshold Amount) / 2 HOW IS THE ASSESSMENT MADE? The trustee makes an assessment on the estimated income based on the information supplied by the bankrupt at the beginning of the assessment year. An assessment (called a determination) is made on these estimates and the bankrupt becomes liable to pay any contributions to the trustee from the date of the assessment. At the end of the assessment period, the bankrupt will supply the actual amount of the past year’s income, along with estimates for the next year. The past year’s assessment is adjusted if necessary, then a new assessment is made for the next year’s estimated income and the process starts again. HOW OFTEN ARE THE ASSESSMENTS MADE? Each assessment period runs from the date of the bankruptcy or its anniversary and ends on the day before the next anniversary. Assessment periods continue until the bankrupt is discharged, including when the bankruptcy is extended through an objection to discharge. 35 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS INCOME CONTRIBUTIONS IN BANKRUPTCY CONTINUED The money paid under these provisions will be paid into the general pool of funds that is available to creditors. WHAT OBLIGATIONS DOES THE BANKRUPT HAVE? The bankrupt must provide information about their income and deductions and provide access to all books and records required by the trustee. If the bankrupt neglects or refuses to provide either, the trustee can lodge an objection to the discharge of the bankrupt and ITSA may prosecute the bankrupt for an offence. HOW DOES THE BANKRUPT GET A NOTICE OF THE ASSESSMENT? Once a determination has been made, the trustee sends a notice to the bankrupt setting out the amount payable and particulars on how the determination was calculated. The trustee will usually include a schedule for the payment of the contributions over the remaining months of the assessment period. IS THIS A LEGAL OBLIGATION? Yes. Issuing a notice of determination creates a legal obligation to pay the contribution. The trustee has the power to nominate when the payments are to be made and the debt can be collected from the bankrupt as a debt due. These rights remain after the bankrupt has been discharged, meaning that the bankrupt can be re-bankrupted for non-payment of any contribution. CAN THE ASSESSMENT BE REVIEWED? Yes. The Act provides a mechanism for any assessment to be reviewed by the Inspector-General, but the request must be made within 60 days of the assessment. Upon receipt the Inspector-General will then have 60 days to decide whether the assessment should be reviewed and make a ruling. The decisions handed down by the Inspector-General may be reviewed by the Administrative Appeals Tribunal. WHAT CAN THE TRUSTEE DO TO ENFORCE COLLECTION? PERSONAL INSOLVENCY WHAT HAPPENS TO THE MONEY PAID UNDER AN ASSESSMENT? 1 If an assessment is made and the bankrupt refuses or neglects to pay, the trustee can: > Issue notices to employers or other people that owe the bankrupt money to garnishee those monies. > Issue an objection to the discharge of the bankrupt, extending the bankruptcy period; > Prohibit the bankrupt from travelling overseas; > Re-bankrupt a discharged bankrupt, if the refusal to pay occurs after the bankrupt has been discharged; or > Issue a notice under the supervised account regime provisions of the Act. WHAT IS THE SUPERVISED ACCOUNT REGIME? Trustees may determine that the supervised account regime be activated. This requires the bankrupt to open a supervised account into which they must deposit all of their income. The trustee then supervises all withdrawals from that account to ensure that income contributions are made. The threat of these provisions generally encourages a bankrupt to make contributions as required. WORRELLS.NET.AU 36 VOID TRANSACTIONS IN BANKRUPTCY WHAT ARE THE PROVISIONS DESIGNED TO DO? Trustees of bankrupt estates investigate any prebankruptcy transactions when they suspect the transaction improperly transferred assets away from the bankrupt that would have come under the trustee’s control and therefore benefited creditors. The Bankruptcy Act will sometimes allow these transactions to be voided and require the other party to return an asset or make a payment to the trustee. Some debtors when realising that they are about to be made bankrupt, may want to protect some of their assets from their creditors. Some debtors hide, move or transfer these assets to a third party to hold during the period of bankruptcy. These provisions are meant to deter debtors from moving assets out of their own hands at the expense of their creditors, and to permit rightful recovery. WHAT TYPE OF TRANSACTIONS MAY BE VOIDED? WHO MAY RECOVER MONEY UNDER THESE PROVISIONS? These powers enable the trustee to void the following types of transactions: Trustees of bankrupt estates and personal insolvency agreements (PIA) may use these provisions to void transactions, if the PIA gives the trustee that right. However, this right is not available to trustees of a PIA where the agreement does not provide this right to the trustee. 1. Undervalued transactions (section 120); WHAT MUST THE TRUSTEE DO TO BE ABLE TO MAKE A RECOVERY? To void a transaction, the trustee must: 1. Identify the transaction. 2. Identify the other party to the transaction. 3.Prove that the transaction occurred within a specific time period, or while the bankrupt was insolvent. 4.Prove that the transaction was either undervalue or had the required intention. 5.Show that the transaction did not involve protected property. WHY DO TRUSTEES VOID SOME TRANSACTIONS? One of a trustee’s roles is to ensure that all of the bankrupt’s assets are available for distribution to creditors. Part of this role is to discover whether the bankrupt entered into a transaction that reduced the amount of assets available for distribution. The trustee will want to recover these assets and void any transaction that has provided an advantage to any creditor so that they can make a more equitable distribution to all creditors. 2.Transfers done with the intention to defeat creditors (section 121); and 3.Transfers where the consideration was paid to a third party (section 121A). UNDERVALUED TRANSACTIONS - SECTION 120 WHAT ARE UNDERVALUED TRANSACTIONS? Transfers of assets for less than market value are deemed ‘undervalue’. Sometimes a debtor will sell or transfer assets to third parties shortly before their bankruptcy and attempt to make the transaction look commercial. These transactions may take the form of the following: > A sale for less than the market value of the asset moving a valuable asset to another party; or > A purchase of something at a greater consideration than it is worth thus moving money to another party. Examples of these transactions include a debtor: > Selling their share of the family house to their spouse for $1.00 or ‘natural love and affection’; > Granting a mortgage or security to someone in exchange for monies that were lent in the past; > Purchasing an asset of limited worth and paying a high price. The trustee may void transfers of property (including money) if they were done within five years before the commencement of the bankruptcy. 37 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS VOID TRANSACTIONS IN BANKRUPTCY CONTINUED Yes. The Act will protect transfers from being voided if (all three factors must be present): 1.It occurred more than two years before the commencement of the bankruptcy; and 2.It did not involve a party related to the debtor; and 3. The debtor was solvent at the time of the transfer and remained solvent after the transaction. Transactions undertaken with non-related parties whilst the bankrupt was solvent should be protected as a solvent debtor will not be prejudicing creditors by transferring assets. The other party to the transaction has the onus of proving that the bankrupt was solvent at the time of the transaction and remained solvent immediately thereafter. IS THE TIMING DIFFERENT IF THE OTHER PARTY IS RELATED TO THE BANKRUPT? Yes. The two year period extends to four years if the other party to the transaction is related to the bankrupt. This means that any undervalue transactions occurring in the period four years before the commencement of the bankruptcy are automatically void if they involve related parties, as defined as ‘related entities’ in the Bankruptcy Act. IS INSOLVENCY IMPORTANT? A person is solvent if they are able to pay all of their debts as and when they become due and payable. A person who is not solvent is therefore insolvent. The debtor must have been insolvent at the time in order to void a transaction if it occurred within the two or four year period mentioned above and within the five year time limit. The court will usually look to the trustee to provide some evidence to substantiate the state of insolvency at the time of the transfer. Consequently the onus of defending these claims and therefore declaring solvency lies with the party seeking to rely on the defence. The Act provides for a presumption of insolvency if the debtor did not keep proper records of their financial affairs during that period, but that presumption is rebuttable (i.e. it may be disproved by positive evidence of solvency). This may be quite difficult if there are truly no records on the financial affairs of the bankrupt. ARE SOME TRANSFERS EXEMPT? Yes. Some transfers of property will not be void. The Act provides protection to payments of tax, payments under family law agreements and payments under Part IX debt agreements. A transfer is exempt if it is: > A payment of tax payable under a law of the Commonwealth or of a State or Territory; or > A transfer to meet all or part of a liability under a maintenance agreement or a maintenance order; or > A transfer of property under a debt agreement; > A transfer of a kind described in the regulations; or > A transfer made under maintenance agreements or orders made in the Family Court. PERSONAL INSOLVENCY ARE SOME TRANSFERS OF ASSETS PROTECTED? 1 The Family Court would have to overturn the original maintenance order before the trustee will be able to make any recovery under this section. It would be difficult for any trustee to convince the Family Court that it should overturn its own decision in order to allow the trustee to recover assets from an ex-spouse. THE TRUSTEE MUST REFUND THE CONSIDERATION RECEIVED Section 120 voids the whole transaction, not just the recovery of an asset or money. This means that to get the transferred asset back, the trustee must refund any consideration received by the bankrupt as part of that transaction. This consequently places each party back to the position they held before the transaction was undertaken. Otherwise the estate would end up with both the consideration provided by the other party as well as the asset that was transferred. WHAT IS NOT CONSIDERATION? Some things are not deemed to be consideration and cannot be refunded. These include: > The transferee being related to the transferor; > The transferee being a spouse or de facto spouse of the transferor; > The transferee’s promise to marry or to become the de facto spouse of the transferor; > Love or affection; and > The transferee granting a spouse a right to live at the transferred property. WORRELLS.NET.AU 38 VOID TRANSACTIONS IN BANKRUPTCY CONTINUED HOW LONG DOES THE TRUSTEE HAVE TO TAKE THE ACTION? HOW DO YOU DETERMINE THE BANKRUPT’S INTENTION? Recovery actions must be commenced by the trustee within six years of the bankrupt becoming bankrupt. One of the main purposes of the transaction must be to protect the asset from creditors. This is subjective and usually must be inferred from the circumstances of the transaction, the financial position of the bankrupt at that time and the result of the transaction. TRANSFERS TO DEFEAT CREDITORS – SECTION 121 WHAT ARE TRANSFERS TO DEFEAT CREDITORS? Sometimes debtors transfer property primarily to protect the property from their creditors. The Act allows such transfers to be voided where the intention of the bankrupt was to stop divisible assets becoming available to creditors, or where the intention of the bankrupt was to defeat or delay the proper distribution of assets to creditors. ANY ACTION TAKEN TO MOVE, HIDE OR SELL ASSETS PRIOR TO BANKRUPTCY WILL BE INVESTIGATED AND POTENTIALLY OVERTURNED. WHAT MAKES A TRANSFER FALL INTO THIS CATEGORY? To be a transaction to defeat creditors, it must involve: 1.Property that in all likelihood would have become part of the estate or been available to creditors and is made unavailable to the trustee because of the transfer; and 2.The intention of making that property unavailable to creditors, permanently or temporarily. WHAT TYPES OF TRANSACTIONS ARE CAUGHT? There must be a transfer of property. Something must pass from the bankrupt that would have become a divisible asset in the estate. However a transfer can also be of property created by the debtor that results in another person becoming the owner of something that did not previously exist. Prime examples are the creation of a mortgage, securities or other interests over property owned by the bankrupt, where the security would stop the property becoming available to the trustee. But intention can also be deemed by the actual or impending insolvency of the debtor (if it can be shown that the bankrupt was or was about to become bankrupt at the time of the transaction). If the debtor was solvent at the time and remained solvent for some time after the transaction, it may be difficult to connect the transaction to the existence of the knowledge of insolvency. WHAT IS INSOLVENCY? A person is solvent if they are able to pay all of their debts as and when they become due and payable. A person who is not solvent is insolvent. IS INSOLVENCY IMPORTANT? The court will usually look to the trustee to provide some evidence on insolvency at the time of the transfer if the trustee is using the deeming provisions. THE TRUSTEE MUST REFUND THE CONSIDERATION RECEIVED Section 121 voids the whole transaction, not just the recovery of an asset or money. This means that to get the transferred asset back, the trustee must refund any consideration received as part of that transaction, thereby placing each party back to the position they held before the transaction was undertaken. If this was not the case, the estate may end up with both the consideration provided by the other party, even if it was less than the value of the asset transferred, as well as the asset that was transferred (that can be realised). TRANSFER NOT VOID IF DONE IN GOOD FAITH The Act will protect transfers where the transferee acted in good faith. To be able to rely on these provisions, the other party to the transfer must have (all three factors must be present): 1. Provided consideration at least to market value (calculated at the time of the transfer); and 39 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS VOID TRANSACTIONS IN BANKRUPTCY CONTINUED 3.Could not have inferred at the time that the transferor was insolvent or about to become insolvent. To be able to use this defence, the other party must have been completely oblivious of the debtor’s financial position and intention. As many of these transactions are done with relatives or other related parties, this lack of knowledge may be difficult to prove. It is not often that transactions examined under this section are undertaken with complete strangers. HOW LONG DOES THE TRUSTEE HAVE TO TAKE THE ACTION? Actions under section 121 may be started at any time after the trustee discovers the transaction. The difference with other recovery provisions under the Bankruptcy Act is that the section 121 transaction has a flavour of fraud and may be pursued more vigorously. TRANSACTIONS WHERE CONSIDERATION GIVEN TO A THIRD PARTY – SECTION 121A WHO ELSE MAY BE INVOLVED IN THESE ACTIONS? Third parties not actually directly involved in a transaction between the bankrupt and another party can be the subject of recovery actions by the trustee, originally under sections 120 and 121 if they have received the consideration that should have been paid to the bankrupt. Currently section 121A is designed to allow the trustee to collect money from a third party where they received money that should have been paid to the bankrupt. In these scenarios it is not essential that the original transaction was undervalued or had the intention to defeat or delay creditors, as it is the payment of the consideration to the third party that will be examined. That is, did the third party give valuable consideration to the bankrupt for that money at that time, or was the intention of directing the payment to the third party done with the prerequisite intention? WHAT CAN BE DONE? The Act deems that the receiving of the consideration should be viewed as a transfer of property by the bankrupt to that third party. That consideration therefore constitutes that the property transferred and the transfer may be viewed under section 120 and 121. If that payment of consideration is considered void for reasons as set out in these sections, the consideration will be recoverable from the third party under this section. It is possible that the trustee will be able to take an action against the original party to the transaction and separately against the third party that received the consideration. PERSONAL INSOLVENCY 2.Have no knowledge of or could not have reasonably inferred the intention of the bankrupt; and 1 PROTECTION OF CERTAIN TRANSFERS WHAT PROTECTION IS PROVIDED IN THE BANKRUPTCY ACT? The Act provides some protection to people dealing with a debtor before bankruptcy. A transaction is not automatically void because the debtor later becomes bankrupt. Essentially protection may be provided to people that had no knowledge of the impending bankruptcy and who acted in normal business circumstances. WHO GETS THIS PROTECTION? This provision protects an innocent, unknowing party who entered in a commercial transaction in ordinary dealings with the bankrupt, as long as the following factors are met: > The transaction happened before the bankruptcy (the bankrupt does not have the right to deal with their assets after bankruptcy); > The other party was unaware of the impending bankruptcy; and > The transaction was in good faith and in the ordinary course of business. ‘Good faith’ and ‘ordinary course of business’ elements may be difficult to prove. The other party must not have acted in any manner that would give the impression that they were not acting in good faith. Ordinary course of business has been held to be in the ordinary course of the relevant industry, not the ordinary course of that particular creditor. The burden of proof rests with the party attempting to gain the protection of the section. WORRELLS.NET.AU 40 PREFERENCES IN BANKRUPTCY WHAT ARE PREFERENTIAL PAYMENTS? Preferential payments or ‘preferences’ are payments or transfers of assets to creditors that gives an advantage over other creditors. These payments or transfers may be able to be recovered by trustees of bankrupt estates under the provisions of the Bankruptcy Act. Preferences are usually payments of money, though a variety of transfers of assets could be preferential. > It occurred at a time when the bankrupt was insolvent; > It occurred within the relevant time period before the bankruptcy; > The transaction gave the creditor an advantage over other creditors (usually determined as the creditor receiving more than they would have if they had proved for that amount in the estate); and WHO MAY RECOVER PREFERENTIAL PAYMENTS? > The creditor suspected or should have suspected that the bankrupt was insolvent at the time. In personal insolvency matters, only trustees of bankrupt estates and personal insolvency agreements (where the agreement includes recovery of these preferential transactions) may claim the return of preferential payments. Similar provisions also exist in the Corporations Act for payments made by companies. WHEN IS SOMEONE INSOLVENT? WHY DO TRUSTEES VOID PREFERENTIAL PAYMENTS? The trustee’s main role is to distribute the bankrupt’s assets fairly between their creditors. To do so they must discover whether any creditor has received treatment that would have given them a distribution - prior to bankruptcy - that was not equitable when compared to the distribution to other creditors in the bankruptcy. Trustees are able to void transactions that involve one creditor so that they can make a more equitable distribution to all creditors. WHAT ARE THE ELEMENTS OF A PREFERENTIAL PAYMENT? Before the court will void a payment or transfer, it must be satisfied that: > A transfer of property was made (this is usually a payment of money); > Something passed from the bankrupt to a creditor or on the creditor’s instructions; The Bankruptcy Act defines insolvent as not being able to pay all your debts as and when they become due and payable. The bankrupt must have been insolvent at the time of the transfer or payment. The reasoning is that a solvent person has the capability of paying all of their debts (whether they actually did or not) and therefore no creditor could have been advantaged over the others by receiving a payment. WHO HAS TO PROVE INSOLVENCY? The onus of proving insolvency lies with the trustee. MUST THERE BE A DEBTOR – CREDITOR RELATIONSHIP? Yes. The transaction must have involved or been done at the direction of a creditor of the bankrupt and must have satisfied a debt that would have been provable in the estate if the transaction had not been undertaken. MUST THERE BE A TRANSFER OF AN ASSET? Yes. There must have been a transfer of some property between the parties. It is common for that transfer to be a payment of money, but any asset passing from the bankrupt to the creditor (even an asset that has just been created by the transaction, like a security) will be sufficient to be a transfer of property. The amount of the preference is the value of the asset transferred. 41 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS PREFERENCES IN BANKRUPTCY CONTINUED The transfer of the asset must have happened during a specific period before the bankruptcy. The period differs depending on how the bankruptcy was commenced: 1.Creditor’s petition - six months before the filing of the creditor’s petition. 2.Debtor’s Petition - six months before the presentation of the debtor’s petition. 3.Debtor’s petition (where a creditor’s petition is pending) - the period starts on the commencement of the bankruptcy; defined as the time of the earliest act of bankruptcy within the six months before the creditor’s petition was filed. MUST THE DEBT BE UNSECURED? Yes. A preference cannot be given to a creditor holding a security over assets. Secured creditors either give up their security (if the creditor is paid in full), or the bankrupt gains equity in the secured asset (if the creditor is not paid in full). However if the security was not properly created or the value of the security is less than the amount of the payment, then the transfer or the excess value over the security’s worth may be deemed as preferential. HOW IS PREFERENTIAL TREATMENT DETERMINED? The creditor must have received more than they would have received if they had refunded the monies and proved for that amount in the bankruptcy. This is purely a mathematical calculation. If the creditor did not receive more by way of the payment than they would have received from a dividend in the bankruptcy, there is no advantage or preferential treatment. WHAT DEFENCES ARE AVAILABLE TO CREDITORS? The three arms of the statutory defence are: 1. The transfer was in the ordinary course of business. 2. The recipient acted in good faith. 3.The recipient gave market value consideration or at least market value. The creditor must be able to prove all three arms of the defence otherwise the entire defence fails. The transfer is also not voidable if it was made pursuant to a maintenance agreement under the Family Law Act, or was made under a Part IX debt agreement. PERSONAL INSOLVENCY WHAT IS THE RELEVANT TIME PERIOD? 1 WHAT IS GOOD FAITH AND THE ORDINARY COURSE OF BUSINESS? The creditor must not have acted in any manner that would give the impression that they were not acting in good faith or under normal trading conditions. Actions that may repute good faith are the issuing of proceedings or statutory notices to the debtor, ceasing supply etc. They must not have forced the payment to be made by way of threat or action. WHAT IS MARKET VALUE CONSIDERATION? Usually the easiest component to prove is that the creditor gave market value consideration. If the creditor is a trade creditor, the initial supply of goods or services that created the debt would provide the market value consideration. A loan creditor can rely upon the initial loan to the bankrupt. The creditor will only have to show that they have given something of similar value in consideration for receiving the payment. IF A CREDITOR RECEIVED MORE THAN THEY WOULD HAVE IN THE BANKRUPTCY – IT IS LIKELY THEY RECEIVED A PREFERENCE. WORRELLS.NET.AU 42 PREFERENCES IN BANKRUPTCY CONTINUED WHEN WILL THE DEFENCES NOT BE AVAILABLE? WHAT CAN CREDITORS DO IF THEY HAVE TO REFUND MONEY TO A TRUSTEE? The creditor cannot rely on the defences when they knew or had reason to suspect that the bankrupt was insolvent and that the transaction would give them a preference over other creditors. Creditors refunding preferences may lodge a proof of debt for the amount refunded. They may also have some rights under any guarantees given by other parties that support that debt. WHAT SHOULD CREDITORS DO IF A TRUSTEE CLAIMS A PREFERENTIAL PAYMENT? HOW LONG DOES THE TRUSTEE HAVE TO MAKE A CLAIM? On a simplistic basis they should make sure that: Claims have to be commenced within six years after the commencement of the bankruptcy. It is not sufficient for the trustee to only have made a formal demand within that period, they must issue legal proceedings within that time period as well. > The transaction was done within the relevant time period; > They are not a secured creditor; > They are (or were) a creditor when the payment was made and that the payment was not a cash on delivery (COD) type transaction; > The trustee shows that they received an advantage over other creditors. The following points are more detailed and complex to determine: > Whether the creditor gave extra credit to the debtor after the payment in question was received. It is possible that the claim may be reduced or eliminated by the amount of extra credit granted. This is commonly known as the ‘running account defence’; > That the trustee can show insolvency at the time of or before the payment was received; > Whether the creditor has a realistic chance of convincing a Judge that all three of the statutory defences are available. 43 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS PART X PERSONAL INSOLVENCY AGREEMENTS Part X (part 10) is a part of the Bankruptcy Act that allows a debtor to enter into an arrangement with their creditors to satisfy their debts without being made bankrupt. This type of proposed arrangement to creditors is called a personal insolvency agreement (PIA). WHAT IS A PERSONAL INSOLVENCY AGREEMENT? 3.A draft personal insolvency agreement detailing the terms of the proposal to be made to creditors. The controlling trustee will sign a consent to act and will forward the documentation to Insolvency and Trustee Service Australia (ITSA) for registration on the official record. ITSA will then allocate an ‘estate number’. HOW IS THE PROPOSAL ACCEPTED? It is the formal agreement between a debtor and their creditors that sets out how the debtor will satisfy their debts. It is in the form of a deed and is executed by the debtor and their trustee once creditors have agreed to the proposal. The controlling trustee must hold a meeting of creditors within 25 business days after the appointment. The creditors attending this meeting will decide whether to accept the proposal or not. There must be a majority in both the number of the creditors and more than 75% in value in favour of the proposal for it to be accepted. This is called a special resolution. The proposal can contain almost any lawful term and conditions. Usually it will provide for the repayment of monies over time and sometimes the sale of some assets. It will also usually contain a moratorium from creditor’s claims for the term of the agreement, and payment of a sum which is less than the full amount in full satisfaction of claims. If the proposal is not accepted by the required majority, the creditors may resolve that the debtor become bankrupt, but cannot actually bankrupt the debtor at that meeting. Creditors may also resolve that the debtor be released from the control of the controlling trustee, allowing creditors to commence recovery action or bankruptcy proceedings against them. WHY CHOOSE A PART X AGREEMENT? IS SIGNING A SECTION 188 AUTHORITY AN ACT OF BANKRUPTCY? A debtor will usually use a personal insolvency agreement to: > Get relief from their debts; > Ensure a fair distribution of their assets to creditors; > Provide a higher dividend than would be payable in bankruptcy; > Maintain their source of income; and > Avoid the restrictions of bankruptcy. HOW IS THE PROCESS STARTED? A debtor must choose a controlling trustee (a solicitor or a registered trustee in bankruptcy) and provide them with three documents: 1.An authority under section 188 giving the controlling trustee control over their assets and requiring them to call a meeting of creditors to consider the proposal. 2.A Statement of Affairs detailing all assets, liabilities and other personal information. PERSONAL INSOLVENCY WHAT IS PART X OF THE BANKRUPTCY ACT? 1 Yes. In the course of the Part X process a debtor will commit a number of acts of bankruptcy, including signing the section 188 authority, calling a meeting of their creditors and obtaining a special resolution by creditors. Any creditor may use these actions to apply to the court to have the debtor made bankrupt if the proposal is not accepted. HOW ARE CREDITORS AFFECTED BY THE PERSONAL INSOLVENCY AGREEMENT? Secured creditors’ rights under their securities remain intact. They may exercise their rights regardless of the outcome of the meeting and acceptance of the proposal. Unsecured creditors with debts that would be provable in a bankruptcy exchange their right to enforce their claims for a right to share in the proceeds of the personal insolvency agreement. If accepted by the required majority, all unsecured creditors will be bound by the agreement whether they attended the meeting or not, or voted in favour of the proposal or not. WORRELLS.NET.AU 44 PART X PERSONAL INSOLVENCY AGREEMENTS CONTINUED IF A RESOLUTION IS PASSED ACCEPTING THE PIA – ALL UNSECURED CREDITORS ARE BOUND BY THE AGREEMENT. > The trustee terminating the agreement with the consent of creditors; > The passing of a special resolution at a meeting of creditors, or > A n application to the court to terminate the agreement and possibly bankrupt the debtor. HOW DOES THE AGREEMENT AFFECT THE DEBTOR’S PROPERTY AND INCOME? WHO ADMINISTERS A PERSONAL INSOLVENCY AGREEMENT? Only property that is included in the personal insolvency agreement is affected. Property that is not included in the agreement is not available to creditors. The debtor is only required to contribute part of their income if the agreement includes terms requiring them to do so. When applicable, the debtor will make the same type of contribution out of their income as they would if they were bankrupt. The proposal for an agreement must include the appointment of a registered trustee or the Official Receiver to administer the agreement. If no one is nominated, the Official Receiver will be the trustee. Their powers and obligations will be set out in the agreement and in conjunction with the Bankruptcy Act. Fundamentally they are; to enforce the terms of the agreement, sell any assets, collect any monies and make a distribution to creditors. CAN THE TRUSTEE PAY DIVIDENDS? Yes. The trustee will make distributions in accordance with the terms of the agreement. When dividends are paid will depend on the duration of the agreement and when funds become available. If the duration is expected to be short, the trustee will usually pay a dividend when all of the assets have been realised and all funds collected. If the agreement extends over a long period, the trustee may make interim distributions as money becomes available. WHEN DOES A PERSONAL INSOLVENCY AGREEMENT END? The agreement ends when the debtor satisfies the requirements of the deed in full. WHAT HAPPENS IF THE DEBTOR DOES NOT COMPLY WITH THE TERMS OF THE AGREEMENT? If the terms of the agreement are not satisfied, then the agreement will be considered to be in default. Usually a default notice will be issued to the debtor within a few days and if not rectified, the agreement will be breached and may be terminated by: DOES SIGNING A SECTION 188 AUTHORITY AFFECT A CREDIT RATING? Yes, the fact that the debtor has signed a section 188 Authority will be recorded by credit agencies. But this may be more favourable than outstanding writs, defaults and a bankruptcy on the debtor’s file. CAN A DEBTOR CONTINUE TO ACT AS A DIRECTOR OF A COMPANY? No. A debtor cannot act as a director whilst subject to the terms of a personal insolvency agreement. This restriction is lifted when the agreement has ended. GOVERNMENT REALISATION CHARGE The administration attracts a government charge known as ‘Asset Realisation Charge’. This charge is payable at the rate of 4.7% of gross monies received into the estate, less payments to secured creditors and trade on costs. It is a priority payment to any dividend payable to creditors. > The provisions of the agreement, automatically terminating the agreement; 45 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS SECTION 73 PROPOSALS During the course of a bankruptcy, a bankrupt may be in a position to make a proposal to their creditors to satisfy their debts and consequently end their bankruptcy. Section 73 of the Bankruptcy Act provides a bankrupt with the mechanism to make that proposal. If accepted, the creditors would expect to receive a larger distribution than they would receive under the continued bankruptcy and the bankrupt would be released from the restrictions associated with bankruptcy. CREDITORS ARE USUALLY ONLY INTERESTED IN A SECTION 73 PROPOSAL IF IT MEANS MORE DOLLARS IN THEIR POCKET. HOW DO BANKRUPTS MAKE A PROPOSAL? The bankrupt will be required to send a written proposal to their trustee requesting that a meeting of creditors be called to consider the proposal. This written request will set out the particulars of their proposal. The trustee will conduct any necessary investigations into the benefits of the proposal, issue a report and call a meeting for the creditors to vote on the acceptance or rejection of the proposal. The bankrupt will usually be required to pay the trustee to undertake this process as there is no requirement for the funds in the estate to be used for this purpose. If the proposal is accepted, the bankruptcy will be annulled at the time of the acceptance. If the proposal is not accepted, the bankruptcy will continue as if the proposal had never been put forward to creditors. COMPOSITION OR ARRANGEMENT? A proposal under section 73 can be structured as either a ‘composition’ or a ‘scheme of arrangement’. A composition is an agreement to pay money to the trustee. The composition can be for any amount and can be paid over any period of time. A scheme of arrangement can contain almost any lawful provision. It can contain provisions for the payment of monies, the sale of certain assets, payments from third parties, or any combination of these factors. INVESTIGATING AND REPORTING Before holding the meeting of creditors the trustee will conduct investigations and issue a report to creditors detailing the terms of the proposal. The report will compare the likely returns from the proposal to that of the continuation of the bankruptcy. This report will not be issued until the investigations are complete and the trustee has properly examined all relevant matters. PERSONAL INSOLVENCY WHAT IS A SECTION 73 PROPOSAL? 1 DELAYS IN CALLING A MEETING OF CREDITORS A trustee is entitled to decline to call a meeting if the proposal does not adequately provide for the payment of the bankruptcy trustee’s approved fees and expenses or costs. The trustee also may require that the bankrupt pay an amount (a surety) to cover the costs and fees of the trustee for investigating the proposal, calling and holding the meeting. This money will have to be paid before the proposal is examined. HOW IS THE PROPOSAL ACCEPTED? The proposal is put to creditors at a meeting called under the same provisions as bankruptcy meetings. The creditors attending that meeting vote on the proposal. The proposal must be accepted by a special resolution, which is both a majority in number of the creditors present and voting, and at least 75% of the dollar value of the creditor’s debts present and voting. If the proposal is accepted, the bankruptcy is consequently annulled. The now ‘ex-bankrupt’ will be bound by the terms of the agreement. The agreement is binding on all creditors, whether they attend or vote at the meeting or not. If the proposal is defeated, the bankruptcy continues as normal. WORRELLS.NET.AU 46 SECTION 73 PROPOSALS CONTINUED WHO ADMINISTERS A SECTION 73 PROPOSAL? WHAT IF THE DEBTOR DEFAULTS? The proposal must include a provision for a trustee to administer the agreement. It is usual that the trustee of the bankrupt estate will be the trustee of the section 73 agreement, but a new trustee may be appointed under the agreement. The trustee’s role is to ensure that the ex-bankrupt complies with the terms of the agreement and enforce the provisions as necessary. They will also pay dividends to creditors. Section 76B provides enforcement provisions. These will be used if the debtor does not fulfil the terms of the agreement. All of the powers that are available to a trustee under Part X of the Act (in the enforcement of personal insolvency agreements) are available to a trustee of a composition or scheme of arrangement. These include: WHAT ABOUT THE ACTS OF THE PREVIOUS BANKRUPTCY TRUSTEE? Section 74 of the Bankruptcy Act provides that the acts of the bankruptcy trustee during the period of bankruptcy remain valid. Without this provision, the bankrupt or any party to a bankrupt’s transactions would be able to challenge its validity. CAN THE TRUSTEE PAY DIVIDENDS? Yes. The trustee of the agreement will make distributions under the terms of the agreement. If the agreement does not stipulate these provisions, they will make distributions when practical given the amount of money on hand and when the agreement is likely to end. WHEN DOES A SECTION 73 AGREEMENT END? The agreement ends when the debtor fully satisfies the requirements of the agreement. > Terminating the agreement automatically through the terms of the agreement; > Terminating the agreement with the consent of creditors; > Terminating the agreement by resolution of creditors; or > Terminating the agreement by court order. Any application to the court to terminate the agreement can also include an application to bankrupt the debtor and initiate a new bankruptcy. GOVERNMENT REALISATION CHARGE The administration of section 73 proposals attracts a government charge known as ‘Asset Realisation Charge’. Currently this charge is payable at the rate of 4.7% of gross monies received into the estate, less payments to secured creditors and trade on costs. It is payable in priority to any dividend to creditors. 47 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS DISCHARGE & ANNULMENT A bankruptcy usually ends with the bankrupt being discharged. Without an objection to discharge being lodged, this will occur three years after the filing of the bankrupt’s Statement of Affairs with ITSA (Insolvency and Trustee Service Australia). Discharge releases the bankrupt from the bankruptcy, however the bankrupt estate (property, assets etc) will continue as long as required for all matters to be satisfactorily concluded. This means the discharged bankrupt still has an obligation to cooperate with the trustee. The alternative to a discharge from bankruptcy is to have the bankruptcy annulled. Discharge and annulment do not have the same legal result. A discharge is the conclusion to the legal status of bankruptcy against the person, while the bankrupt estate will continue until the trustee has completed their duties. An annulment cancels the bankruptcy entirely – as if it never happened, therefore removing the bankrupt from bankruptcy and ending the bankrupt estate completely. The Bankruptcy Act provides for an extension to a bankruptcy to a total of five or eight years in circumstances where the bankrupt has not cooperated with the trustee or when an offence has been committed. If an objection is lodged against the discharge of a bankrupt, the automatic discharge date will not occur until the end of the granted extended period. DISCHARGE FROM BANKRUPTCY TIMING OF DISCHARGE The bankruptcy of a person will normally end three years after the Statement of Affairs is filed with ITSA. This occurs pursuant to section 149 of the Bankruptcy Act. This is the most common way that a person ceases to be a bankrupt. If the bankruptcy is started by way of a debtor’s petition, the Statement of Affairs would have been filed with the debtor’s petition at the time of bankruptcy. Without an objection to discharge being lodged, the bankruptcy will end three years after the date of the filing of both of these documents. If the bankruptcy is started by way of an order of the court (a sequestration order), the Statement of Affairs would not have been filed at the time of the bankruptcy. The bankrupt will have to submit a completed Statement of Affairs to ITSA. In this scenario the bankrupt will be discharged three years after ITSA receives the Statement of Affairs. It is usual for someone who has been made bankrupt by the court to be bankrupt for longer than a three year period, if only by a few weeks or so, due to the need for the bankrupt to complete and submit the statement to ITSA. Consequently the longer the bankrupt takes to send their Statement of Affairs to ITSA, the longer that the period of bankruptcy will continue. If the Statement of Affairs is never filed, the bankruptcy will continue until the bankrupt dies. PERSONAL INSOLVENCY INTRODUCTION 1 It is important to note that the bankruptcy does not start with the filing of the Statement of Affairs, it commences when the order of the court is made or at the time that the debtor’s petition is accepted. It is only the end date that is dependent upon the date of the filing of the Statement of Affairs. Some people believe that they do not become bankrupt until their Statement of Affairs is filed. This is not correct. The discharge is purely an automatic process of law. The trustee and/or ITSA need not do anything to grant the bankrupt a discharge, whether at the end of the standard three year period or at the end of a period extended due to an objection to discharge. Usually the trustee will write to the bankrupt and confirm they have been discharged and ask for information to conduct a final income assessment. BANKRUPTCY ACT 1966 - SECTION 149 Automatic discharge (1) Subject to section 149A, a bankrupt is, by force of this subsection, discharged from bankruptcy in accordance with this section. (4) If the bankrupt becomes a bankrupt after the commencement of section 27 of the Bankruptcy Amendment Act 1991, the bankrupt is discharged at the end of the period of 3 years from the date on which the bankrupt filed his or her statement of affairs. WORRELLS.NET.AU 48 DISCHARGE & ANNULMENT CONTINUED This section also allows for the discharge of bankrupts who were bankrupted before this section was amended in 1991 but had not lodged Statements of Affairs before the amendment. Discharge without the lodgement of a Statement of Affairs is no longer possible. BANKRUPT TO CONTINUE TO ASSIST TRUSTEE AFTER DISCHARGE Even though the bankruptcy ends, there is still an obligation on the discharged bankrupt to assist the trustee as the conduct of the bankrupt estate may still be continuing. Though it is common for the estate to be completed within the three year period, sometimes it is not completed in that period. The estate will not end until the trustee has completed all of the necessary tasks. The discharged bankrupt must provide all reasonable assistance to the trustee, and there are penalties if they do not do so. BANKRUPTCY ACT 1966 - SECTION 152 Discharged bankrupt to give assistance. A discharged bankrupt must, even though discharged, give such assistance as the trustee reasonably requires in the realisation and distribution of such of his or her property as is vested in the trustee. Taxation Office to offset monies payable to the bankrupt after bankruptcy against debts payable by the bankrupt before bankruptcy. As the debts are released upon the discharge of the bankruptcy, if the bankruptcy ends before discharge via annulment the debts will therefore still exist and will have to be satisfied in some other manner. These debts are usually satisfied in the process of getting the annulment e.g. payment in full or through a section 73 agreement. BANKRUPTCY ACT 1966 - SECTION 153 Effect of discharge (1)Subject to this section, where a bankrupt is discharged from a bankruptcy, the discharge operates to release him or her from all debts (including secured debts) provable in the bankruptcy, whether or not, in the case of a secured debt, the secured creditor has surrendered his or her security for the benefit of creditors generally. Section 82 sets out what debts are provable in the estate and will be released upon discharge. Most of the time all of a bankrupt’s debts will fall into this category and be discharged, but there are some significant exceptions. BANKRUPTCY ACT 1966 - SECTION 82 Penalty: Imprisonment for 6 months. Debts provable in bankruptcy In most cases the discharged bankrupt will be cooperative with the trustee throughout the period of the bankruptcy. An objection to discharge is generally lodged if they have not been cooperative. Few bankruptcies continue longer than the statutory three years. (1)Subject to this Division, all debts and liabilities, present or future, certain or contingent, to which a bankrupt was subject at the date of the bankruptcy, or to which he or she may become subject before his or her discharge by reason of an obligation incurred before the date of the bankruptcy, are provable in his or her bankruptcy. RELEASE FROM DEBTS One of the effects of discharge is to release the bankrupt from their provable debts. These are debts that were outstanding at the date of bankruptcy (not ones incurred after the bankruptcy commenced) and that can be proved in the bankrupt estate for dividends. But there are some debts that are not provable in the estate and will not be released and some that are only partially released. It is important to note that the debts are only released at the point when the bankrupt is discharged from bankruptcy. This allows some creditors like the Australian Debts that are provable are released and debts that are not provable are not. Furthermore there are some debts that are provable in the estate for the amount owing, but by statute are still not released in full at discharge. These generally relate to amounts under a maintenance agreement or maintenance order given before the date of the bankruptcy. The amount that was outstanding under the agreement at the time of the bankruptcy is released, but amounts that become payable after the bankruptcy commenced are not released by discharge. 49 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS DISCHARGE & ANNULMENT CONTINUED Debts provable in bankruptcy (1A)Without limiting subsection (1), debts referred to in that subsection include a debt consisting of all or part of a sum that became payable by the bankrupt under a maintenance agreement or maintenance order before the date of the bankruptcy. Section 82 also lists debts that are not provable and will not be released on discharge. This is confirmed by section 153 which provides that non-provable debts are not released upon discharge. These sections include a liability to pay an income contribution to the trustee, debts incurred by way of a fraud and liabilities under maintenance agreements or orders. Section 82 sets out these debts in detail. BANKRUPTCY ACT 1966 - SECTION 153 Effect of discharge (2) The discharge of a bankrupt from a bankruptcy does not: (a) release the bankrupt from: (i) a debt on a recognizance; or (ii) a debt with which the bankrupt is chargeable at the suit of the sheriff or other public officer on a bail bond entered into for the appearance of a person prosecuted for an offense against a law of the Commonwealth or of a State or Territory of the Commonwealth; (aa) release the bankrupt from liability to pay an amount to the trustee under subsection 139ZG(1); (b) release the bankrupt from a debt incurred by means of fraud or a fraudulent breach of trust to which he or she was a party or a debt of which he or she has obtained forbearance by fraud; or (c) subject to any order of the Court made under subsection (2A), release the bankrupt from any liability under a maintenance agreement or maintenance order; Note: A discharged bankrupt remains liable under any pecuniary penalty order because such liabilities are not provable in bankruptcy, see subsection 82(3A). A bankrupt should be aware that these types of debts will survive the bankruptcy process and will need to be paid. RIGHTS OF SECURED CREDITORS The debt owed to a secured creditor is not released against the asset secured - only against the bankrupt. Securities in place at the time the bankruptcy commences can be enforced against the secured asset at any time, even after the discharge of the bankrupt. Generally secured assets would have been sold in the three years prior to the date of discharge, but in some cases they may not have been. PERSONAL INSOLVENCY BANKRUPTCY ACT 1966 - SECTION 82 1 SECURITIES OVER ASSETS AT THE TIME OF BANKRUPTCY CAN BE ENFORCED AT ANY TIME. These debts (effectively the shortfalls after the sale of the asset secured) are released from the bankrupt personally at discharge. The secured creditor cannot recover any shortfall suffered after selling the asset secured from the discharged bankrupt. Most securities are exercised and the asset sold before the discharge of the bankrupt and any shortfall would have been proved in the estate, but this is not always the case. Sometimes these assets take longer than three years to realise. If that is the case, the secured creditor will not recover any shortfall. If the secured asset has not been sold before discharge, one important factor is that any amount proved (an estimated shortfall) in the estate is released at discharge. That debt therefore no longer exists and cannot be claimed against the secured asset. This will affect creditors who make large estimates of shortfalls by underestimating the value of the secured asset. WORRELLS.NET.AU 50 DISCHARGE & ANNULMENT CONTINUED BANKRUPTCY ACT 1966 - SECTION 153 BANKRUPTCY ACT 1966 - SECTION 153 Effect of discharge Effect of discharge (3) The discharge of a bankrupt from a bankruptcy does not affect the right of a secured creditor, or any person claiming through or under him or her, to realise or otherwise deal with his or her security: (4) The discharge of a bankrupt from a bankruptcy does not release from any liability a person who, at the date on which the bankrupt became a bankrupt: (a) if the secured creditor has not proved in the bankruptcy for any part of the secured debt - for the purpose of obtaining payment of the secured debt; or (b) if the secured creditor has proved in the bankruptcy for part of the secured debt - for the purpose of obtaining payment of the part of the secured debt for which he or she has not proved in the bankruptcy; and, for the purposes of enabling the secured creditor or a person claiming through or under him or her so to realise or deal with his or her security, but not otherwise, the secured debt, or the part of the secured debt, as the case may be, shall be deemed not to have been released by the discharge of the bankrupt. The key point to note is that the secured part of their debt will survive a discharge from bankruptcy and the deficiency will be released. OBLIGATIONS OF BUSINESS PARTNERS, GUARANTORS & JOINT DEBT HOLDERS The discharge of a bankrupt does not release a business partner of the bankrupt from a partnership debt. These debts would normally hold a joint liability under the Partnership Act. These provisions also applies to people that have entered into contracts or arrangements with the bankrupt, have guaranteed a debt of the bankrupt or simply have joint debts with the bankrupt. These people will still be liable for such debts, or the part of the debts that they would have been liable for if the bankrupt had not become a bankrupt. (a) was a partner or a co-trustee with the bankrupt or was jointly bound or had made a joint contract with the bankrupt; or (b) was surety or in the nature of a surety for the bankrupt. These joint debts are only released against the discharged bankrupt. They are not released against the other parties to the debt. Creditors can pursue the other parties to a debt, even after the discharge of the bankrupt, and their subsequent release from the debt from the bankrupt. ANNULMENT OF BANKRUPTCY An annulment is a complete undoing of the bankruptcy. It is as if the bankruptcy never happened, apart from the fact that it will still appear on the public record (the NPII) and credit reference databases for some time. For an annulment to occur the bankrupt needs to take one of three actions. Two of these actions require satisfaction of the bankrupt’s debts, at least in part; the third requires an order of the court. 1. Annulment on payment of debts in full A bankruptcy will be annulled if the estate has sufficient monies to pay all of the debts and the costs of the estate in full. If that occurs, the bankrupt is no longer insolvent and there is no need for the bankrupt estate or a release from debts. This usually happens when the bankrupt receives monies from a third party (usually a relative) or when the bankrupt’s assets are sold or refinanced. BANKRUPTCY ACT 1966 - SECTION 153A Annulment on payment of debts (1) If the trustee is satisfied that all the bankrupt’s debts have been paid in full, the bankruptcy is annulled, by force of this subsection, on the date on which the last such payment was made. 51 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS DISCHARGE & ANNULMENT CONTINUED BANKRUPTCY ACT 1966 - SECTION 153A Annulment on payment of debts (1A) In determining whether there has been full payment of a debt that bears interest, the interest must be reckoned up to and including the date on which the debt (including interest) is paid. Bankrupts must understand that the extra costs incurred in the estate may be significant and that these debts must also be paid in full in order to obtain this type of annulment. 2. Section 73 proposal A section 73 proposal is made under section 73 of the Bankruptcy Act, hence the name. That section provides a mechanism for bankrupts to propose an alternative to their creditors - a formal arrangement - to the continued bankruptcy. The process is similar to proposing a Part X agreement to creditors, but the difference being is that it is initiated during the bankruptcy. The process involves the creditors accepting and receiving a benefit which would not have been available to them in the bankruptcy, in exchange for agreeing to annul the bankruptcy. The annulment occurs on the acceptance of the proposal and the new agreement takes effect. Section 73 proposals are discussed in detail in this guide on page 46. BANKRUPTCY ACT 1966 - SECTION 75 Effect of composition or scheme of arrangement (2) The acceptance of a composition or scheme of arrangement does not: (a) except with the consent of the creditor to whom the debt is due, release the bankrupt from a provable debt that would not be released by his or her discharge from bankruptcy; or (b) release any other person from any liability from which he or she would not be released by the discharge of the bankrupt. PERSONAL INSOLVENCY The debts include all those that have been proved in the bankruptcy, but also the interest accrued after the commencement of the bankruptcy on those debts that have interest components. The costs, charges and expenses of the administration of the bankrupt estate includes the remuneration and expenses of the trustee, the Asset Realisation Charge (ARC) payable on the amount necessary to meet all of the debts and costs and if the bankruptcy was commenced by a creditor’s application - the costs of the petitioning creditor. 1 3. Annulment by the court The bankrupt can apply to the court for an order annulling (effectively overturning) the bankruptcy. The court will only entertain an application if they believe that the bankruptcy should never have commenced in the first place. The application may be brought against a sequestration order (a creditor’s petition) or the acceptance of a debtors petition by ITSA. There can be numerous reasons under which a bankrupt may apply for an annulment and is not detailed here; rather the rights of bankrupts to be able to do so are outlined. BANKRUPTCY ACT 1966 - SECTION 153B Annulment by Court (1) If the Court is satisfied that a sequestration order ought not to have been made or, in the case of a debtor’s petition, that the petition ought not to have been presented or ought not to have been accepted by the Official Receiver, the Court may make an order annulling the bankruptcy. (2) In the case of a debtor’s petition, the order may be made whether or not the bankrupt was insolvent when the petition was presented. Debts of the now ex-bankrupt are not released by operation of the law as there is no discharge. The debts are released only by agreement with the creditors and this usually occurs through a term of the agreement. Therefore the agreement must be completed before any unpaid debts are released. Non-provable debts are also dealt within section 75. WORRELLS.NET.AU 52 DISCHARGE & ANNULMENT CONTINUED PROTECTION OF THE TRUSTEE Once the proved debts and costs have been paid under option one; or a formal section 73 proposal is accepted by creditors under option two; or the court orders an annulment under option three; the bankrupt is annulled and the trustee will forward the appropriate notices to ITSA for updating on the National Personal Insolvency Index (NPII). But what about any actions taken by the trustee before the annulment? The Bankruptcy Act protects the acts performed by the trustee while they are trustee of the bankrupt estate. It does not undo transactions or sales entered into during this period. It also allows the trustee to use assets in the annulled estate to pay any costs and remuneration that remain unpaid at the time of the annulment. If the assets in the estate are not sufficient to meet the costs and expenses of the trustee, they can collect the balance from the annulled bankrupt. That is, in extreme circumstances, the trustee may be able to bankrupt the ex-bankrupt for costs incurred before the bankruptcy was annulled. BANKRUPTCY ACT 1966 - SECTION 154 Effect of annulment (2) If the property of the former bankrupt referred to in paragraph (1)(b) is insufficient to meet the costs, charges and expenses referred to in that paragraph, the amount of the deficiency is a debt due by the former bankrupt to the trustee and is recoverable by the trustee by action against the former bankrupt in a court of competent jurisdiction. BANKRUPTCY ACT 1966 - SECTION 154 Effect of annulment (1) If the bankruptcy of a person (in this section called the former bankrupt) is annulled under this Division: (a)all sales and dispositions of property and payments duly made, and all acts done, by the trustee or any person acting under the authority of the trustee or the Court before the annulment are taken to have been validly made or done; and (b) the trustee may apply the property of the former bankrupt still vested in the trustee in payment of the costs, charges and expenses of the administration of the bankruptcy, including the remuneration and expenses of the trustee; and (c) subject to subsections (3), (6) and (7), the remainder (if any) of the property of the former bankrupt still vested in the trustee reverts to the bankrupt. 53 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS 1 PERSONAL INSOLVENCY WORRELLS.NET.AU 54 INDICATORS OF INSOLVENCY 55 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS INDICATORS OF INSOLVENCY 2 IS INSOLVENT TRADING AN OFFENCE? Yes. Insolvent trading may be an offence and may be referred to ASIC for further investigation and potential criminal prosecution. It is recommended that directors seek their own legal advice, in relation to such offences. Section 588G - Director’s duty to prevent insolvent trading by company goes on to stipulate: (3) A person commits an offence if; (a) the person is a director of the company when it incurs a debt; and 1 Creditors can only take actions against directors for their individual debts. Unlike liquidators, they cannot group all creditors’ debts into their claim. The Corporations Act will stop the creditor from commencing action when the liquidator has begun proceedings or has intervened in an application for a civil penalty order. That is, claims will be restricted when the liquidator has already started their own action. RELATED TOPICS (b) the company is insolvent at that time, or becomes insolvent by incurring debt, or by incurring at 5 PHASES OF that FAILURE that time debts including that debt; and HOW LONG DO LIQUIDATORS HAVE TO TAKE AN INSOLVENT TRADING ACTION? The Corporations Act allows liquidators six years from 58commence an action the beginning of the liquidation to for insolvent PROOFS OF DEBT AND SECURED CREDITORS trading. Proceedings63must have been (c) the person suspected at the time when the company commenced within that six year 65 period. It is not sufficient MEETINGS OF CREDITORS incurred the debt that the company was insolvent or just to issue a demand. DIVIDENDS 68 would become insolvent as a result of incurring that debtCGT or other debts (as in paragraph (1)(b); and WHAT SHOULD DIRECTORS73 DO IF A AND INSOLVENCY (d) the GST person’s failure to prevent the company incurring AND INSOLVENCY the debt was dishonest. LIQUIDATOR MAKES A CLAIM? 77 Yes. If a liquidator does not make a claim, the creditors of the company (individually or in a group) may make a claim themselves. The creditors may commence an action at any time with the written consent from the liquidator. Creditors may ask the liquidator to give them consent up to six months after the liquidation commences. 2. That the debts were incurred after that time 3. Proof of directorship at that time (whether formally appointed as such or not). A Liquidator should be asked to demonstrate: OBJECTIONS TO DISCHARGE 85 1. That the company was insolvent during the CAN CREDITORS TAKE INSOLVENT VOIDING SUPERANNUATION CONTRIBUTIONS 87 appropriate period TRADING ACTIONS? In settling claims with the liquidator it must be ensured that the settlement is sanctioned by the court (usually by way of a consent order). This will provide protection from any future potential claims made by creditors of the company. THE COURTS HAVE MADE IT CLEAR THAT THE POSITION OF DIRECTOR CARRIES CERTAIN RESPONSIBILITIES, WHICH CANNOT BE AVOIDED, INCLUDING THE DUTY TO KEEP INFORMED ABOUT THE COMPANY’S SOLVENCY. WORRELLS.NET.AU 56 INDICATORS OF INSOLVENCY RELATED TOPICS INSOLVENCY IMPACTS MANY STAKEHOLDERS DIFFERENTLY, ACROSS VARIOUS INDUSTRIES AND SECTORS, SOME OF WHICH ARE EXPLORED IN THIS SECTION. 57 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS INDICATORS 5 PHASES OF INSOLVENCY OF FAILURE 2 This is the time when new motor vehicles are leased, new premises are considered and financial budgeting does not seem important. Owners believe that the business will continue to grow. The commitments entered into during this phase may have an affect on the business and the owner’s personal life in the future. Based on our past experience dealing with business failures, we have prepared what we call the ‘Five Phases to Failure’ and the elements which are likely to be found at each phase. But many businesses are seriously under-capitalised when they start, surviving on supplier credit and overdrafts. When budgets are prepared (usually for banks and investors) they are not done in consultation with accountants and are typically overly optimistic and incomplete. There will be no provision for slow payments by debtors, cost overruns, bad debts or losses in the first few months. Profit is not of major concern as none was expected in the first few periods, but the losses are not covered by capital, they are covered by debt. Growth of turnover is considered all important but the cost of making these sales, especially by discounting, is not fully understood. No two business failures are identical so not all of the elements will be found in every case. But when you see enough failures patterns start to appear. We believe that the ‘Five Phases to Failure’ can provide useful benchmarks for struggling businesses. Used as an early warning system, they may save some businesses from insolvency as business owners will identify the deterioration of their financial position early enough to take proactive action. A failing business may display characteristics from more than one phase at one time and they may spend a little or a lot of time in each phase. These are not definite steps that can be predicted with any certainty to appear and last for definite periods. They are more like road signs that indicate the direction of a business failure journey. During this phase we can expect to see: 1. CONFIDENT PHASE (THE RISE) 3.Suppliers offering discounts and credit to win supply contracts. The first phase occurs with the opening of the business and during the early periods of trading. Business owners are full of confidence when they start trading. They have high expectations about how the business will perform and exude enthusiasm, and this will blind some to seemingly obvious pitfalls. Many people starting businesses will have no business experience and little or no knowledge of budgeting, accounting or financial management. They may not seek advice in the early stages. Yet they are confident of success. Turnover builds during these early days as customers take advantage of opening specials. New suppliers give generous discounts and extended terms to secure the new customer and the owners will probably sign credit applications and guarantees. Financial information is prepared, if not analysed in any detail, and expansion plans are made to fulfill the expected continued growth. RELATED TOPICS Every year thousands of businesses open their doors and commence trading. Many of these businesses will fail in the first few years, some will fail in the years after that, and only a few will prosper and survive in the long term. This is by no means a new phenomenon and the statistics change very little from year to year. 1.Good trading with a reasonable demand for the product or services offered. 2.Increasing turnover. New business is won at the expense of more established competitors, mainly by discounting. 4.The business products and the staff are innovative and ahead of competitors. 5.Directors willing to sign personal obligations and guarantees. 6.Financial statements and budgets are prepared, although not necessarily thoroughly analysed. 7. New premises and/or plant are brought online. 8.Expansion and trading are often being funded on finance, because of limited capital. 9.Growth of turnover is considered all important but the cost of making these sales is not fully understood. 10. Regular drawings by owners. 11.Great plans for future expansion being confidently discussed. 12. Staff bonuses and incentives are offered. WORRELLS.NET.AU 58 INDICATORS 5 PHASES OFOF FAILURE INSOLVENCY CONTINUED Some business owners realise that this period will end and seek advice from their accountants. Their accountants help them prepare for the inevitable start of phase two by keeping a realistic view of the level of sales, ensuring that overheads are kept under control and that sufficient capital is available when required. Phase two is where the future of many businesses is decided. 2. CONSOLIDATION PHASE (THE PLATEAU) Eventually the honeymoon period ends and things settle down. Sales now have to be won from established competitors that are already adjusting to the new player in the market and heavy discounting is no longer an affordable option. The effects of competition begin to be felt, as existing players bring their operations up to date and start actively competing for business. The owners recognise that to succeed it is not simply good enough to be new and energetic, it is also necessary to be disciplined, knowledgeable and pragmatic. Financiers, customers and suppliers need to be constantly reassured about the strengths of the business, its products, service and finances. Suppliers will end their discounts and extended terms and now require payment. Some customers, having tried the new business and taken advantage of the discounts, will go back to their regular suppliers so sales will start to drop. The first question is, now that sales have stabilized or have declined from the initial period, is whether the business is profitable on the bottom line? Many businesses still have a gross profit, but cannot meet overheads. This affects under-capitalised business very quickly. The second question is whether profits are sufficient to repay any losses incurred in the opening phase of the business, as these losses are currently supported by suppliers and the bank. To counter this problem, some people will make sales on extended terms or to anyone that will place an order, resulting in slow payments and bad debts. The difference between sales, profits and cash flow needs to be recognised. At this point some businesses adapt to the new conditions and remain profitable and some do not. The ones that do not will find new business harder to win. Financiers and investors will pay closer attention to the declining results and banks will notice the ever increasing overdraft balance. Financial information may be produced, but the owners may not have the skills or knowledge to interpret and evolve a survival strategy. Importantly many of them will still not get advice, and when they do, some advisors will not want to deliver bad news. Left alone, profits will reduce or disappear and cash flow will tighten. Confidence and enthusiasm will start to decline. Many businesses will stay in this phase for long periods, struggling to survive. Those that don’t adapt to the new conditions can expect to see: > Sales getting harder to win and increased competition. > Turnover becoming stagnant or reducing for two or more consecutive periods. > Current asset ratio weakening. > Closer attention from the bank and investors. > Margins being squeezed as suppliers end their early discounts and prices have to be dropped to get sales. > Credit being harder to obtain from suppliers who require guarantees from directors. > A n intermittent inability to meet all commitments the overdraft balance increases. > Grand plans quietly downgraded to more realistic levels or are dropped entirely. > Uncertainty about the business’ ability to trade profitably in the future. > Preparation of financial statements becoming less regular and less rigorous. > Directors and owners becoming less enthusiastic. > Long periods being spent on managing cash flow rather than managing profit. Business owners who understand the trading results or seek advice from their accountants or trade groups will build on their foundations of budgets and capital and survive. But those who cannot or will not rethink and adapt their business model eventually advance to the third phase. 59 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS INDICATORS 5 PHASES OF INSOLVENCY OF FAILURE CONTINUED 2 A business in the debt phase is usually characterised by: Tough trading conditions have led to real financial problems. A steady decline will continue until the business closes or sufficient bottom line profits are earned to cover past losses. The limited initial working capital would have been used up and cash flow is now entirely supplied by creditors, including the Australian Taxation Office (ATO) and banks. The injection of further capital without making the business profitable just delays the inevitable failure. > Creative accounting being used for reporting to banks and investors. Cash flow problems cause a series of other problems. The lack of working capital and continued losses mean that some debts are not being paid. Some creditors will now not supply further credit and only trade on a cash on delivery (COD) basis, plus they will require partial payments of old debt with payments for new orders. This makes cash flow even worse. Getting sufficient stock becomes a problem causing customers to shop elsewhere – compounding the problem with lower sales. Business owners may use creative accounting when dealing with financiers and investors. Preparation of financial statements becomes intermittent and advice from accountants and bankers is generally ignored. All planning is done on a day to day survival basis. Some owners are solely concerned with getting enough money to pay the more urgent debt, borrowing from anyone that will lend or from family members, or selling or mortgaging houses to obtain cash injections. The business is technically insolvent and insolvent trading is now an issue for company directors. The business must be made profitable before the problem of past losses can be solved. Profits may enable a company to propose a deed of company arrangement, and a sole practitioner to propose a personal insolvency agreement. These will provide some time for past debts to be paid without the threat of winding up or bankruptcy. Importantly, people take the stress home causing problems in their family life, particularly when they have borrowed money from family members. Businesses owners are now risking more than just money and assets. > Spending is reduced on non-core activities i.e. marketing. > Further and greater use of ATO funds and failure to remit superannuation monies. > Further slippage in turnover, margins and profits. RELATED TOPICS 3. DEBT PHASE (THE DECLINE) > Quality customers are lost as they find more stable suppliers. > A need for longer term ‘arrangements’ with some creditors. > Some suppliers only supplying on COD basis. > Planning is done on a day by day survival basis. > Accountants consulted but advice generally ignored. > Internal systems and controls begin to break down. > Management’s main preoccupation is demands from creditors. > Insolvent trading is now an issue for company directors. Some people will now admit that there is a problem and will seek help. This is a big step towards survival, but no guarantee that the business will survive. Sometimes advisors can only control the crash as the business fails and attempt to reduce the damage. But some will not seek advice and they will end up in the fourth phase. 4. DENIAL PHASE Ultimately businesses are run by people and now human nature plays a major role in their future. Some people will reach the denial phase. They will continue to trade, justifying their actions in the belief that a solution is just around the corner, or that next month’s trading will be better. No amount of financial statements or cash flow projections will make them change their minds. Their accountants may convince them to talk to advisors, but they leave the meeting adamant that any problems will work themselves out. Other people see the situation differently. Employees begin to look for more secure employment. Financiers and investors make demands to try to reduce their exposure. Creditors start issuing proceedings and the remaining customers look for a more reliable supplier. Almost no WORRELLS.NET.AU 60 5 PHASES OF FAILURE CONTINUED financial statements are prepared and bad results are not believed. Owners do not know the extent of outstanding debts, and tax and superannuation has not been paid for some months. Cash flow is entirely dependent upon debtors making payments as all other sources of money, both personal and borrowed, are exhausted. Blame is laid on everyone else (accountants, bankers and solicitors included). The only thing that advisors can do is keep putting the facts and figures to the business owners and ensure that their own professional obligations are fulfilled, and hope that the business owner will start to believe that there is a problem. Some will come to that conclusion and appoint the necessary people to handle the business. Some will not. For them, this phase generally ends when director penalty notices are received from the ATO or legal proceedings are served by creditors. This is reflected in: > A belief that problems that exist can be overcome relatively simply. Wishful thinking is the order of the day. > Greater losses are incurred but the true extent is not acknowledged or known. > Management’s time allocated to non-core activities. 5. THE COLLAPSE Denial is superseded by reality. Reality may come quickly with the appointment of a liquidator or bankruptcy trustee, or come slowly as all sources of money are extinguished, remaining staff leave and the doors eventually close. All working capital is long gone and owners start to look to protect their personal positions through asset protection strategies set up at the commencement of trading. Goodwill is non-existent, the landlord is changing the locks and the banks have cut off the overdraft. Creditor support has ended and customers have no faith in the business. Owners start to discover the extent of the debts and the number of personal guarantees they signed during the early days. Liquidation and bankruptcy are terms now used in daily conversation. This is where some people finally realise that they need help, but often it is too late to save the business. The best that accountants or insolvency practitioners may be able to do is control the financial crash. By this time there is little likelihood of saving the business, even under a deed of company arrangement or personal insolvency agreement. It may be that this course of action will enable the debtor to avoid bankruptcy. > Bank and investor relations make demands to reduce their exposure. In this phase we expect to see: > Management shows signs of complacency or arrogance. > Non-adherence to any payment arrangements with the ATO. > Blame for the situation is laid on everyone else. > Directors and proprietors look to protecting themselves. > Preparation of any financial statements is all but abandoned. > All working capital has been exhausted. > Goodwill is lost. > Demands from creditors are ignored and proceedings are issued. > Bank and investors are not interested in further extensions. > A refusal to recognise the existence of bad debts and redundant stock. > Insufficient funds are available to pay wages, rent, or chattel leases. > It becomes difficult to get supply on credit or at a reasonable cost. > The ATO issues director penalty notices. > Management becomes unavailable to make decisions, or if decisions are made, they are regularly countermanded. > Current asset ratio likely to be less than 0.5. This is where many business owners first seek advice from their accountants and solicitors, and when the only realistic advice is to see an insolvency practitioner. > Administrators appointed and are expected to work miracles with virtually no working capital or reliable information. > Creditors fail to accept the director’s proposal or trading on and the business is closed. > Sole proprietors become bankrupt. 61 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS 5 PHASES OF FAILURE CONTINUED > Family situations reach a crisis stage, often leading to separation and divorce. CONCLUSION How do business owners get a business off this road to failure? Sometimes there are no solutions. A business that is not profitable may survive on injections of funds alone, but eventually those funds have to run out. Some businesses simply do not have a large enough profitable market or an appropriately formed business model to survive, regardless of any actions taken or capital invested. Sometimes the business just will not work despite the effort and money invested into it. RELATED TOPICS > Directors are subject to demands from guaranteed creditors and insolvent trading claims from liquidators, resulting in bankruptcy. 2 Business decisions are made by people and to start the recovery process these people have to admit that there is a problem, make some tough decisions and be willing to take corrective action. Some people just will not do it in time to make a difference, and time is usually critical. Those who do make the tough decisions will generally achieve a much better outcome for themselves and their families. The first step is to get an experienced accountant to prepare accurate and up to date financial statements. Using these statements, management should work with the accountant in the preparation of a realistic business plan and meaningful budgets. It is imperative for management to be fully informed and to look at the position objectively. It may be necessary to involve an insolvency practitioner, especially if help is desirable with managing creditors, or if it is clear that the business’ difficulties are more than a short term cash flow problem. WORRELLS.NET.AU 62 PROOFS OF DEBT AND SECURED CREDITORS WHAT IS A SECURED CREDITOR? A secured creditor is one that has been granted a security or charge over assets to protect their outstanding debt. This guide deals with how and when a secured creditor may lodge a proof of debt in relation to their debt, or the unsecured part of their debt. WHICH ASSETS FALL UNDER THE SECURITY? Almost any asset may be secured under an appropriate charge, but only assets that are actually secured under a charge will be available to the secured creditor. The security will identify the assets that it covers or will detail the classes of assets that are subject to the security. WHAT CAN THE SECURED CREDITOR DO WITH THE ASSETS SECURED? If the credit agreement with the secured creditor has been breached, they may take control of the assets covered by their charge. They are not entitled to take control over assets not covered by their charge. In the majority of cases, the secured creditor will sell the assets and keep sufficient monies to satisfy their secured debts and costs of enforcing their charge. They will refund the balance to the debtor. HOW IS THE SECURED CREDITOR AFFECTED IF THE DEBTOR IS IN LIQUIDATION OR BANKRUPTCY? The rights of a secured creditor are usually not affected by the appointment of a liquidator or bankruptcy trustee. But there are certain times when a security will be unenforceable. WHAT IF THERE IS A SHORTFALL AFTER THE SALE OF THE ASSETS? DO THE ASSETS HAVE TO BE SOLD BEFORE THEY CAN LODGE A PROOF OF DEBT? No. The secured creditor may lodge a proof of debt for the estimated shortfall by estimating the value of the unsold secured assets and deducting that amount from the amount owed. A secured creditor will then be entitled to vote on and receive dividends for that estimated shortfall, but in exercising their rights without due consideration of the consequences it may backfire unfavourably. ESTIMATING A SHORTFALL To be able to lodge a proof of debt for an estimated shortfall, the secured creditor will have to estimate the value of the assets held under the security. The estimated value is declared on the proof of debt form along with the full amount of the debt and the calculated shortfall. The secured creditor may consider creating a safety net to ensure maximum return by using a low estimate of the value of the remaining assets - making the shortfall as large as possible, so the shortfall and any dividend paid on that shortfall is high. But there are consequences for placing a deliberately low estimate on secured assets and these are outlined below. REDEMPTION OF SECURITY Both liquidators and bankruptcy trustees have a right to redeem securities by paying out the estimated value as stated on the secured creditor’s proof of debt. So when a secured creditor undervalues the secured assets to make their shortfall large, the liquidator or trustee may pay them that low amount and release the asset from the charge. Secured creditors will lose their right to the true value of the asset and will only be able to prove for the shortfall. Any shortfall after the sale of secured assets under the charge can be quantified and proved in the estate. The secured creditor may simply lodge a proof of debt for the shortfall in the appropriate insolvent estate and participate in any dividend with other creditors. 63 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS PROOFS OF DEBT AND SECURED CREDITORS CONTINUED 2 DEEMED SURRENDERING OF SECURITY If the liquidator or trustee does not or cannot redeem the security by paying out the amount estimated, they may require that the asset be placed for sale. The sale will realise the asset and quantify any shortfall owing to the secured creditor. A secured creditor may choose to intentionally surrender their security and prove for the whole amount of their debt in the estate. AMENDING THE ESTIMATE BY REQUEST The value of the asset secured may alter over time for many reasons. If this occurs, the secured creditor may apply to the liquidator, trustee or the court to amend the estimated value of the asset on their proof of debt. If the liquidator, trustee or court is satisfied that the original value was made under a genuine error or the value has changed since the estimate was made, they may allow the creditor to amend the estimate. Secured creditors may also be deemed to have surrendered their security if they vote for the whole of their debt at a meeting of creditors (the exception being voluntary administration meetings). If the security is deemed surrendered, they lose all rights to the assets secured under the charge. Secured creditors should exercise care when voting at meetings they only vote for their shortfall (estimated or actual). RELATED TOPICS ENFORCED SALE OF ASSET(S) AMENDING THE ESTIMATE BY SALE If the asset is sold after the estimate is made, the amount realised in the sale is automatically exchanged for the estimate made by the secured creditor. HOW DOES AN AMENDMENT OF THE VALUE AFFECT DIVIDENDS PAID BEFORE THE AMENDMENT? A change in the estimated value may happen after a dividend has been paid to the secured creditor. Increasing the value of an estimate (lowering the shortfall and therefore reducing the amount of the proof of debt) will mean that the secured creditor would have received too much in their dividend and they will have to pay back the excess amount. Lowering the value of an estimate (raising the shortfall and the amount of the proof of debt) will entitle the creditor to a further (catch up) dividend if further dividends are paid. WORRELLS.NET.AU 64 MEETINGS OF CREDITORS WHY ARE MEETINGS OF CREDITORS CALLED? WHO MAY CALL A MEETING OF CREDITORS? Meetings are held so that creditors can find out the status of an estate, ask questions, give suggestions about how the file is handled and approve the appointee’s remuneration. The Bankruptcy Act outlines the rules about how and when meetings are to be called and run, as well as how issues are to be decided at the meeting. Only the trustee in bankruptcy can call meetings of creditors. A trustee in bankruptcy may call meetings at any time, but must call meetings when: WHAT ARE THE BASIC STEPS? The meeting process is similar to most other organised meetings of clubs, associations or corporations. There is a logical order to the events surrounding the meeting and certain things must be done before, during and after the meeting. 1.Creditors should receive adequate notice of the time and place of the meeting. They should be given a report that contains all of the information needed for them to make informed decisions on the matters to be discussed and resolutions being put to that meeting. > Whenever the creditors so direct by resolution; and > Whenever so requested in writing by at least 25% of the value of creditors; > Whenever so requested in writing by less than 25% of the value of creditors, where creditors have lodged sufficient security for the costs of the meeting. WHAT PERIOD OF NOTICE MUST BE GIVEN? The period of notice is prescribed by the Acts and varies dependent upon the type of meeting being called. It is usually about 14 days but some meetings, particularly voluntary administration meetings, have shorter notice periods. WHAT SHOULD BE SENT TO CREDITORS WHEN A MEETING IS CALLED? The following should be sent to creditors: 2. The meeting should be run according to a formal agenda set out in the notice of meeting. > A notice calling the meeting and setting out the agenda for the meeting; 3. The president (chairperson) of the meeting will be elected by those attending. > Particulars of any resolutions that are to be dealt with at that meeting and sufficient information in order to make an informed decision on the resolution; 4. Resolutions will be decided by a vote of those creditors attending the meeting and who are entitled to vote. Resolutions are determined in favour of the prescribed majority. What constitutes a majority may differ according to the type of meeting or the type of resolution sought. 5. The participants may adjourn the meeting by putting forward a motion to that effect and having the resolution ‘passed’ by the creditors. 6. All matters during a meeting will be recorded as minutes of the meeting and distributed within the prescribed time. > A proof of debt form; and > A proxy form and if applicable a voting slip. Creditors should obtain any missing documents from the external administrator who is calling the meeting. WILL A REPORT TO CREDITORS BE ISSUED? A report from the external administrator will generally accompany the notice of meeting and the other documents. The report should outline the current position of the estate and the investigations undertaken contain details about further examinations and the potential actions to be taken by the external administrator, all relevant information and recommendations on any decisions that are to be made at the meeting. 65 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS MEETINGS OF CREDITORS CONTINUED No. Creditors do not lose any rights to prove for dividends if they do not attend meetings. However they will not have a say in the conduct of the estate nor on any resolution. It is prudent to encourage creditors to at least attend by proxy to ensure that a quorum is formed and the meeting can proceed without adjournment. WHERE AND WHEN ARE MEETINGS HELD? Meetings should be held at a time and place convenient to the majority of the creditors. A convenient time is generally during business hours on a normal business day. A convenient place is generally in the town or city centre where a majority in number of the creditors conduct their business. WHO RUNS THE MEETING? A chairperson or a president runs the meeting. A president must be chosen to control meetings called under the Bankruptcy Act. The president can be anyone at that meeting, but is usually the trustee or some person associated with the trustee as they have experience in conducting meetings. Some of the actions taken and decisions made may not be enforceable if they are not handled in the technically correct manner, so it is beneficial to have an experienced person control the meeting. IS THERE AN AGENDA? > Submit a claim before or at the commencement of a meeting and have it noted on the register of attendance; and > If the claim is not admitted for any reason, make sure an objection is noted in the minutes. DO CREDITORS HAVE TO LODGE A PROOF OF DEBT TO BE ABLE TO VOTE? For meetings under the Bankruptcy Act; no - section 64D provides that a written statement setting out the claim is advisable, but it is not necessary for a proof of debt to be lodged. RELATED TOPICS DO CREDITORS NEED TO ATTEND MEETINGS? 2 HOW IS A PROOF OF DEBT ADMITTED? The external administrator will decide whether or not to admit the proofs of debt or claim for voting by examining the material attached to the proof of debt and comparing it to the information contained in the company records. The decision is final at the meeting but can be challenged in the court after the meeting has been held. If such a challenge is successful, the outcome of the meeting itself may be challenged if the use or otherwise of that claim would have definitely changed the outcome of the meeting. If a claim is rejected, the creditor should have a statement read into the minutes disagreeing with the decision and reserving the right to challenge the decision in an appropriate forum. At this point however, there is nothing more that the creditor can do to influence the meeting, but they may remain in attendance until the meeting is closed. Yes. Only the matters on the agenda can be decided upon at the meeting. The agenda is generally set by the relevant Act but may be amended. The agenda should be set out in the notice of meeting issued to creditors. WHEN SHOULD CREDITORS LODGE THEIR CLAIMS? Creditors should lodge a claim prior to or at the meeting otherwise creditors will not be able to vote at the meeting, as only creditors who have proved that they are owed creditors in the estate may vote. Creditors should follow these rules: > Attach copies of invoices or other documentation detailing the amount owed and how it arose, or indicate that these records are available if required to prove the debt; WORRELLS.NET.AU 66 MEETINGS OF CREDITORS CONTINUED CAN CREDITORS ASK QUESTIONS? Yes. A meeting of creditors is a forum for creditors to ask questions. Questions should always be addressed to the chairperson or president, who in turn will put the question directly to the relevant person if required. Alternatively, creditors may ask questions of the chairperson, trustee or liquidator directly. HOW CAN CREDITORS ATTEND THE MEETING? Creditors will have to decide how to attend a meeting. They may attend in person, by proxy or attorney, or by participating over the phone. The distinction between a proxy and an attorney is that a proxy will usually only vote in accordance with instructions and directions given to them. An attorney can decide how to vote, and can respond to changing circumstances during a meeting. WHO CAN BE A PROXY? Almost anyone over the age of 18 can act as a proxy. HOW ARE RESOLUTIONS DECIDED? A vote of creditors is called a resolution - the creditors resolving a proposal or motion. Most resolutions are ordinary resolutions, which under the Bankruptcy Act requires a simple majority in value only. There are provisions for some proposals at meetings to require a ‘special resolution’, being more than 50% in number and 75% in value. CAN RESOLUTIONS BE PASSED WITHOUT A PHYSICAL MEETING? Though there are no corresponding virtual meeting provisions in the Corporations Act, effectively meetings can be held with only proxies and special proxies being held in the name of the chairman, and with no creditor physically attending the meeting. The result is one or more resolutions passed without a ‘physical’ meeting of people. CAN MEETINGS BE ADJOURNED? Yes. Anyone may propose a resolution for an adjournment of the meeting. At times the chairperson or president may adjourn the meeting to better consider proofs of debt and voting rights. The type of meeting will determine the maximum time period allowed for any adjournment. WHO WILL KEEP THE MINUTES? Minutes are kept by a minutes secretary. The Corporations Regulations provide that the chairperson must cause minutes to be filed and they will determine who will be the minutes secretary. The Bankruptcy Act requires creditors to appoint the minutes secretary. It will usually be a staff member of the trustee. Minutes of the meeting called under the Corporations Act will be lodged with the Australian Securities & Investments Commission (ASIC) within the appropriate time period. Worrells also lodge the minutes on the estate’s file information page on our website, which is not a requirement under legislation. Meetings under the Bankruptcy Act are not formally lodged with Insolvency and Trustee Service Australia (ITSA), but are lodged on the estate’s file information page. The Bankruptcy Act allows single resolutions to be passed by creditors without a meeting being called. This is known as a virtual meeting. Voting is done through the mail with creditors indicating their acceptance or rejection of the motion, or they can object to the vote being taken in that format and request a meeting to be called to decide the matter. There is currently no corresponding provision in the Corporations Act. 67 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS DIVIDENDS Dividends are the logical end to most insolvency appointments. But they can cause a delay in finalising the estate due to the need to follow the legal process, adhere to statutory time limits and conduct the examinations necessary to admit or reject proofs of debt as appropriate. The minimum time periods to pay dividends are defined in the Bankruptcy Act. If there are no complications, a dividend will take about two months to distribute. The tasks that commonly give rise to complications and time delays are the admittance of proofs of debt. These may defer the dividend for some time, especially if the rejection of a proof of debt is appealed in the courts. DIVIDENDS IN DETAIL The payment of dividends is often the only real tangible output from insolvent estates, though often even this result is not possible. Sometimes there are simply no assets to realise and no funds to distribute. The Bankruptcy Act sets out the obligation to pay dividends as quickly as practical. In practice the trustee will have to withhold sufficient monies to complete the remaining work required in the estate. They will also determine the most appropriate time to pay dividends given further anticipated realisations - if any - and the costs of paying multiple smaller dividends. 3.Rejecting proofs of debt where appropriate - to ensure that only legitimate creditors of the estate participate in the dividend distribution. 4. Paying the dividend - distributing the funds. 1. CALLING FOR PROOFS OF DEBT All creditors must be given the opportunity to lodge their claim in the form of a proof of debt. So the first step is calling for proofs of debt from all known creditors. A proof of debt is a formal document used to make a claim in the estate, which demonstrates that a debt exists and sets out the particulars of the debt. Without sufficient proof that the debt exists, it will not be admitted for the amount stated, or potentially not at all. The proof of debt form is specific to the Bankruptcy Act requirements. The correct form needs to be used in order to participate in a dividend. The trustee may not be able to admit claims that are not sufficiently detailed on the correct form, which may result in the creditor being excluded from the dividend. Creditors can lodge proofs of debt at any stage in the administration; they do not need to wait until a dividend is called. In theory once a creditor has lodged a proof of debt, they need not lodge another. But creditors should ensure that their claim has been lodged and appears in any list of proof of debts received. If they are in doubt, they should lodge another. The trustee cannot just pay out money to anyone in any manner. Dividends must be declared in accordance with the steps set out in the Bankruptcy Act and dividends must be paid to creditors in a certain order under various priorities. TIME PERIODS FOR CALLING FOR PROOFS OF DEBT STEPS IN PAYING DIVIDENDS The period that must be given to lodge proofs of debt under the Bankruptcy Act it is defined as a ‘reasonable period’. Usually a 21 day period is used under the Bankruptcy Act on the basis that, if it is deemed reasonable under the Corporations Act it should therefore be reasonable under the Bankruptcy Act. There are four basic steps that must be followed to pay a dividend. These steps are: 1.Calling for proofs of debt - giving every known creditor the opportunity to lodge a claim (proof of debt) in the estate and participate in the dividend distribution. RELATED TOPICS INTRODUCTION 2 The appointee must formally notify all known or potential creditors of the intended dividend distribution and request that proofs of debt be lodged by a certain date. 2.Admitting proofs of debt - verifying that the debt is proper to the satisfaction of the trustee. WORRELLS.NET.AU 68 DIVIDENDS CONTINUED It is important to have definite time periods in which to lodge claims so that the payment of the dividend is not delayed or challenged due to the lodgement of claims as cheques are being drawn. The cut-off date is final and the provisions stipulate both creditors and trustees rights if a proof of debt is not lodged within the time period. NOTICES TO BE ISSUED The Bankruptcy Act does not require any advertising of the dividend, though it is sometimes done. It only requires that a notice is sent to all known creditors who have not lodged proofs of debt. Again common practice is to send a notice to all creditors and provide an update on the estate. Occasionally a trustee will advertise a personal insolvency dividend when they suspect that there may be creditors that have not been disclosed; particularly when a Statement of Affairs has not been lodged and an application will have to be made to the court to pay the dividend. DATES FOR PAYMENT The Bankruptcy Act does not set a maximum time period after the intended date of declaring a dividend, but says that dividends must not be paid before 21 days after the lodgement date for proofs of debt. Therefore the trustee will have to wait about 21 days to receive proofs of debt, and without further complication, wait another 21 days after that before they can issue dividend cheques. NON-LODGEMENT OF PROOF OF DEBT There has to be a mechanism to close the proof of debt register at a certain time so that the dividend can be paid without being challenged. The Bankruptcy Act says that if creditors do not lodge their proofs of debt within the specific period, they will be excluded from that dividend. If there are sufficient funds to pay a further dividend at a later date, these creditors may lodge their proofs of debt and be paid the original dividend they missed out on (a catch-up dividend), and then participate in the next dividend. If there are not sufficient funds available to pay a second dividend (a second dividend is never declared), they will not receive a dividend at all. Hence it is imperative for creditors to lodge their proofs of debt before the expiry of the initial lodgement period. The Bankruptcy Act sets these provisions out in section 144. BANKRUPTCY ACT 1966 - SECTION 144 Right of creditor who has not proved debt before declaration of dividend A creditor who has not proved his or her debt before the declaration of a dividend is entitled to be paid, out of any available money for the time being in the hands of the trustee, dividends that he or she has failed to receive before that money is applied to the payment of a future dividend, but he or she is not entitled to disturb the distribution of a dividend declared before he or she proved his or her debt. 2. ADMITTING PROOFS OF DEBT Before a dividend can be paid on any proof of debt, it must be admitted. This is a different process to having a proof of debt admitted for voting purposes at a meeting of creditors. It is not always the case that proofs of debt admitted at meetings will be admitted for dividends as the burden of proof is different. The time available to consider a proof of debt is also different in both cases, as some proofs of debt are lodged at the start of the meeting when there is no time for appointees to properly consider the claim. Such reviews may be necessary for admittance for dividends. The important point to make here is that the burden of proving the existence and amount of a claim lies on the creditor making the claim. The onus is not on the trustee to disprove a claim. Section 83 sets out the requirement. BANKRUPTCY ACT 1966 - SECTION 83 Debt not to be considered proved until admitted For the purposes of this Act, a creditor shall be taken not to have proved a debt until a proof of debt lodged by him or her in respect of that debt has been admitted. The trustee will make an assessment of the material provided by the creditor and decide on the correctness or validity and the amount of the debt. If they believe that all or part of the debt is not fully proved, they will seek further clarification and material from the creditor. If they cannot obtain that clarification, they may reject the proof of debt in full or in part. 69 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS DIVIDENDS CONTINUED The trustee will only have to assess the material attached to the proof of debt and information in the available records. Creditors should ensure that they attach copies of all appropriate documentation (invoices and statements) to their proof of debt when it is initially lodged. They should keep the originals themselves, in case they are needed later or the copies are lost. Section 140 of the Bankruptcy Act provides that a dividend cannot be paid before 21 days after the lodgement date. This time is used to examine the proofs of debt that have been lodged. The Bankruptcy Act also sets a 14 day time period for the trustee to admit, reject or otherwise deal with the claim. Having the appeal heard by the court may delay the payment of a dividend. Unfortunately, the time period for this process is governed by the availability of the courts. The Bankruptcy Act contains these provisions in section 102. BANKRUPTCY ACT 1966 - SECTION 102 Admission or rejection of proofs (1) The trustee shall examine each proof of debt and the grounds of the debt sought to be proved and, subject to the power of the Court to extend the time, shall, not later than 14 days after the expiration of the period specified in the notice of intention to declare a dividend as the period within which creditors may lodge their proofs of debt, either: (a) admit the proof of debt in whole; (b) admit it in part and reject it in part; In that time period, the trustee will have three options: (c) reject it in whole; or 1.To admit the proof of debt, which can be done if sufficient information is attached to the proof; (d) require further evidence in support of it. 3. To request further information. (2) Where the trustee rejects a proof of debt in whole or in part, he or she shall inform the creditor by whom it was lodged, in writing, of the grounds of the rejection. 3. REJECTING PROOFS OF DEBT APPEALS AGAINST TRUSTEE’S DECISION The onus of proving that they have a valid claim lies with the creditor. If the material attached to the proof of debt does not sufficiently prove that a debt exists in the stated amount, the practitioner will not be able to admit the claim or some part of the claim. Two options are then available: Creditors have the right to have the decision to reject their proof of debt reviewed by the court. Creditors’ rights are set out section 104 of the Bankruptcy Act. Even if a proof of debt is rejected, the liquidator or trustee may amend that decision upon the provision of better information, if the information is provided within the required time period. 2.To reject the proof of debt, if there is no doubt that the debt is either fully or partially not provable; or 1.Ask the creditor for further information to make a better determination (which is the usual case); or 2.Reject the proof of debt in full or in part (usually done if better information is not forthcoming). Rejecting a proof of debt is done when the creditor either will not or cannot provide sufficient information to prove that they have a valid claim in the stated amount. The notice of rejection will set out the particulars of the claim that are rejected and the reasons for rejection. The creditor has a right to appeal the rejection of their proof of debt and have the court decide whether the proof should be admitted or not. RELATED TOPICS The bottom line is that creditors must provide sufficient proof to show that the claim should be admitted for dividends. It is not up to the liquidator or trustee to try to locate sufficient information. 2 However, if a proof of debt is formally rejected, creditors must be aware that they have a limited time period to apply to the court for adjudication. Even if they are furnishing better information to the liquidator or trustee, they must be mindful that this time period is expiring. The court may allow an application after the time period expires, but creditors should not assume that the court will do so. There are strict time limits for seeking such relief and these will be set out in the notice of rejection. If the application for the review of the decision is not made WORRELLS.NET.AU 70 DIVIDENDS CONTINUED within that time period, the court will generally not hear the appeal. We would always suggest that creditors seek legal advice as soon as a rejection is received. BANKRUPTCY ACT 1966 - SECTION 104 Appeal against decision of trustee in respect of proof (1) A creditor, or the bankrupt, may apply to the Court for review of a decision of the trustee under subsection 102(1), (3) or (4) in respect of a proof of debt. (2) The Court may, upon the application, confirm, reverse or vary the decision of the trustee. (3) Subject to the power of the Court to extend the time, an application under this section to review a decision shall not be heard by the Court unless it was made within 21 days from the date on which the decision was made. The onus of proving to the court that the claim should be admitted lies with the creditor. They have to show that the decision to reject the claim was incorrect based on the information that was provided to the practitioner. REVOKING A DECISION TO OBJECT There are times when the trustee will decide that their rejection or admittance of a proof of debt should be reversed. In some cases the reversal may only be partial, with a part of the debt being rejected or admitted after the initial assessment. The Bankruptcy Act sets out this right in section 102. BANKRUPTCY ACT 1966 - SECTION 102 Admission or rejection of proofs (3) Where the trustee considers that a proof of debt has been wrongly admitted, he or she may: (a) revoke the decision to admit the proof of debt and reject it in whole; or (b) amend the decision to admit the proof of debt by increasing or reducing the amount of the admitted debt. Once the appointee has made that decision and amended their initial decision, they will have to give notice to that creditor of their new decision and if appropriate, make adjustments to the dividend to be paid or in some cases pay a catch up dividend. 4. PAYMENT OF DIVIDENDS The last step in the process is the physical payment of the dividend. This happens after the proof of debt lodgement date has expired, all of the proofs of debt have all been admitted or rejected and any appeals have been heard. The appointee will forward a cheque to the creditor along with a Form 2 for personal insolvencies. If dividend cheques are not banked within a reasonable time period or if creditors cannot be located, the monies will be held by the external administrator for a period of six months after the date of payment, and then forwarded to the appropriate government authority. After this time the creditor will then have to seek the money from that authority. PRIORITIES IN THE PAYMENT OF DIVIDENDS It is a standard concept that all creditors will rank equally in insolvent estates and will be paid ‘pro-rata’ dividends. This concept is set in statute in the following section. BANKRUPTCY ACT 1966 - SECTION 108 Debts proved to rank equally except as otherwise provided Except as otherwise provided by this Act, all debts proved in a bankruptcy rank equally and, if the proceeds of the property of the bankrupt are insufficient to meet them in full, they shall be paid proportionately. But from a practical point this is not always the case. The Bankruptcy Act sets out an order for the priorities of payment of dividends under section 109, but only gives a limited priority to outstanding employee wages and no priority to retrenchments payments. (4) Where the trustee considers that a proof of debt has been wrongly rejected in whole, he or she may: (a) revoke the decision to reject the proof of debt; and (b) admit the proof of debt in whole or admit the proof of debt in part and reject it in part. 71 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS DIVIDENDS CONTINUED 2 BANKRUPTCY ACT 1966 - SECTION 110 Priority payments Application of estates of joint debtors (e) fifth, in payment of amounts (including amounts payable by way of allowance or reimbursement under a contract of employment or under an award or agreement regulating conditions of employment, but not including amounts in respect of long service leave, extended leave, annual leave, recreation leave or sick leave), not exceeding in the case of any one employee $1,500 or such greater amount as is prescribed by the regulations for the purposes of this paragraph, due to or in respect of any employee of the bankrupt, whether remunerated by salary, wages, commission or otherwise, in respect of services rendered to or for the bankrupt before the date of the bankruptcy; (1) In the case of joint debtors, whether partners or not, the joint estate shall be applied in the first instance in payment of their joint debts, and the separate estate of each joint debtor shall be applied in the first instance in payment of his or her separate debts. (g) seventh, in payment of all amounts due to or in respect of any employee of the bankrupt, whether remunerated by salary, wages, commission or otherwise, in respect of long service leave, extended leave, annual leave, recreation leave or sick leave in respect of a period before the date of the bankruptcy; To assist the trustee, the employee creditor should clearly indicate whether they are claiming as an employee and use the required proof of debt forms for that purpose. JOINT BANKRUPTCY ESTATES The Bankruptcy Act has a provision for joint and separate estates. This occurs when two or more bankrupts have joint and several assets and liabilities. For example, bankrupt business partners will have partnership assets (joint) that are held together and individual assets held separately. They may also have individual and joint creditors. The question is how are joint and individual assets to be divided amongst the joint and individual creditors in bankrupt estates? In the first instance, joint assets are used to pay joint creditors, and each bankrupt’s individual assets are used to pay each bankrupt’s individual creditors. In some cases there are no surplus assets in either of these different estates and the matter can end there. (2) If there is a surplus in the case of any of the separate estates, it shall be dealt with as part of the joint estate and if there is a surplus in the case of the joint estate, it shall be dealt with as part of the respective separate estates in proportion to the right and interest of each joint debtor in the joint estate. RELATED TOPICS BANKRUPTCY ACT 1966 - SECTION 109 The result generally is: > A ny surplus assets in an individual estate of one bankrupt can be used to pay joint creditors in the joint estate to the limit necessary to satisfy those joint claims. If there is still a surplus of assets after paying both individual and joint creditors, the bankrupt whose estate had the surplus is annulled from bankruptcy and the surplus money will be returned to them. > A ny surplus in the joint estate will be divided proportionately to the individual estates and their portion of that money can be used to pay their individual creditors. If either of the individual estates has sufficient monies to pay the individual creditors and still has a surplus, that particular bankrupt will be annulled from bankruptcy and the surplus is paid to them. Unless the other individual bankruptcy estate also has sufficient monies to pay their individual creditors, they will not be annulled. > There is no right to use surplus assets from one individual estate to pay creditors in the other individual estate. But in some cases, one estate (the joint or either or both of the individual estates) will have a surplus. How any surplus is used is answered in section 110. WORRELLS.NET.AU 72 CGT AND INSOLVENCY OVERVIEW INCOME TAX ASSESSMENT ACT 1997 - SECTION 104.10 One of the roles of an external administrator is the realisation of assets owned by the insolvent person. The sale of some of these assets could create a liability under the capital gains tax (CGT) legislation when they are sold. This is a factor that the external administrator will be concerned about, at least to a limited extent. Disposal of a CGT asset: CGT event A1 (7) CGT event A1 does not happen if the disposal of the asset was done: (a) to provide or redeem a security; or There are three main issues with capital gains tax and insolvent estates: (b) because of the vesting of the asset in a trustee under the Bankruptcy Act 1966 or under a similar foreign law; or 1.Who is responsible for the payment of capital gains realised after the appointment of an external administrator? (c) because of the vesting of the asset in a liquidator of a company, or the holder of a similar office under a foreign law. 2.What happens to capital losses available at the date of the appointment? BANKRUPTCY 3.Holding companies when a solvent wholly-owned subsidiary is wound up. 1.WHO IS RESPONSIBLE FOR CAPITAL GAINS REALISED AFTER THE APPOINTMENT OF AN EXTERNAL ADMINISTRATOR? The Income Tax Assessment Act 1997 (ITAA) includes provisions that deal with insolvent estates and capital gains, at least where the estate is a bankruptcy, a liquidation or a secured creditor taking action under a security. These provisions state that any actions or realisations taken by: > Bankruptcy trustees and part X trustees; > Liquidators; and > Other people formally acting under a security; that lead to a capital gain tax liability, are deemed to have been done by the company, bankrupt or debtor; and not by the external administrator. This means that the external administrator is not made personally liable for any CGT liability. It places the liability on the entity that originally owned the asset. The ITAA confirms that “the vesting of the individual’s CGT assets in the trustee under the Bankruptcy Act 1966 or under a similar foreign law is ignored” in relation to CGT. The provisions related to bankruptcy are: INCOME TAX ASSESSMENT ACT 1997 - SECTION 106.30 Effect of bankruptcy (1) For the purposes of this Part and Part 3-3, the vesting of the individual’s CGT assets in the trustee under the Bankruptcy Act 1966 or under a similar foreign law is ignored. (2) This Part and Part 3-3 apply to an act done in relation to a CGT asset of an individual in these circumstances as if it had been done by the individual: (a) as a result of the bankruptcy of the individual by the Official Trustee in Bankruptcy or a registered trustee, or the holder of a similar office under a foreign law; (b) by a trustee under a personal insolvency agreement made under Part X of the Bankruptcy Act 1966, or under a similar instrument under a foreign law; (c) by a trustee as a result of an arrangement with creditors under that Act or a foreign law. This process starts by looking at the ‘vesting’ or otherwise of the asset. The legislation states that the vesting of assets in a bankruptcy or liquidation, or the providing or redeeming of a security is not a disposal of a CGT asset and the beneficial owner (the estate) does not change. This is set out in section 104.10 of the ITAA. 73 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS CGT AND INSOLVENCY CONTINUED Firstly the vesting of property in the trustee is not deemed to be a disposal of the asset, so there is no capital gain tax liability automatically created from the vesting of assets. Secondly, any acts of the trustee under a part IV bankruptcy, section 73 arrangement or Part X personal insolvency agreement that give rise to a CGT liability are deemed to have been done by the individual (the bankrupt or debtor) and not the trustee. LIQUIDATION This section provides that any act by a liquidator that accrues a capital gain is deemed to be an act of the company and not the liquidator; therefore no personal liability will pass onto the liquidator. INCOME TAX ASSESSMENT ACT 1997 - SECTION 106.35 Effect of liquidation This Part and Part 3-3 apply to an act done by a liquidator of a company, or the holder of a similar office under a foreign law, as if the act had been done instead by the company. SECURED CREDITORS This section deems that acts done by people holding or appointed under security documents that accrue a capital gain are done by the entity that gave the security, not the entity that exercises the security. This also extends to a controller appointed to assist the mortgagee in exercising the security. property usually only act as agents (for the owner of the assets) with powers to sell under the security. The only thing that does change is the right of the security holder to actually sell the asset on behalf of the debtor. It is only the disposal (sale) of that asset that may create a CGT liability. EXTERNAL ADMINISTRATION SUMMARY T he appointment of a liquidator, trustee, controller; or the vesting of property and the exercising of a security does not create a deemed acquisition or disposal of a CGT asset. Without another disposal of the asset, no CGT liability will accrue to any party. Where a capital gain arises that would lead to a tax liability, the insolvency practitioner will advise the Australian Taxation Office (ATO). The ATO will then lodge a proof of debt in the estate for that liability. WHAT ABOUT VOLUNTARY ADMINISTRATORS? The position is slightly different legally, but ends with the same result. The Corporations Act provides that a voluntary administrator acts as the agent of the company and not, effectively, in their own right. Any CGT debt arising during that period will be a company debt, not a debt of the administrator. Any CGT liability is not a debt incurred by the voluntary administrator, so they are not personally liable for it. This position is very similar to that of entities holding security over assets. CORPORATIONS ACT 2001 - SECTION 437B INCOME TAX ASSESSMENT ACT 1997 - SECTION 106.60 Administrator acts as company’s agent Acts by security holders When performing a function, or exercising a power, as administrator of a company under administration, the administrator is taken to be acting as the company’s agent. This Part and Part 3-3 apply to an act done by an entity (or an agent of the entity) in relation to a CGT asset for the purpose of enforcing or giving effect to a security, charge or encumbrance the entity holds over the asset as if the act had been done instead by the person who provided the security. One further point is that exercising a security or the appointment of a receiver or agent does not change the ownership of the asset and does not accrue a CGT liability as ownership of the asset does not change. Controllers of RELATED TOPICS This section has two effects on CGT and bankruptcy. 2 Administrators of deed of company arrangements are also usually protected. Most deed administrators simply act as a manager of a bank account and enforcer of the provisions of the deed. Rarely will a deed administrator control the trading and other actions of a company under a deed that lead to asset realisations. WORRELLS.NET.AU 74 CGT AND INSOLVENCY CONTINUED Trading is generally done directly by the company, or with the deed administrator acting as agent of the company under the provisions of the deed. 2.WHAT HAPPENS TO CAPITAL LOSSES AVAILABLE AT THE DATE OF THE APPOINTMENT? The procedure for calculating capital gains for tax purposes for individuals is set out in section 102-5 of the ITAA. Two events occur that eliminate past CGT losses: 1.A person is not entitled to bring forward any capital losses from prior years into a year in which he or she became a bankrupt or was released from their debts. This only pertains to people becoming bankrupt, not to companies. But the provision works twice, once when the person is made a bankrupt, and then again usually three years later when they are released from their debts at discharge. 2. A person is not entitled to bring forward any capital losses into a year in which they are released from their debts under a law relating to bankruptcy. Discharge from such debts occurs at the end of the bankruptcy or the end of a Part IX, Part X or a section 73 arrangement. Any capital losses accrued before the bankruptcy or other related appointment will be lost at the end of that administration. The factor of timing in either becoming a bankrupt (the commencement of the bankruptcy) and the release of debts (usually at the end of a bankruptcy or the agreement) may have to be taken into consideration. INCOME TAX ASSESSMENT ACT 1997 - SECTION 102.5 Assessable income includes net capital gain (2) However, if during the income year: (a) you became bankrupt; or (b) you were released from debts under a law relating to bankruptcy; any net capital loss you made for an earlier income year must be disregarded in working out whether you made a net capital gain for the income year or a later one. Annulments of bankruptcies eliminate the bankruptcy. Annulments obtained by payment of debts (section 153) or through the court will reinstate these losses as there is no bankruptcy and no release of debts - as they are paid. Annulments obtained through section 73 proposals still provide a release from debts and therefore any CGT losses will be lost. INCOME TAX ASSESSMENT ACT 1997 - SECTION 102.5 Assessable income includes net capital gain (3) Subsection (2) applies even though your bankruptcy is annulled if: (a) the annulment happens under section 74 of the Bankruptcy Act 1966 ; and (b) under the composition or scheme of arrangement concerned, you were, will be or may be released from debts from which you would have been released if instead you had been discharged from the bankruptcy. There appears to be no such provision for a company entering into liquidation. There is generally no real need for these provisions as the life of the company will come to an end at the conclusion of the liquidation and there will be no opportunity to use any accrued CGT losses ‘after a liquidation’. There is no statutory provision dealing with the availability of losses to a company that is subject to a deed of company arrangement, so it is expected that any losses would be available to offset against any capital gains made by the company realising assets (or by the deed administrator acting as agent of the company). It is possible that the ATO will argue that the same policy as the bankruptcy provisions set out above should apply, if the company will continue in existence after the conclusion of the deed of company arrangement, or will only allow losses in the same percentage as dividends paid to the ATO and a release of part of such debt. 3.HOLDING COMPANIES WHEN A SOLVENT WHOLLY-OWNED SUBSIDIARY IS WOUND UP The first thing to note is that the subsidiary being would up must be solvent. The ITAA gives specific tax relief in the case of a holding company receiving an asset (a rollover of an asset) from the liquidator of a subsidiary under 75 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS CGT AND INSOLVENCY CONTINUED This is partially due to the fact that, as the liquidated company is solvent, the ATO will be paid all outstanding tax liabilities by that company and therefore will be no release of debts. This CGT relief only applies if the roll-over of the asset was transferred in relation to the cancellation of the shareholding in the 100% owned subsidiary that is being wound up. The holding company effectively receives the asset in consideration for the cancellation of the shares. INCOME TAX ASSESSMENT ACT 1997 - SECTION 126.85 Effect of roll-over on certain liquidations (1) A capital gain a company (the holding company) makes because shares in its 100% subsidiary are cancelled (an example of CGT event C2: see section 104- 25) on the liquidation of the subsidiary is reduced if the conditions in subsection (2) are satisfied. The reduction is worked out under subsection (3). The capital gain that a holding company makes from the roll-over of the asset, because post-CGT shares in its 100% owned subsidiary are cancelled on the liquidation of the subsidiary is reduced only if certain conditions are satisfied. These conditions are: > There must be a roll-over of at least one ‘CGT asset’ (i.e. acquired on or after 20 September 1985) and the asset must be disposed of (transferred) by the subsidiary to the holding company in the course of its liquidation; > The disposal must either be part of the liquidator’s distribution in the course of the liquidation; or have occurred within 18 months of the dissolution of the subsidiary (if they are part of an interim distribution); > The liquidated company must be a 100% owned subsidiary from the time of the disposal until the cancellation of the shares; > The market value of the asset(s) must comprise at least part of the capital proceeds for the cancellation of the shares; > One or more of the shares that were cancelled must have been acquired by the holding company on or after 20 September 1985, that is, they must be post-CGT shares. The mechanics to calculate this relief is summarised below. Section 126-85 of the ITAA contains the full explanation, a snapshot is referenced below. INCOME TAX ASSESSMENT ACT 1997 - SECTION 126.85 RELATED TOPICS a members’ voluntary winding up. This relief may only be a reduction of the CGT, not an entire exemption. 2 Effect of roll-over on certain liquidations (3) The reduction of the capital gain is worked out in this way. METHOD STATEMENT Step 1. Work out (disregarding this section) the sum of the capital gains and the sum of the capital losses the holding company would make on the cancellation of its shares in the subsidiary. Step 2. Work out (disregarding this Subdivision): (a)The sum of the capital gains the subsidiary would make on the disposal of its CGT roll-over assets to the holding company; and (b)The sum of the capital losses it would make except for Subdivision 170-D on the disposal of its CGT assets to the holding company; in the course of the liquidation assuming the capital proceeds were the assets’ market values at the time of the disposal. Step 3. If, after subtracting the sum of the capital losses from the sum of the capital gains, there is an overall capital gain from step 1 and an overall capital gain from step 2, then continue. Otherwise there is no adjustment. Step 4. Express the number of post-CGT shares as a fraction of the total number of shares the holding company owned in the subsidiary. Step 5. Multiply the overall capital gain from Step 2 by the fraction from Step 4. Step 6. Reduce the overall capital gain from Step 1 by the amount from Step 5. The result is the capital gain the holding company makes from the cancellation of its shares in the subsidiary. WORRELLS.NET.AU 76 GST AND INSOLVENCY INTRODUCTION The introduction of goods and services tax (GST) added extra tax obligations to both taxpayers and insolvency practitioners appointed to those taxpayers. This guide explains the more common issues arising from the appointment of external administrators and GST. It deals with who is responsible for any GST liability and when that liability will arise. However, the technicalities of GST are best left to tax accountants. The insolvency of an entity, particularly the vesting of assets in a bankruptcy trustee, does not automatically give rise to any GST consequences or liabilities as there has been no ‘taxable supply’ by any party. However, the appointment of an external administrator does change the status of the entity for GST purposes, and the practitioner will assume some of the taxpayer’s responsibilities. They also must start reporting for GST in their own right. These rules are governed by the A New Tax System (Goods and Services Tax) Act 1999. THE INCAPACITATED ENTITY What is an incapacitated entity? An entity (the taxpayer) becomes an incapacitated entity and an external administrator becomes a “representative of the incapacitated entity” upon any of the following types of appointments to the taxpayer: > Bankruptcy > Controlling trusteeship > Liquidation > Receivership (even if only appointed over some of the assets) > Voluntary administration > E xecuting a deed of company arrangement An incapacitated entity is defined (section 195-1of the Act) as: incapacitated entity means: (a) An individual who is a bankrupt; or (b) An entity that is in liquidation or receivership; or (c) an entity that has a representative. The ‘catch all’ part of that definition is “an entity that has a representative”. This effectively includes all other insolvency type appointments that are not bankruptcies, liquidations or receiverships. A ‘representative’ of the incapacitated entity is also defined in section 195-1 as: (a) a trustee in bankruptcy; or (b) a liquidator; or (c) a receiver; or (ca) a controller (within the meaning of section 9 of the Corporations Act 2001 ); or (d) an administrator appointed to an entity under Division 2 of Part 5.3A of the Corporations Act 2001 ; or (e) a person appointed, or authorised, under an Australian law to manage the affairs of an entity because it is unable to pay all its debts as and when they become due and payable; or (f) an administrator of a deed of company arrangement executed by the entity. Nearly all formal appointments over the financial affairs of a person or company are likely to convert that entity into an incapacitated entity and require the registration of the representative with the Australian Taxation Office (ATO). The appointment makes the representative (the practitioner) a new entity for GST purposes. Registration of the representative for GST purposes will be required if the incapacitated entity is, or was required to be, registered for GST purposes. TWO REGISTRATIONS There are two parts to the registration process. The first is the registration of the representative of the incapacitated entity to advise the ATO that a representative has been appointed. The second is registration of the representative for GST if that is required. Registration for GST is necessary regardless of whether the entity is expected to exceed the turnover limits after the appointment, if the entity was or should have been registered before the appointment. A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 58.20 Representatives are required to be registered (1)A representative of an incapacitated entity is required to be registered in that capacity if the incapacitated entity is registered or required to be registered. (2) This section has effect despite section 23-5 (which is about who is required to be registered). 77 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS GST AND INSOLVENCY CONTINUED In fact, the ATO must cancel the representative’s GST registration if they believe that they do not need to be registered; section 58.25 “The Commissioner must cancel the registration of a representative of an incapacitated entity if the Commissioner is satisfied that the representative is not required to be registered in that capacity”. In summary, if the entity becomes incapacitated: 1.The practitioner becomes the representative of the incapacitated entity and becomes a new tax entity in his or her own right. They must register with the ATO as the representative of the incapacitated entity; 2.If the incapacitated entity was or should have been registered for GST, the representative must register for GST. Final returns should be lodged for GST purposes as at the date of the appointment and the ATO will calculate the outstanding debt, if any. The new tax period (deemed to have started at the date of the appointment) will end on the date that the normal tax period would have ended and returns will have to be lodged separately for that period. That is, the tax period is divided into two periods at the date of appointment. A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 27.39 Tax periods of incapacitated entities (1) If an entity becomes an incapacitated entity, the entity’s tax period at the time is taken to have ended at the end of the day before the entity became incapacitated. (2) If a tax period (the first tax period) ends on a particular day because of subsection (1), the next tax period starts on the day after that day and ends when the first tax period would have ended but for that subsection. The registration as a representative of the incapacitated entity ends when the appointment ends. The practitioner (the liquidator or trustee etc.) simply has to notify the Commissioner to cancel the registration. The practitioner must notify the Commissioner within 21 days after ceasing to be a representative. The representative also has a tax period. It begins on the date of appointment (the date of the new divided tax period described above) and each period has the same start and end dates as the incapacitated entity - so the initial tax period is likely to be shorter than a normal tax period unless the appointment happened to occur on the first date of a tax period. A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 58.30 A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 58.35 Notice of cessation of representation Tax periods of representatives A representative who ceases to be a representative of an incapacitated entity must notify the Commissioner of that cessation, in the approved form, within 21 days after so ceasing. (1) If a representative of an incapacitated entity is required to be registered in that capacity, the tax periods applying to the representative in that capacity are the same tax periods that apply to the incapacitated entity. TAX PERIODS AND LODGEMENTS How does the appointment of a representative affect tax periods? RELATED TOPICS The representative may not have any GST responsibilities if the incapacitated entity did not have any - for example a consumer bankruptcy. If there is a requirement for the representative to register for GST, the representative must lodge returns in their own right and report various matters to the ATO. 2 (2) This section has effect despite Division 27 (which is about how to work out the tax periods that apply). Most insolvency appointments happen during a financial year, not June 30. The current tax period for the incapacitated entity is deemed to have ended on the day before the appointment. A new tax period commences on the day of the appointment. WORRELLS.NET.AU 78 GST AND INSOLVENCY CONTINUED The obligations of the representative end when the appointment ends, but the entity may or may not continue in existence after that date. The Act provides that the entity will have a concluding tax period (its tax obligations will end) when it dies (in the case of a person) or ceases to exist (in the case of other business entities). A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 27.40 An entity’s concluding tax period (1) If: (a) an individual dies; or (b) another entity for any reason ceases to exist; the individual’s or entity’s tax period at the time is taken to have ceased at the end of the day before the death or cessation. (1A) If an entity ceases to carry on any enterprise, the entity’s tax period at the time is taken to have ceased at the end of the day on which the cessation occurred. (2) If an entity’s registration is cancelled, the entity’s tax period at the date of effect of the cancellation (the cancellation day) ceases at the end of the cancellation day. (2) You must give the return whether or not: (a) your net amount for the tax period is zero; or (b) you are liable for the GST on any taxable supplies that are attributable to the tax period. The practical effect is that the representative will usually control the financial affairs of the incapacitated entity after the appointment and will report the GST consequences on transactions done after that appointment. The intention is to pass any postappointment GST responsibility to the representative while they are in control. Some appointments (for example: administrator of a deed of company arrangement) do not leave the representative in control of the entity and it may have a requirement to do its own reporting. In these cases, the entity will have to lodge a BAS itself and the representative will lodge one for their transactions. If the entity or representative is required to be registered for GST purposes, an obligation to commence lodging returns commences on the appointment, regardless of how the representative has been appointed. WHO IS LIABLE FOR THE GST? It is unlikely that this provision will have much affect on a bankruptcy trustee (even if they are required to be registered for GST purposes) as the bankrupt is likely to survive the bankruptcy process. Companies in liquidation on the other hand, usually are deregistered upon the cessation of the liquidation. The Act was altered to clarify who was responsible for GST debits and credits and whether the entity or the representative would be liable for the GST payable. The short answer is that the representative is liable for the tax consequences of transactions that were entered into during their appointment, regardless of the capacity of their appointment. WHO MUST LODGE THE BAS? A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 58.5 The Act provides that the representative (who is registered for GST) must lodge returns in each tax period regardless of whether there has been any activity or any amount of GST to pay or refund to be received. A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 31.5 Who must give GST returns General principle for the relationship between incapacitated entities and their representatives (1) Subject to this Division, any supply, acquisition or importation by an entity in the capacity of a representative of another entity that is an incapacitated entity is taken to be a supply, acquisition or importation by the other entity. (1) If you are registered or required to be registered, you must give to the Commissioner a GST return for each tax period. 79 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS GST AND INSOLVENCY CONTINUED (3) To avoid doubt, if the other entity ceases to be an incapacitated entity, this section continues to apply in relation to the supply, acquisition or importation, or to the act or omission, after the other entity ceases to be an incapacitated entity. A further effect of the section is to ensure that the entity will be liable for, or entitled to, any GST consequences of transactions entered into during the period of the representative’s appointment. The second step is to make the representative liable to pay the GST that the entity would be liable to pay - as far as that liability “is within the scope of the representative’s responsibility or authority for managing the incapacitated entity’s affairs”. A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 58.10 Circumstances in which representatives have GST-related liabilities and entitlements General rule (1) A representative of an incapacitated entity: (a) is liable to pay any GST that the incapacitated entity would, but for this section or section 48-40, be liable to pay on a taxable supply or a taxable importation; and (b) is entitled to any input tax credit that the incapacitated entity would, but for this section or section 48-45, be entitled to for a creditable acquisition or a creditable importation; and (c) has any adjustment that the incapacitated entity would, but for this section or section 48-50, have; to the extent that the making of the supply, importation or acquisition to which the GST, input tax credit or adjustment relates is within the scope of the representative’s responsibility or authority for managing the incapacitated entity’s affairs. Appointments that do not give the representative the “responsibility or authority” to make transactions, like a deed of company arrangement appointment that does include such powers, will not give rise to personal liability for GST transactions. But if the representative enters into the transaction, they will be liable for the GST consequences. The representative is not liable when the supply or acquisition occurred before becoming the representative of the incapacitated entity. RELATED TOPICS The section will continue to apply if the entity ceases to be an incapacitated entity and the representative resigns, meaning that the incapacitated entity will be liable for further GST liabilities based on transactions that occurred while it was incapacitated. 2 (2) This section does not apply to the GST payable on a taxable supply to the extent that one or more of the following apply: (a) the incapacitated entity received the consideration for the supply before the representative became a representative of the incapacitated entity; (b) if, under Division 83 or 84, the GST is payable by the recipient of the supply - the incapacitated entity provided the consideration for the supply before the representative became a representative of the incapacitated entity; (c) if: (i) the supply is a supply for which a voucher to which Division 100 applies is redeemed; and (ii) the incapacitated entity supplied the voucher before the representative became a representative of the incapacitated entity; the consideration for the supply referred to in subparagraph (i) does not exceed the consideration provided for the incapacitated entity’s supply of the voucher. (3) This section does not apply to an input tax credit for a creditable acquisition to the extent that the incapacitated entity provided the consideration for the acquisition before the representative became a representative of the incapacitated entity. These provisions end the argument of who is responsible for GST transactions. The entity is responsible, but the representative is liable if they entered into the transaction. The representative has to lodge returns at the same time as the entity, but the commencement date of the first period will depend on the appointment date. WORRELLS.NET.AU 80 GST AND INSOLVENCY CONTINUED A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 58.35 Tax periods of representatives (1)If a representative of an incapacitated entity is required to be registered in that capacity, the tax periods applying to the representative in that capacity are the same tax periods that apply to the incapacitated entity. (2) This section has effect despite Division 27 (which is about how to work out the tax periods that apply). It is possible that two BAS’s should be lodged for an entity. Take for example, a deed of company arrangement where the deed administrator files a BAS for tax consequences under the administration of the deed, and the company trades under its own right and lodges its own BAS each period. Each entity will only report its own transactions on their own BAS. ADJUSTMENTS TO PRE-APPOINTMENT GST LIABILITIES In many insolvent estates, the ATO has an outstanding debt for GST. Some adjustments may be required to the GST consequences of pre-appointment transactions that may cause the ATO to increase or decrease their outstanding debt. These are called ‘increasing’ or ‘decreasing’ adjustments. A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 19.10 2.Adjustments to taxable credits due to the non-payment of creditors through a dividend where GST has been claimed pre-appointment (increasing adjustment). Further, if a representative accounts on an accrual basis, the GST effects of transactions by the entity that occurred before the appointment of the representative may be attributed to the first tax period of the representative. A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 58.40 Effect on attribution rules of not accounting on a cash basis (1) If: (a) a representative of an incapacitated entity does not account on a cash basis; and (b) because of section 58-10, all or part of the amount of GST payable on a taxable supply is payable by the representative, or the representative is entitled to all or part of the input tax credit for a creditable acquisition then, to the extent that, but for this section, the GST or input tax credit would be attributable to a tax period that ended before the representative became a representative of the incapacitated entity, the GST or input tax credit is instead attributable to the first tax period applying to the representative in that capacity. (3) An adjustment event: (2) This section has effect despite sections 29-5 and 29-10 (which are about attribution of GST on taxable supplies and of input tax credits for creditable acquisitions). (a) can arise in relation to a supply even if it is not a taxable supply; and WRITING OFF BAD DEBTS Adjustment Events (b) can arise in relation to an acquisition even if it is not a creditable acquisition. ACCRUAL BASED ACCOUNTING The two most common adjustments under accrual accounting relate to the GST consequences from; 1.The non-collection of debtors where GST has been paid before the appointment (decreasing adjustment); and It is not uncommon for practitioners to write off pre-appointment debtors as uncollectable. There can be numerous reasons for this to occur. It is also possible that the insolvent entity has accrued these debts before the appointment and may have paid or accrued GST on them. If these debtors are written off, the GST on those debts should in theory be refunded. In practice they are deducted off the GST debt outstanding. 81 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS GST AND INSOLVENCY CONTINUED Writing off bad debts (taxable supplies) (1) You have a decreasing adjustment if: (a) you made a taxable supply; and (b) the whole or part of the consideration for the supply has not been received; and NON-PAYMENT OF CREDITORS Unless there are sufficient assets to pay all creditors in full - which is a rarity - there will be some part of creditors’ debts that will go unpaid. If the insolvent entity has claimed the GST on these creditor amounts before the appointment, they will in theory have to be refunded to the ATO to the extent that the creditors were unpaid. In practice the GST liability to the ATO increases. (c) you write off as bad the whole or a part of the debt, or the whole or a part of the debt has been overdue for 12 months or more. A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 21.15 The amount of the decreasing adjustment is 1/11th of the amount written off, or 1/11th of the amount that has been overdue for 12 months or more, as the case requires. (1) You have an increasing adjustment if: (2) However, you cannot have an adjustment under this section if you account on a cash basis. The Act clarifies that the adjustment cannot be made if the representative accounts on a cash basis. A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 58.15 Adjustments for bad debts (1) For the purposes of determining whether an adjustment arises under section 21-5 or 21-15 for the whole or a part of a debt relating to a taxable supply or creditable acquisition for which a representative of an incapacitated entity is liable to pay GST, or is entitled to an input tax credit, under section 58-10: (a) the adjustment cannot arise if, when the whole or part of the debt is written off, or has been overdue for 12 months, the representative accounts on a cash basis; but (b) it does not matter whether the incapacitated entity accounts on a cash basis at that or any other time. (2) This section has effect despite subsections 21-5(2) and 21-15(2) (which preclude adjustments for bad debts when accounting on a cash basis). RELATED TOPICS A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 21.5 2 Bad debts written off (creditable acquisitions) (a) you made a creditable acquisition for consideration; and (b) the whole or part of the consideration is overdue, but you have not provided the consideration overdue; and (c) the supplier of the thing you acquired writes off as bad the whole or a part of the debt, or the whole or a part of the debt has been overdue for 12 months or more. The amount of the increasing adjustment is 1/11th of the amount written off, or 1/11th of the amount that has been overdue for 12 months or more, as the case requires. (2) However, you cannot have an adjustment under this section if you account on a cash basis. CASH ACCOUNTING The two most common adjustments under cash reporting system relate to the GST consequences from; 1.The collection of debtors where GST has not been paid before the appointment (increasing adjustment); and 2.Adjustments due to the payment of creditors through a dividend where GST has not been claimed preappointment (decreasing adjustment). WORRELLS.NET.AU 82 GST AND INSOLVENCY CONTINUED A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 19.40 A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 19.50 Where adjustments for supplies arise Increasing adjustments for supplies You have an adjustment for a supply for which you are liable to pay GST (or would be liable to pay GST if it were a taxable supply) if: If the corrected GST amount is greater than the previously attributed GST amount, you have an increasing adjustment equal to the difference between the corrected GST amount and the previously attributed GST amount. (a) in relation to the supply, one or more adjustment events occur during a tax period; and (b) GST on the supply was attributable to an earlier tax period (or if the supply was not a taxable supply, would have been attributable to an earlier tax period had the supply been a taxable supply); and (c) as a result of those adjustment events, the previously attributed GST amount for the supply (if any) no longer correctly reflects the amount of GST (if any) on the supply (the corrected GST amount ), taking into account any change of circumstances that has given rise to an adjustment for the supply under this Subdivision or Division 21 or 134. COLLECTION OF DEBTORS Sometimes practitioners will collect amounts from debtors that were billed before the appointment. Under a cash accounting system, no GST would have been paid on these amounts. In practice, this payment of the GST is an increasing adjustment to the liability to the ATO. PAYMENT OF DIVIDENDS TO CREDITORS Under the cash accounting system, GST is not claimed on supplies from creditors until the payment is made to the creditor. No GST credit will have been allowed for outstanding creditors at the time of the appointment, but will be allowed when a dividend is paid to those creditors. The practitioner will be able to claim the GST on dividends paid by way of a decreasing adjustment to the ATO liability for the amount of the dividend paid to relevant creditors. A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 - SECTION 19.55 Decreasing adjustments for supplies If the corrected GST amount is less than the previously attributed GST amount, you have a decreasing adjustment equal to the difference between the previously attributed GST amount and the corrected GST amount. 83 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS GST AND INSOLVENCY CONTINUED 2 The following table sets out the general adjustments required for adjusting events occurring after the appointment for pre-appointment transactions. CASH REPORTING ACCRUALS REPORTING Debtors Where debtors are collected by the representative under a cash reporting system, GST is attributable to the amount collected. An increasing adjustment should be made to the ATO’s proof of debt. Where debtors are written off as uncollectable (and GST has been accrued on these debtors), the amount of GST attributable to the written off debtors becomes a decreasing adjustment to the ATO’s proof of debt. Dividend to Creditors Where dividends are paid to creditors under a cash system, GST credits arise for the amount of the payments. These will give rise to a decreasing adjustment to the ATO’s proof of debt. Where GST credits have been claimed and those creditors are now not going to be paid, an increasing adjustment is made to the ATO’s proof of debt to add back the unpaid credits. RELATED TOPICS SUMMARY OF ADJUSTMENTS Representatives must notify the ATO of increasing adjustments or the representative may become liable for the lost dividends that should have been collected by the ATO. The ATO will then adjust their proof of debt to better reflect their debt on pre-appointment transactions once they know the final result of those transactions. SUMMARY The following points provide a summary of these provisions: > The appointment of an external administrator requires that administrator to register as a representative of an incapacitated entity; > If the incapacitated entity is required to be registered for GST, the representative will be required to register for GST; > The incapacitated entity’s tax year will end on the date of the appointment and a final BAS will have to be filed; > The representative registered for GST purposes has a responsibility to file BAS’s during their administration; > The representative will have to notify the ATO of any increasing adjustments due to collection of debtors and payment of partial dividends. WORRELLS.NET.AU 84 OBJECTIONS TO DISCHARGE WHAT IS AN OBJECTION TO DISCHARGE? Under normal circumstances a person’s bankruptcy will automatically end three years after the bankrupt’s Statement of Affairs is filed with the Insolvency and Trustee Service Australia (ITSA). This is called a discharge from bankruptcy. However the trustee of a bankrupt estate may extend the period of a person’s bankruptcy by lodging an objection to discharge. WHY OBJECT TO A BANKRUPT’S DISCHARGE? An objection to discharge may be use as a punishment for some action taken by the bankrupt before or after bankruptcy, or a method of encouraging them to cooperate with the trustee. There are also times when it would be in the interest of the creditors or the general public that the bankrupt not be discharged at the usual time because the bankrupt has committed some offence under the Bankruptcy Act. WHEN CAN A TRUSTEE OBJECT TO A BANKRUPT’S DISCHARGE? An objection may be lodged at any time during the bankruptcy, but there needs to be statutory grounds to do so. An objection must be lodged before the discharge to be effective, as you cannot extend the time of a bankruptcy that has ended. The opportunity to object is gone once a bankrupt has been discharged. HOW DOES A TRUSTEE OBJECT TO A BANKRUPT’S DISCHARGE? The trustee lodges the required notice of objection with ITSA and forwards a copy to the bankrupt. Once that notice is recorded by ITSA on the NPII (the National Personal Insolvency Index is the statutory register) the objection will have legal effect. FOR HOW LONG WILL THE BANKRUPTCY BE EXTENDED? Objections do not last forever. A bankruptcy may be extended for either two or five years, making the period of the bankruptcy either five or eight years. The period of extension will depend on the particular statutory ground for the objection. The usual discharge provisions will then apply at the new extended periods, with automatic discharge occurring at the end of the extended period. In effect the objection only takes effect once the original discharge date is reached, as the objection only extends the date of discharge. The bankrupt would have remained bankrupt during the first three years anyway. HOW IS THE EXTENSION LENGTH DETERMINED? The extension period is determined by the statutory ground under which the objection was lodged. A ‘special ground’ will result in a five year extension, and a ‘nonspecial ground’ will result in a two year extension. WHAT ARE THE GROUNDS FOR OBJECTING? The objection must be based on a very specific statutory ground. These grounds are: Special Grounds (five year extension): 1. Failure to provide written information about their property or income; 2. Failure to disclose particulars of income or expected income; 3. Failure to pay a contribution amount to the trustee; 4. Spent money or disposing of assets or spending monies within five years before bankruptcy without adequate explanation; 5. Leaving and not returning to Australia when requested; 6. Failure to sign a document as required by the trustee under the provisions of the Bankruptcy Act; 7. Making a transfer that is void under section 121 of the Bankruptcy Act; 8. Intentionally providing false or misleading information to the trustee; 9. Intentionally failing to disclose a liability that existed at the time of bankruptcy; or 10. Failing to disclose a beneficial interest in any property. Other Grounds (two year extension): 1. Continuing to manage a corporation in contravention of the Corporations Act and without leave being granted; 2. Leaving Australia and not returning; 3. Making a void transfer under section 120 or 122 of the Bankruptcy Act; 85 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS OBJECTIONS TO DISCHARGE CONTINUED 5. Failure to disclose a liability that existed at the time of bankruptcy; 6. Failure to comply with section 77(1) or section 80; 7. Failure to attend a creditors meeting under certain circumstances or an interview or examination without reasonable excuse; or 8. Failure to disclose a beneficial interest in property. WHAT IF THERE IS MORE THAN ONE GROUND? If there is more than one ground, the period of extension will be based on the ground with the longest period. The time periods are not cumulative. If the ground with the longest period is subsequently lifted, the period of extension will then be based on the next longest period attached to a remaining ground. The period of extension may still be the original extension period if two special or two non-special grounds apply and only one is lifted. IS THERE A DIFFERENCE BETWEEN OBJECTION NOTICES FOR SPECIAL AND NON-SPECIAL GROUNDS? The main difference in the objection process is the amount of information required on the notice. The trustee used to have to state a reason when lodging any objection. Reasons are no longer required for objections based on special grounds due to the nature of those grounds. The notice only requires information on the ground on which the objection is based and the evidence that the ground exists. Objections based on non-special grounds still require reasons to be given in the notice. CAN AN OBJECTION BE WITHDRAWN? The trustee may withdraw an objection at any time. The trustee will normally withdraw the objection if the grounds have been satisfied. But the trustee does not have to withdraw it, especially if the objection is based on a special ground. If all grounds have been satisfied, the notice of objection may be completely withdrawn. DOES WITHDRAWING AN OBJECTION END THE BANKRUPTCY? Maybe. If the bankrupt would have normally been discharged during the period that the objection was in force (if the three years expired during the objection period), withdrawing the objection will automatically discharge the bankrupt as at the date of the withdrawal of the objection, not the original discharge date. If the objection is withdrawn during the normal three year bankruptcy period, the bankruptcy will end by automatic discharge at the end of that three year period. RELATED TOPICS 4. Misleading conduct by the bankrupt involving an amount in excess of an indexed amount, currently $5,176; 2 CAN THE OBJECTION BE REMOVED BY A HIGHER AUTHORITY? Yes. The Bankruptcy Act provides a review process. The bankrupt may apply to the Inspector-General to review the decision to lodge an objection. The request for a review must be made within 60 days of the notification of the objection being received by the bankrupt. The Inspector General must first decide whether or not to review the objection, and if they decide to do so, review the objection and make the decision within 60 days after the receipt of the request. The Inspector-General must decide the review on the following basis: 1. Whether the ground is a ground set out under the Act; 2.Whether there is sufficient evidence to support that ground; and 3.The conduct of the bankrupt before the objection was lodged. It is more difficult to have an objection based on a special ground removed as there are no reasons for the Inspector-General to review, and no consideration is taken of the conduct of the bankrupt after the lodgement of the objection. That is, even if the bankrupt finally complies with the trustee’s requests, the bankrupt’s conduct will not automatically give rise to a removal or withdrawal of the objection. To have an objection based on a special ground removed, the bankrupt may have to show that circumstances existed that do not justify the objection in the first instance. WORRELLS.NET.AU 86 VOIDING SUPERANNUATION CONTRIBUTIONS INTRODUCTION Trustees of bankrupt estates investigate prebankruptcy transfers or transactions when they believe the transaction improperly dissipated or removed assets that would otherwise have come under the trustee’s control and therefore are available to creditors. The Bankruptcy Act will sometimes permit these transactions to be voided and require the other party to return an asset or make a payment to the trustee. Sometimes contributions made by or on behalf of the bankrupt (pre-bankruptcy) to superannuation funds fall into this category. To void such a transaction, the trustee must show that: 1. A transaction was entered into. 2. They can identify the other party to the transaction. 3.The transaction occurred within a specific time period, or while the debtor was insolvent. 4.The transaction was either undervalue or had the required purpose. 5. It does not involve protected property. This guide deals with contributions made pre-bankruptcy that have all of these factors. REASONS FOR VOIDING THESE TRANSACTIONS One of a trustee’s functions is to ensure that all of the bankrupt’s assets are available for distribution to their creditors. Part of that role is to discover whether the bankrupt entered into a transaction before they became bankrupt that reduced the amount of assets that are available for distribution. The trustee will want to recover these assets. The provisions set out in this guide give the trustee the power to recover monies paid to eligible superannuation plans in the period before the bankruptcy. Some debtors, realising that they are about to be made bankrupt, want to protect some of their assets from their creditors. Some debtors hide, move or transfer these assets to a third party to hold during the period of bankruptcy. Sometimes debtors pay the money into their superannuation plan as superannuation is generally an exempt asset. These provisions are meant to deter debtors from moving assets out of their own hands into their superannuation plan at the expense of their creditors, and allow a trustee to recover the money from the fund when the payments fall under the relevant conditions. VOIDING PAYMENTS TO ELIGIBLE SUPERANNUATION PLANS CONTRIBUTIONS BY THE BANKRUPT Various sections of the Bankruptcy Act are designed to void transactions or transfers of property in order to provide a fair distribution of a bankrupt’s assets to their creditors. One well known section is section 121 ‘transfers to defeat creditors’ which is designed to void transfers where the intention of that transfer is to remove the property from the grasp of the trustee or creditors. Subdivision B of Division 3 of Part VI of the Bankruptcy Act is aimed at voiding transfers of property to eligible superannuation plans where the intention of the transfer was to defeat creditors. The main provisions are very similar to section 121, but these provisions have been tailored specifically with application to superannuation plans. This was necessary as the Bankruptcy Act generally excludes monies in superannuation plans from being divisible property. Transfers made by a debtor are void if they occurred after 28 July 2006 and: >They are made to eligible superannuation plans of the bankrupt; >The property would have formed part of the property available to creditors in a bankrupt estate if the transfer had not been made; >The main purpose of the transaction was to keep that asset from falling into the trustee’s hands and being available to creditors. BANKRUPTCY ACT 1966 - SECTION 128B Superannuation contributions made to defeat creditors contributor is a person who later becomes a bankrupt Transfers that are void (1) A transfer of property by a person who later becomes a bankrupt (the transferor) to another person (the transferee) is void against the trustee in the transferor’s bankruptcy if: (a) the transfer is made by way of a contribution to an eligible superannuation plan; and 87 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS VOIDING SUPERANNUATION CONTRIBUTIONS CONTINUED (c) the transferor’s main purpose in making the transfer was: (i) to prevent the transferred property from becoming divisible among the transferor’s creditors; or (ii) to hinder or delay the process of making property available for division among the transferor’s creditors; and (d) the transfer occurs on or after 28 July 2006. Most people will initially think of payments of money as transfers, but any property being transferred can be subject to these provisions. The section also goes one step further to include any transaction that creates new property. This is usually in the form of securities or equitable/legal interests over assets still owned by the debtor. That is, creating a charge in favour of the superannuation plan may be deemed to be a transfer of property. 7. For the purposes of this section: (a) transfer of property includes a payment of money; and (b) a person who does something that results in another person becoming the owner of property that did not previously exist, is taken to have transferred the property to the other person; and (c) the market value of property transferred is at market value at the time of the transfer. The trustee of the estate will examine payments to superannuation plans and any other assets created and will assess whether the payment falls within the above criteria. The difficult part of the examination is determining the intention of the debtor at the time of the transfer. How that intention may be determined or deemed is set out on page 89. CONTRIBUTIONS BY A THIRD PARTY Transfers to superannuation plans made by third parties on behalf of the debtor may also be caught under these provisions. Third parties may have assets that belong to the debtor or owe money to the debtor. Paying that money into a superannuation plan on the instruction of the debtor will be a transaction that can be examined. These are referred to as a ‘schemes’ in the Act. Again the intention of the transfer must be to defeat creditors. RELATED TOPICS (b) the property would probably have become part of the transferor’s estate or would probably have been available to creditors if the property had not been transferred; and 2 Transfers made by third parties are void if: > They are made to eligible superannuation plans of the bankrupt; > The property would have formed part of the property available to creditors in a bankrupt estate (usually as a debt due) if the transfer had not been made; > The transfer occurred under a scheme to which the debtor was a party to - effectively if it was done under the debtor’s direct or implied instructions; > The main purpose of the transaction was to keep that asset from falling into the trustee’s hands and being available to creditors. BANKRUPTCY ACT 1966 - SECTION 128C Transfers that are void (1) If: (a) a person (the transferor) transfers property to another person, (the transferee); and (b) the transfer is by way of a contribution to an eligible superannuation plan for the benefit of a person who later becomes a bankrupt (the beneficiary); and (c) the transferor did so under a scheme to which the beneficiary was a party; and (d) the property would probably have become part of the beneficiary’s estate or would probably have been available to creditors if the property had not been transferred; and (e) the beneficiary’s main purpose in entering into the scheme was: (i) to prevent the transferred property from becoming divisible among the beneficiary’s creditors; or (ii) to hinder or delay the process of making property available for division among the beneficiary’s creditors; and WORRELLS.NET.AU 88 VOIDING SUPERANNUATION CONTRIBUTIONS CONTINUED (f) the transfer occurred on or after 28 July 2006; the transfer is void against the trustee in the beneficiary’s bankruptcy. (2) For the purposes of paragraph (1)(b), disregard a benefit that is payable in the event of the death of a person. As with transfers made by the debtor, transfers of any property or newly created property by the transaction may be caught by these provisions. The major difference is the exclusion under subsection 2 of ‘benefits’ payable in the event of the death of a person. 9. For the purposes of this section: (a) transfer of property includes a payment of money; and (b) a person who does something that results in another person becoming the owner of property that did not previously exist is taken to have transferred the property to the other person; and (c) the market value of property transferred is its market value at the time of the transfer. INTENTION One of the main purposes of the transaction must be to protect the asset from creditors - to defeat creditors’ interest in the property. This intention only needs to be one of the main purposes of the transaction, not the only purpose. This is a subjective aspect which is usually inferred from the circumstances of the transaction, the financial position of the debtor at that time and the result of the transaction. This intention can be deemed by the actual or impending insolvency of the debtor - but only if it can be shown that the debtor was or was about to become bankrupt at the time of the transaction. If the debtor was solvent at the time and remained solvent for some time after the transaction with no indication of an impending bankruptcy, it will be difficult to connect the eventual insolvency to the transaction. It is common that transactions with this intention are undertaken when a debtor has a pending legal action against them and it appears likely or inevitable that judgment will be brought down against them. Alternatively it could be that a loan or other agreement has been breached and will lead to a demand that they will not be able to meet. In these circumstances, showing or deeming that the intention existed may be quite easy. Most bankrupts who undertake transactions to protect assets usually only do so close to the time of bankruptcy. BANKRUPTCY ACT 1966 - SECTION 128B Showing the transferor’s main purpose in making a transfer (2)The transferor’s main purpose in making the transfer is taken to be the purpose described in paragraph (1)(c) if it can reasonably be inferred from all the circumstances that, at the time of the transfer, the transferor was, or was about to become, insolvent. (3) In determining whether the transferor’s main purpose in making the transfer was the purpose described in paragraph (1)(c), regard must be had to: (a) whether, during any period ending before the transfer, the transferor had established a pattern of making contributions to one or more eligible superannuation plans; and (b) if so, whether the transfer, when considered in the light of that pattern, is out of character. (4) Subsections (2) and (3) do not limit the ways of establishing the transferor’s main purpose in making a transfer. The trustee will also examine the debtor’s historical pattern of making contributions to eligible superannuation funds. If the payment is one of a series of very similar payments over a long period, there could be an argument that the required intention did not exist. If the payment is a once off large payment, especially if it is significantly larger than any previous payments, it can probably be safely deemed that the intention existed. THIRD PARTY CONTRIBUTIONS The same deeming provisions apply to transfers by third parties. If it can be shown that the debtor was insolvent or was about to become insolvent at the time, the intention can be deemed. The same indicators may also be used to determine the intention of the debtor. There is no requirement for the other party to know or suspect the insolvency, as there is no claim being made against that other party. 89 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS VOIDING SUPERANNUATION CONTRIBUTIONS CONTINUED Showing the beneficiary’s main purpose in entering into the scheme (3) The beneficiary’s main purpose in entering into the scheme is taken to be the purpose described in paragraph (1)(e) if it can reasonably be inferred from all the circumstances that, at the time when the beneficiary entered into the scheme, the beneficiary was, or was about to become, insolvent. The Act provides for a presumption of insolvency if the debtor did not keep proper records of their financial affairs during that period. That presumption is rebuttable i.e. it may be disproved by positive evidence of solvency. This may be quite difficult if there are truly no records on the financial affairs of the debtor. BANKRUPTCY ACT 1966 - SECTION 128B Rebuttable presumption of insolvency (4) In determining whether the beneficiary’s main purpose in entering into the scheme was the purpose described in paragraph (1)(e), regard must be had to: (5) For the purposes of this section, a rebuttable presumption arises that the transferor was, or was about to become, insolvent at the time of the transfer if it is established that the transferor: (a) whether, during any period ending before the scheme was entered into, the transferor had established a pattern of making contributions to one or more eligible superannuation plans for the benefit of the beneficiary; and (a) had not, in respect of that time, kept such books, accounts and records as are usual and proper in relation to the business carried on by the transferor and as sufficiently disclose the transferor’s business transactions and financial position; or (b) if so, whether the transfer, when considered in the light of that pattern, is out of character. (b) having kept such books, accounts and records, has not preserved them. (5) For the purposes of paragraph (4)(a), disregard a benefit that is payable in the event of the death of a person. The same rebuttable presumption of insolvency applies to transfers made by third parties. (6) Subsections (3) and (4) do not limit the ways of establishing the beneficiary’s main purpose in entering into a scheme. Rebuttable presumption of insolvency INSOLVENCY The debtor does not have to have been insolvent at the time of the transaction for it to be void. As detailed in the last section, is it the intention of the debtor that is important through showing insolvency or pending insolvency is a key means of showing that intention. If the trustee is relying on that deeming provision, the court will require evidence on insolvency. Solvency and insolvency is defined in the Act as: BANKRUPTCY ACT - SECTION 5 Interpretation (2) A person is “solvent” if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable. (3) A person who is not solvent is “insolvent”. RELATED TOPICS BANKRUPTCY ACT 1966 - SECTION 128C 2 BANKRUPTCY ACT 1966 - SECTION 128C (7) For the purposes of this section, a rebuttable presumption arises that the beneficiary was, or was about to become, insolvent at the time the beneficiary entered into the scheme if it is established that the beneficiary: (a) had not, in respect of that time, kept such books, accounts and records as are usual and proper in relation to the business carried on by the beneficiary and as sufficiently disclose the beneficiary’s business transactions and financial position; or (b) having kept such books, accounts and records, has not preserved them. The rebuttable presumption is designed to stop bankrupts from avoiding their past transactions being overturned simply by destroying or hiding the records needed to examine the transaction. The presumption essentially deems that the debtor is insolvent at a particular time unless there are records that prove otherwise. WORRELLS.NET.AU 90 VOIDING SUPERANNUATION CONTRIBUTIONS CONTINUED As a consequence of that deemed insolvency, the transactions under examination can be said to have been done under the required intention. PROTECTION OF OTHER PARTIES The Bankruptcy Act goes to some lengths to ensure that innocent parties to void transactions are not prejudiced any more than necessary. The provisions that relate to the voiding of superannuation contributions are no different. The Act provides protection for two parties. The first party is the trustee of the eligible superannuation plan. When a contribution is received, certain taxes and other charges are deducted and paid to the government, fund managers etc. The trustee of the bankrupt estate will seek the voiding of the transfer - meaning the entire amount of the contribution. Payment of the entire contribution would leave the superannuation trustee (the plan) out of pocket to the extent of the taxes and charges. The Act provides that when an amount of the contribution is recovered, the amount of taxes and charges that apply to that contribution must be paid to the superannuation trustee, to ensure that they are not out of pocket. BANKRUPTCY ACT 1966 - SECTION 128B Refund of contributions tax etc. (5A) If: (a) as a result of subsection (1), a transfer made by way of a contribution to an eligible superannuation plan is void against the trustee in the transferor’s bankruptcy; and (b) any of the following amounts was debited from the contribution: (i) an amount in respect of tax in respect of the contribution; (ii) a fee, or a charge, in respect of the contribution; and (c) in compliance with a section 139ZQ notice that relates to the transfer, the trustee of the eligible superannuation plan pays an amount to the trustee in the transferor’s bankruptcy; and (d) the amount paid in compliance with the section 139ZQ notice exceeds the amount so debited; the trustee in the transferor’s bankruptcy must pay to the trustee of the eligible superannuation plan an amount equal to the amount so debited. The interesting part is that this protection only applies to payments that are made to the bankruptcy trustee under a section 139ZQ notice. It is debatable whether this protection will apply if the superannuation trustee voluntarily returns the contribution to the bankruptcy trustee, or even if the bankruptcy trustee obtains an order of the court for the contribution to be returned. The other protection is given to innocent parties that received title to any property in good faith - meaning without any knowledge of the intention of the transfer. Protection of successors in title 6.This section does not affect the rights of a person who acquired property from the transferee in good faith and for at least the market value of the property. THIRD PARTY CONTRIBUTIONS This protection also applies to superannuation trustees when the contributions are made by other parties, but are voided under the appropriate provisions. The provisions are the same, only worded as contributions by other parties. BANKRUPTCY ACT 1966 - SECTION 128C Refund of contributions tax etc. 7A.If: (a) as a result of subsection (1), a transfer made by way of a contribution to an eligible superannuation plan is void against the trustee in the beneficiary’s bankruptcy; and (b) any of the following amounts was debited from the contribution: (i) an amount in respect of tax in respect of the contribution; (ii) a fee, or a charge, in respect of the contribution; and (c) in compliance with a section 139ZQ notice that relates to the transfer, the trustee of the eligible superannuation plan pays an amount to the trustee in the beneficiary’s bankruptcy; and 91 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS VOIDING SUPERANNUATION CONTRIBUTIONS CONTINUED The same protection is also given to parties that obtain title to property without knowing the intention of the transfer when the contribution is made by another party. Protection of successors in title 8.This section does not affect the rights of a person who acquired property from the transferee in good faith and for at least the market value of the property. PROTECTION AGAINST CRIMINAL AND CIVIL PROSECUTION The Bankruptcy Act also protects the trustee of the eligible superannuation plan from criminal and civil prosecution for acts done in good faith. These acts include complying with a section 139ZQ notice or an order of the court. BANKRUPTCY ACT 1966 - SECTION 128L Protection of trustee of eligible superannuation plan (1) No criminal or civil proceedings lie against the trustee of an eligible superannuation plan because of anything done (or not done) by the trustee in good faith. SUPERANNUATION ACCOUNT-FREEZING NOTICES The Bankruptcy Act gives bankruptcy trustees certain powers to assist them in making these claims. One is the power to issue superannuation account-freezing notices. The notices are issued by the Official Receiver and are only done so when the bankruptcy trustee has satisfied the Official Receiver that there are “reasonable grounds” that a contribution to a plan is void. The notice comes into force when it is given to the trustee of the eligible superannuation plan. BANKRUPTCY ACT 1966 - SECTION 128E Superannuation account freezing notice (1) This section applies in relation to a member of an eligible superannuation plan if the Official Receiver has reasonable grounds to believe that: (a) a transaction is void against the trustee of a bankrupt’s estate under section 128B or 128C; and RELATED TOPICS (d) the amount paid in compliance with the section 139ZQ notice exceeds the amount so debited; the trustee in the beneficiary’s bankruptcy must pay to the trustee of the eligible superannuation plan an amount equal to the amount so debited. 2 (b) either: (i) the whole or a part of the member’s superannuation interest is attributable to the transaction; or (ii) the trustee of the bankrupt’s estate has made an application for a section 139ZU order that relates to the transaction and the member’s superannuation interest. These notices affect the superannuation plan trustee’s rights to deal with the funds in the plan, except in limited circumstances. The notices are designed to ensure that the money is not paid out or otherwise disbursed before the issue of the potentially void transactions in question is resolved. One important point is that the notice is either directed at the money paid into the plan from the contribution under examination (the money will have to be traced and identified in the plan at the time of issuing the notice) or the bankruptcy trustee must make an application for an order under section 139ZU in relation to rolled-over superannuation interests. The money must be identifiable. These notices do not act in the same way as a section 139ZQ notice (139ZQ notices are a quasi-judicial demand). In fact, one of the remedies that a bankruptcy trustee has is the ability to apply to the Official Receiver to issue a notice under section 139ZQ. WORRELLS.NET.AU 92 VOIDING SUPERANNUATION CONTRIBUTIONS CONTINUED BANKRUPTCY ACT 1966 - SECTION 128E Giving of freezing notice (2) The Official Receiver may, by written notice (a superannuation account - freezing notice) given to the trustee of the eligible superannuation plan, direct the trustee of the plan not to: (a) cash or debit; or (b) permit the cashing, debiting, roll-over, transfer or forfeiture of; the whole or any part of the superannuation interest except: (c) for the purposes of complying with a notice under section 139ZQ; or (d) for the purposes of complying with an order under section 139ZU; or (e) for the purposes of charging costs against, or debiting costs from, the superannuation interest; or (f) for the purposes of giving effect to a family law payment split; or (g) in accordance with the written consent of the Official Receiver given under section 128H; or (h) for the purposes of complying with an order under paragraph 128K(1)(b); or (i) for the purposes of complying with an order under subsection 139ZT(2); or (j) in such circumstances (if any) as are specified in the regulations. Because the notice is given by the Official Receiver and affects the rights of the bankrupt on what would be otherwise exempt (non-divisible) property, the reasons for issuing the notice and the circumstances behind the decision to issue must be set out in the notice. That is, the notice must set out why the Official Receiver believes that the contributions to the superannuation plan are void. BANKRUPTCY ACT 1966 - SECTION 128E (3) The superannuation account-freezing notice must set out the facts and circumstances because of which the Official Receiver considers that the Official Receiver has reasonable grounds to believe that: (a) the transaction is void against the trustee of the bankrupt’s estate under section 128B or 128C; and (b) either: (i) the whole or a part of the member’s superannuation interest is attributable to the transaction; or (ii) the trustee of the bankrupt’s estate has made an application for a section 139ZU order that relates to the transaction and the member’s superannuation interest. A superannuation account-freezing notice is not an open ended right for a bankruptcy trustee. The notice may be revoked by the Official Receiver at any time. The notice will be automatically revoked if the money is claimed under the section 139ZQ notice and the notice is revoked or of the court sets aside the 139ZQ notice. That is, if the superannuation account-freezing notice was supporting a section 139ZQ notice and that notice is satisfied or is revoked, the freezing notice is automatically also revoked. BANKRUPTCY ACT 1966 - SECTION 128F (3) If: (a) subparagraph 128E(1)(b)(i) applied in relation to a superannuation account-freezing notice given in relation to a member of an eligible superannuation plan; and (b) during the 180-day period after the superannuation account-freezing notice comes into force, a section 139ZQ notice is given in relation to the transaction referred to in paragraph 128E(1)(a); the superannuation account-freezing notice is revoked: (c) when the trustee of the plan complies with the section 139ZQ notice; or (d) when the section 139ZQ notice is revoked; or (e) when the Court sets aside the section 139ZQ notice. The bankruptcy trustee effectively has 180 days to take or conclude their action after the freezing notice is given. If they cannot provide sufficient evidence within that time to satisfy the Official Receiver that a section 139ZQ notice should be issued, the freezing notice will be revoked. 93 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS VOIDING SUPERANNUATION CONTRIBUTIONS CONTINUED Revocation of freezing notice if no section 139ZQ notice given after 180 days (4) If subparagraph 128E(1)(b)(i) applied in relation to a superannuation account-freezing notice given in relation to a member of an eligible superannuation plan, the superannuation account-freezing notice is revoked if: (a) 180 days pass after the notice comes into force; and (b) no section 139ZQ notice has been given in relation to the transaction referred to in paragraph 128E(1)(a). Similarly if the bankruptcy trustee is seeking relief through a section 139ZU order, then the court may order; > compliance with that order; or > that order being set aside or dismissed; or > if the application for the order is withdrawn within the 180 day period, the freezing notice will automatically be revoked. BANKRUPTCY ACT 1966 - SECTION 128F Revocation of freezing notice when section 139ZU order complied with etc. (5) If: (a) subparagraph 128E(1)(b)(ii) applied in relation to a superannuation account-freezing notice given in relation to a member of an eligible superannuation plan; and (b) during the 180-day period after the superannuation account-freezing notice comes into force, a section 139ZU order is made in relation to the transaction referred to in paragraph 128E(1)(a) and in relation to the member’s superannuation interest; the superannuation account-freezing notice is revoked: (c) when the trustee of the plan complies with the section 139ZU order; or (d) when the section 139ZU order is set aside on appeal. Revocation of freezing notice when application for section 139ZU order dismissed or withdrawn (6) If: (a) subparagraph 128E(1)(b)(ii) applied in relation to a superannuation account-freezing notice given in relation to a member of an eligible superannuation plan; and (b) during the 180-day period after the superannuation account-freezing notice comes into force: RELATED TOPICS BANKRUPTCY ACT 1966 - SECTION 128F 2 (i) the Court dismisses an application for a section 139ZU order in relation to the transaction referred to in paragraph 128E(1)(a) and in relation to the member’s superannuation interest; or (ii) an application for a section 139ZU order in relation to the transaction referred to in paragraph 128E(1) (a) and in relation to the member’s superannuation interest is withdrawn; the superannuation account-freezing notice is revoked. The notice is also revoked if no order under section 139ZU is made within the 180 day period. BANKRUPTCY ACT 1966 - SECTION 128F Revocation of freezing notice if no section 139ZU order made after 180 days (7) If subparagraph 128E(1)(b)(ii) applied in relation to a superannuation account-freezing notice given in relation to a member of an eligible superannuation plan, the superannuation account-freezing notice is revoked if: (a) 180 days pass after the notice comes into force; and (b) no section 139ZU order has been made in relation to the transaction referred to in paragraph 128E(1) (a) and in relation to the member’s superannuation interest. The trustee is bound by a 180 day period, but that period may be extended on application to the court. WORRELLS.NET.AU 94 VOIDING SUPERANNUATION CONTRIBUTIONS CONTINUED BANKRUPTCY ACT 1966 - SECTION 128F BANKRUPTCY ACT 1966 - SECTION 139ZU Extension of 180 day period Order relating to rolled-over superannuation interests etc. (8) The Court may, on application by the Official Receiver, extend, or further extend, the 180 day period referred to in subsection (5), (6) or (7). (1)If, on application by the trustee of a bankrupt’s estate, the Court is satisfied that: (9) The Official Receiver may make an application under subsection (8): (a) if the Official Trustee is the trustee of the bankrupt’s estate - on the initiative of the Official Receiver; or (b) if a registered trustee is the trustee of the bankrupt’s estate - on application by the registered trustee. SECTION 139ZU ORDERS The provisions that allow bankruptcy trustees to recover money paid into eligible superannuation plans also contemplate the transfer of money (the roll-over of superannuation interests) between more than one plan or between one or more people. It allows the tracing of the void money into a second plan. Section 139ZU allows the court to make an order directing a payment of money from the second plan to the bankruptcy trustee, but there are limitations. The first limitation is that the contribution to the first plan must be void under the provisions set out above. This is the void transaction. But if the money has been transferred (rolled over) to another plan, there may not be sufficient funds left in that first plan to satisfy a claim. If there is sufficient money still in the first plan to pay the claim, this provision will not be necessary. But there may be a shortfall. The money, or part of it, would now be in a second plan. (a) a transaction is void against the trustee of the bankrupt’s estate under section 128B or 128C; and (b) the transaction was by way of a contribution to an eligible superannuation plan (the first plan)for the benefit of a person (the beneficiary) who may or may not be the bankrupt; and (c) the beneficiary’s withdrawal benefit in relation to the first plan falls short of the amount of the money, or the value of the property, received as a result of the transaction; and (d) the beneficiary has a superannuation interest in another eligible superannuation plan; and (e) the superannuation interest referred to in paragraph (d) is attributable, in whole or in part, to the roll over or transfer, after the transaction referred to in paragraph (a) happened, of the whole or a part of the beneficiary’s superannuation interest in the first plan; the Court may, by order, direct the trustee of the other eligible superannuation plan to pay to the trustee of the bankrupt’s estate a specified amount not exceeding whichever is the lesser of the following: (f) the amount of the shortfall referred to in paragraph (c); (g) the beneficiary’s withdrawal benefit in relation to the other eligible superannuation plan. The shortfall contemplated in the section is the shortfall between the money remaining in the first plan and the amount of the bankruptcy trustee’s claim. Only the amount of the shortfall may be claimed from the second plan. Essentially the trustee can keep tracing the money into the new plan and effect a recovery of the shortfall. 95 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS 2 RELATED TOPICS WORRELLS.NET.AU 96 INDICATORS OF INSOLVENCY WHAT ABOUT ACCRUED DEBTS? The debt must be incurred, not just accrued, when the company is insolvent. There is a distinction between the two. Incurring a debt is the legal creation of a debt that did not previously exist. Accrued debts usually relate to ongoing contractual agreements. These types of contractual agreements are incurred at the time of entering into the original agreement and only become payable (or accrue) at a later date. As long as the original agreement was entered into while the company was solvent, and the later amounts only accrue because of that original contract, they will not form part of an insolvent trading claim. For example, lease payments that become due on a regular basis are under a contract that was entered into prior to the insolvency of the company. HOW DO DIRECTORS BECOME LIABLE FOR THESE CLAIMS? Section 588G sets out the director’s duty to prevent insolvent trading and sets the parameters by which the liquidator can initiate the process for making a claim against the director. Directors contravene this section by allowing the company to incur the debt when they are aware that there were grounds for suspecting that the company was insolvent. Once a director has breached the duty set out in section 588G, the provisions of section 588M will allow a recovery of compensation from that director. A claim is possible where the director is in contravention, the creditors suffered loss or damage because of the company’s insolvency and the debt was wholly or partly unsecured. Breaching this provision gives grounds for the liquidator to make a claim against the director. Once this breach of 588G occurs, the provisions of section 588M will allow a recovery action to be taken against that director by the liquidator. The circumstances where recovery action is possible pursuant to section 588M are as follows: (b) t he person (in this section called the creditor) to whom the debt is owed has suffered loss or damage in relation to the debt because of the company’s insolvency; and (c) t he debt was wholly or partly unsecured when the loss or damage was suffered; and (d) the company is being wound up; whether or not (e) the director has been convicted of an offence in relation to the contravention; or (f) a civil penalty Order has been made against the director in relation to the contravention. (2) The company’s liquidator may recover from the director, as a debt due to the company, an amount equal to the amount of loss or damage. WHAT DEFENCES ARE AVAILABLE TO DIRECTORS? The Corporations Act provides statutory defences that may be available to directors. They can be summarised as: 1.The director had reasonable grounds to expect (not just suspect) that the company was solvent. 2.A reasonable, competent person was producing information that would reasonably lead to a belief that the company was solvent. 3.The director had a good reason for not taking part in the management of the company at the relevant time (only relevant to having a good reason not to). 4.The director took all reasonable steps to stop the company from incurring the debt, including attempting to appoint a voluntary administrator to the company. 1.The burden of proving the defences is placed upon directors. The courts have made it clear that the position of director carries certain responsibilities, which cannot be avoided, including the duty to keep informed about the company’s solvency. (1) This section applies where: (a) a person (in this section called the director) has contravened subsection 588G(2) or (3) in relation to the incurring of a debt by a company; and 97 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS INDICATORS OF INSOLVENCY 3 IS INSOLVENT TRADING AN OFFENCE? Yes. Insolvent trading may be an offence and may be referred to ASIC for further investigation and potential criminal prosecution. It is recommended that directors seek their own legal advice, in relation to such offences. Section 588G - Director’s duty to prevent insolvent trading by company goes on to stipulate: (3) A person commits an offence if; Creditors can only take actions against directors for their individual debts. Unlike liquidators, they cannot group all creditors’ debts into their claim. The Corporations Act will stop the creditor from commencing action when the liquidator has begun proceedings or has intervened in an application for a civil penalty order. That is, claims will be restricted when the liquidator has already started their own action. WORRELLS ARTICLES (a) the person is a director of the company when it incurs a debt; and (b) the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at WHAT’S IN A NAME? that time debts including that debt; and IT’S MY MONEY, ISN’T IT? (c) the person suspected at the time when the company ARE SUPERANNUATION MONIES incurred the debt that the company was insolvent or WITHIN THE TAXMAN’S REACH? would become insolvent as a result of incurring that debt or other debts (as in paragraph (1)(b); and CAN CREDITORS TAKE INSOLVENT TRADING ACTIONS? Yes. If a liquidator does not make a claim, the creditors of the company (individually or in a group) may make a claim themselves. The creditors may commence an action at any time with the written consent from the liquidator. Creditors may ask the liquidator to give them consent up to six months after the liquidation commences. The Corporations Act allows liquidators six years from the beginning of the liquidation100 to commence an action for insolvent trading. Proceedings 101must have been commenced within that six year period. It is not sufficient just to issue a demand. 102 WHAT SHOULD DIRECTORS DO IF A LIQUIDATOR MAKES A CLAIM? A Liquidator should be asked to demonstrate: 1. That the company was insolvent during the appropriate period 2. That the debts were incurred after that time 3. Proof of directorship at that time (whether formally appointed as such or not). In settling claims with the liquidator it must be ensured that the settlement is sanctioned by the court (usually by way of a consent order). This will provide protection from any future potential claims made by creditors of the company. THE COURTS HAVE MADE IT CLEAR THAT THE POSITION OF DIRECTOR CARRIES CERTAIN RESPONSIBILITIES, WHICH CANNOT BE AVOIDED, INCLUDING THE DUTY TO KEEP INFORMED ABOUT THE COMPANY’S SOLVENCY. CORPORATE INSOLVENCY (d) the person’s failure to prevent the company incurring the debt was dishonest. HOW LONG DO LIQUIDATORS HAVE TO TAKE AN INSOLVENT TRADING ACTION? INDICATORS OF INSOLVENCY CONTAINED IN THIS SECTION ARE SELECTED ARTICLES FROM OUR MONTHLY WORRELLS PLAIN TALK E-UPDATE. JOIN OVER 9,400 PEOPLE WHO RECEIVE IT EACH MONTH BY SUBSCRIBING VIA WORRELLS.NET.AU WORRELLS ARTICLES 99 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS INDICATORS WHAT’S OF INSOLVENCY IN A NAME? We also used the forum provided by our e-Update’s to state our view that S110 of the Bankruptcy Act, a section that appears to have its genesis in a 1728 court decision, has not only outlived its usefulness, but is quite capable of providing what are clearly inequitable outcomes. We also pointed out that the law contained in S110 was wide open to manipulation. Lastly we observed that bankruptcy trustees could be required to spend much time (and therefore creditor’s funds) on complying with this antiquated section. If you missed these articles they are available on our website. How Long is the Bankruptcy Shadow? How Relevant is a Rule Created in 1728 to a 21st Century Bankruptcy? It would be nice to report that our views have prevailed and that changes are expected… but that has not happened. However, despite this, we believe that publishing our views is a healthy exercise and will in due course at least add to the debate, and may lead to reform. “Bankruptcy” is, we believe, a highly pejorative term. It conjures up, at least in some people’s minds, suggestions of wrong doing and of financial profligacy. There is no doubt that the perceived and the actual stigma of bankruptcy has greatly receded over the last twenty years or so, but the Worrells partners know from their regular contact with those facing impossible financial difficulties that they often delay seeking the protection of the legislation simply because they do not want to be thought of as a “bankrupt”. That delay adds to their misery and is not something which the legislation, or society, should want to see happen. WORRELLS ARTICLES In June last year we published an article critical of the fact that the public record of a person’s bankruptcy is kept forever open. We pointed out that this approach is antipathetic to the notion that bankruptcy is intended to provide a fresh start, at least after the three year discharge period. Our position remains that the bankruptcy record should be expunged after, say, five to seven years in the same way that other credit history is wiped from the record. 3 Certainly there are a small percentage of bankrupts who are simply rogues, who appear to have no social conscience, who are indeed profligate. For such people being described as bankrupt is entirely appropriate. But to lump the unemployed worker who has impossible credit card debts under the same heading appears wrong. We acknowledge that finding an alternative term for small debtors and consumers is difficult, as is finding an appropriate cut off level. But we would like to see the problem tackled. IVOR WORRELL, Partner Worrells Brisbane February 2013 Plain Talk e-Update That being the case we have another issue to air. It seems to us that the label “Bankrupt” may have outlived its usefulness, at least as far as small debtors including consumer debtors are concerned. WORRELLS.NET.AU WORRELLS.NET.AU100 IT’S INDICATORS MY MONEY, OF INSOLVENCY ISN’T IT? Over the years, we have seen many, many companies, where the director has been very surprised to learn that they owe the company money. In years gone by, it was common strategy for the director to take money out of a company by way of a loan, which often had no immediate terms of payment, so as to avoid paying any taxes. The landscape changed somewhat, when the Tax Office become concerned about Division 7A Loan Accounts, and as a result, often there is a loan agreement between the director and the company, when a director takes funds from a company. It never ceases to amaze us how often the directors are surprised by amounts that they have drawn from the company and which has shown in the books as money owed by them back to the company. Most directors consider that as it is their company, they are solely entitled to the funds, and as a result it is not a loan at all. A number of lessons come out of such matters for us, they include: In a recent matter that we have been involved in, it became apparent that the director had been drawing an amount $200,000 to $300,000 per annum from the company over a period of time. I should say, that this was in addition to a substantial salary that was paid to him. As a result, by the time the director came to see me, the loan due back to the company, was in excess of $2,000,000. The director had no real ability to repay those funds given that a substantial amount of funds appear to have been used as lifestyle expenses. This factor alone, potentially made the company insolvent, given the company had what could otherwise be described as a healthy business. 2.Closely monitoring loan accounts of the company is imperative, as ultimately, if the company becomes insolvent, a liquidator may be looking to recover from the director which may ultimately affect the solvency of the director. 1. Paying tax by way of PAYG withholding, and therefore a salary, drawn from the company, is not such a bad thing. It allows the director to know exactly where the company is at. PAUL BURNESS, Partner Worrells Melbourne April 2013 Plain Talk e-Update 101WORRELLS WORRELLSSOLVENCY SOLVENCY&&FORENSIC FORENSICACCOUNTANTS ACCOUNTANTS ARE SUPERANNUATION MONIES WITHIN THE TAXMAN’S REACH? INDICATORS OF INSOLVENCY The Australian Taxation Office (ATO) holds many powers to recoup what’s owed to them. One of which is the power to ‘garnishee’ the tax debtor’s bank accounts, some trust funds, property sale proceeds, company shares and trade debtors. The question has long lingered about whether superannuation funds were, practically speaking, also part of the list. The mechanism behind a garnishee notice is a simple process of an entity receiving a notice demanding monies held on behalf of a tax debtor, which is expressly to be taken as being authorised by the debtor and/or any other persons also entitled to all or part of the funds. This third party is compelled to make the payment directly to the ATO and is indemnified in doing so. Superannuation funds by nature are supposed to be a protected source of money and so it has been said that a garnishee order would not be effective until the tax debtor’s (member’s) benefits are payable under the rules of the fund – which is usually when the member retires or dies! In the event of bankruptcy superannuation monies are excluded from the definition of divisible property and therefore cannot be realised by a bankruptcy trustee for the benefit of creditors. Early this year the Denlays filed an application in the Federal Court seeking a judicial review of the Commissioner’s decision to issue the garnishee notice, particularly given the stay on the enforcement of the judgment. The court accepted the Denlay’s argument and quashed the garnishee notice ordering that the monies be refunded to the superannuation fund, and interestingly awarded costs in favour of the Denlays on an indemnity basis. What is important to note is that the garnishee was quashed essentially because it was inappropriate to issue such a notice at the time of a court ordered stay on enforcement proceedings, not because superannuation monies are generally believed to have some sort of protection. WORRELLS ARTICLES Denlay v Commissioner of Taxation (2013) FCA 307 saw a long speculated question put to a test, which is conceivably one of many to come. 3 If you wish further information on the new provisions, please contact us. JASON BETTLES, Partner Worrells Gold Coast May 2013 Plain Talk e-Update In the case of Denlay v Commissioner of Taxation a garnishee was issued over the taxpayers’ superannuation fund. Interestingly, at the time of the issuing of the garnishee the parties were part way through the hearing of appeals filed by the Denlays to amended income tax assessments made by the ATO, and at a time when the ATO had consented to an order for a stay of the enforcement of a judgment in relation to the tax debt. Mr & Mrs Denlay was declared bankrupt in 2012 upon lodging debtor’s petitions, Jason Bettles, Partner Worrells Gold Coast is the bankruptcy trustee of both estates. Mr Denlay was not in a position to pay the tax debt or further fund the appeal of the assessment. WORRELLS.NET.AU WORRELLS.NET.AU102 GLOSSARY INDICATORS OF INSOLVENCY Scan the QR code below to go direct to our online Glossary of terms. 103WORRELLS WORRELLSSOLVENCY SOLVENCY&&FORENSIC FORENSICACCOUNTANTS ACCOUNTANTS INDICATORS OF INSOLVENCY WORRELLS.NET.AU104 BRISBANE P 07 3225 4300 [email protected] IPSWICH P 07 3280 6200 [email protected] TOOWOOMBA P 07 4637 6500 [email protected] GOLD COAST P 07 5553 3444 [email protected] BALLINA P 02 6686 7952 [email protected] MAROOCHYDORE P 07 5459 1000 [email protected] NOOSA P 07 5447 3766 [email protected] SYDNEY P 02 9249 1200 [email protected] CENTRAL COAST P 02 4363 6300 [email protected] CANBERRA P 02 6287 6000 [email protected] MELBOURNE P 03 9613 5500 [email protected] BALLARAT P 03 5338 4694 [email protected] BENDIGO P 03 5444 3783 [email protected] worrells.net.au
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