Struggling with debt? Bankruptcy isn't always the answer

High credit card debt, Workers' Compensation obligations, unpaid tax, and failure to pay interest free loans are some of the reasons people find themselves applying for bankruptcy.

In the last month, with COVID-19 restrictions in place, construction remained the most common industry for people filing for personal insolvencies, but the largest increase was recorded in accommodation and food services.

The most recent data from the Australian Financial Security Authority, shows that in December 2019 the number of bankruptcies in that quarter were at their lowest level since December 1994.

According to O'Neill Partners consulting solicitor Sally Nash, this may be because people were managing debt better or that money was easier to repay with lower interest rates.

However, with COVID-19 affecting the current quota, Nash says it is difficult to predict what will happen.

"With respect to COVID, both the JobKeeper and JobSeeker payments will assist in preventing people from going bankrupt," she says.

"In addition the government has lifted the monetary threshold for a Bankruptcy Notice from $5000 to $20,000 and extended the time period for payment from 21 days to six months.

Nash doesn't expect to see a change in the bankruptcy statistics for at least 12 months, and "much will depend on the debtor negotiations with financial institutions and commercial landlords", she says.

According to Nash, the profile of a bankrupt used to be a woman under 35 who had racked up a big credit card debt.

"It has now become an older demographic of people who were in business, and when their debts ran up, saw it as the only way to clear their debts clear," she says.

"More often than not, people will find other ways of meeting financial obligations than going bankrupt, particularly if it is just to one creditor."

If you're struggling with debt and feel that bankruptcy may be your only way out, talk to your creditors, suggests Nash.

Many people avoid speaking to their creditors out of embarrassment, she says, but they may be flexible with timing, payment schedules or a smaller payment to settle the debt.

The ATO is a common creditor, as people who avoid paying tax for some time find themselves struggling under penalties and interest charges.

"The ATO is likely to be amenable to making an arrangement," she says.

ICare (formerly Work Cover) is another area where businesses may find themselves in dire financial straits.

"If a worker is injured, that worker is paid workers' compensation which will then be recouped by ICare against the employer, if the employer doesn't have the insurance they are liable for the compensation, plus any unpaid premiums," Nash says.

However, if people have large amounts of credit card debt, that will be harder to negotiate, she says.

In bankruptcy many assets, superannuation and income are protected, but not the family home.

Options to consider before declaring bankruptcy

Temporary debt relief

If you have been financially impacted by coronavirus (COVID-19), you may be eligible to receive financial assistance or if your business has been impacted, you can find more information on the business.gov.au website.

Through the COVID 19 provisions announced in March, banks have been asked to defer mortgage repayments to home owners, investment property landlords and small to medium businesses, for six months.

During this time, people might be able to seek advice from a free financial counsellor , negotiate a payment plan with creditors or see if any of the below measures.

1. Financial hardship

If you cannot pay bills you can apply for financial hardship with creditors. Typically, this occurs if you are between jobs and are facing a particular period of difficulty - such as the current pandemic.

Currently, banks are offering a moratorium on mortgage repayments of up to six months.

Creditors may include banks, financial institutions and landlords, and the hardship provisions may include a payment hiatus of three to six months, after which your payments will be reinstated.

2. Financial counselling

Financial/debt counsellors have experience in this area and may be able to recommend the best solution for your particular circumstances.

You can contact a financial counsellor through Moneysmart.

3. Debt agreements

A debt agreement is an agreement between you and your creditors. It can be flexible in the arrangement to recover debt, reasonably, without bankrupting the debtor.

After the agreement is made you make repayments to the debt agreement administrator and at the end of the agreement your debt is cleared, typically around three to five years.

4. Personal Insolvency Agreements

Also known as a PIA Part X (10), this is an agreement between you and your creditors, approved by creditors, which allows you to settle or compromise the debt without becoming bankrupt.

It involves a trustee being appointed initially to take control of your property and make an offer to creditors for them to consider.

This may be made to pay part of your debts in a lump sum or by installments. It can also include recovery of other property that the debtor agrees to contribute.

What you need to know about bankruptcy

You can declare yourself bankrupt (a debtor's petition), or a creditor can make you bankrupt (a creditor's petition).

Once you become bankrupt you are freed from most debts and allowed to make a fresh start.

Bankruptcy lasts three years from filing a Statement of Affairs but may be extended for non-compliance with the provisions of the Bankruptcy Act. Your bankruptcy is however noted on a public register forever and this definitely affects your credit rating, usually for seven years.

However, it doesn't include all debts. For example, if you have a home loan through a bank or financial institution, your debt contract is to them, and this is not subject to any bankruptcy status.

HECS and child maintenance orders are also exempt from debts cancelled through bankruptcy.

You are also unable to incur additional credit without declaring that you are bankrupt if the amount is above a combined total of $5882.

Cars and motorbikes under $8000 value may be retained, or if you haven't paid off the vehicle, the amount that counts towards the limit is its value minus what you still owe.

For example, if your car is worth $13,000 and you still owe $5000, then this will meet the limit of $8000.

Tools of trade are another asset you can keep if you need these to earn income but only up to the value of $3800.

Generally, superannuation entitlement and wages are not available in a bankruptcy. Wages may be subject to the prescribed thresholds be the subject of a contribution scheme.

However, there are things you can't do. You can't travel or make arrangements for travel without permission from your trustee.

For example, if you are travelling for work, your employer will need to give start and end dates to the travel, and acknowledge they are paying.

You are also required to surrender your passport to your trustee.

You are also not permitted to be the director, or involved in the management, of a company.

Benefits of bankruptcy

The biggest advantage of being declared bankrupt is that your wages are no longer subject to a garnishee order, where money is deducted from your pay for particular creditors.

Further, sheriffs will not be able to take possession of assets like the TV or car or personal household goods for distribution amongst creditors.

"Both these reasons are usually the catalyst for filing for bankruptcy," says Nash.

However, a garnishee can take money from any bank accounts you have, and if you have joint accounts the assets will be split 50/50.

One bankrupt in a couple

If one person in a couple is declared bankrupt and they own property together, the property will generally be split 50/50 and the bankrupt's half will be recovered by the trustee.

The trustee will then want to sell his half - and this may be sold to the other partner (if they can afford it), who will also have to pay stamp duty as this is a transfer of ownership. If there is no agreement a Court order for sale can be made.

Inheriting money after declaring bankruptcy

If you are bankrupt and you are left a bequest in a will, all of that bequest will be vested in the trustee in the bankruptcy.

Nash says she has told people to have wills of relatives changed to prevent this happening, but this has only happened in one case in 45 years.

"Bankruptcy is a private thing, people don't generally discuss it with friends or family, it still has a stigma," she says.

Managing your cash flow to avoid excess debt

Cashflow is one of the greatest issues of businesses going bad. Making sure you are communicating any issues with your creditors upfront is one way you can stave off spiralling debt.

Small business is often sole operators who don't provision for revenue expenses and do not have money deducted from their income as it comes in.

When tax is not taken from income, it's a good idea to keep a separate account to quarantine this from other spending money.

For many people, a simple budgeting app can help overspending by recording all outgoings against income to really understand cashflow.

The business.gov.au website lists relief options for people who can't pay debts because of COVID 19.

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