2012/13 GUIDE TO PERSONAL INSOLVENCY worrells.net.au
PLAIN TALK. STRAIGHT ANSWERS. FAST RESULTS. Editor Chris Cook, Partner Worrells Brisbane 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 2 WORRELLS 3 GLOSSARY PERSONAL INSOLVENCY 13 5 PHASES OF FAILURE 14 BANKRUPTCY 18 DIVISIBLE PROPERTY IN BANKRUPTCY 21 BANKRUPTCY AND THE FAMILY HOME 26 GETTING OUT OF BANKRUPTCY 29 INCOME CONTRIBUTIONS IN BANKRUPTCY 30 VOID TRANSACTIONS IN BANKRUPTCY 32 PREFERENCES IN BANKRUPTCY 36 VOIDING SUPERANNUATION CONTRIBUTIONS 38 PART X PERSONAL INSOLVENCY AGREEMENTS 45 SECTION 73 PROPOSALS 47 REVESTING OF PROPERTY 49 DISCHARGE & ANNULMENT 50 RELATED TOPICS 55 PROOFS OF DEBT AND SECURED CREDITORS 56 PUBLIC EXAMINATIONS 57 Meetings of Creditors 59 Dividends 62 CGT And Insolvency 69 GST AND INSOLVENCY 72 ARTICLES 79 THE TAXMAN COMETH 80 ASSET PROTECTION STRUCTURES EXPOSED UNDER PPS ACT 81 DEALING WITH REAL PROPERTY AFTER DISCHARGE 83 WHAT HAPPENS WHEN A MEMBER OF A SELF MANAGED SUPER FUND BECOMES BANKRUPT? 84 A TALE OF THREE PROPERTIES 85 87
A WORD FROM IVOR Our Guide to Personal Insolvency inevitably focuses largely on personal bankruptcies, so it s worthwhile knowing that the term bankruptcy derives from two Latin words, bancus meaning table, and ruptus meaning broken. Before the advent of shops, when merchants and traders carried on business from markets, they set up their businesses on tables or benches in the market place, to display their wares. In those early days, if a merchant could not pay his debts, the practice was for his table to be broken so as to signify that he was out of business. Whether the merchant broke his own table or whether his creditors took a hand in the process is not clear; probably both happened. In any event bancus ruptus or broken table has evolved into our word bankruptcy. Along with the evolution of the term bankruptcy, both the law relating to personal insolvency and the community s perception of the bankruptcy process have evolved. Today we have a very detailed and codified framework of Bankruptcy law, drawn from both legislation and from Court judgments. Bankruptcy law aims to combine equity for and between creditors, with the need to provide a fresh financial start for debtors who could not otherwise survive. To a very large degree the law succeeds in its aims. Another major evolution relates to the incredible amount of information that the ordinary person can get from the web on almost any subject, including bankruptcy. But not all of the information focuses on what most people really want to know, not all of it is expressed in everyday English, and not all of it aims to correct the many misconceptions which still abound about bankruptcy and its consequences for both debtors and creditors. Worrells 2012/13 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 16 partners. For our professional colleagues the Guide will provide a quick reference explanation of the relevant law which can be used in their office, or passed onto clients. For those facing the uncertainty of bankruptcy, or who are subject to one of the other forms of personal insolvency, often one of the most difficult issues is uncertainty about what will happen. Using its simple English question and answer format the Guide shines a light on and explains the uncertainties which most affect debtors. We have also included in our Guide a selection of interesting and illuminating articles taken from our popular monthly Plain Talk e-update newsletter. Bankruptcy is not about punishing business owners for making mistakes. And it s not about penalising people for taken risks, because risk taking is the very essence of our market economy. It s about removing impossible financial obligations in a way which is transparent and fair to all. Of course each insolvency is unique on some way, and although our Guide is accurate at the date of publication, both the law and the practice of insolvency continue to evolve. That is why we encourage all readers to treat the information in the Guide as a statement of general principles and always to seek qualified professional advice, or to contact a Worrells partner, before committing to any course of action. Ivor Worrell Coordinating Partner bankruptcy is not about punishing business owners for making mistakes. WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU
The essence of Worrells and our contemporary culture is now illustrated through our brand. We strived for an evolution toward a modern and fresh brand - one that reflects who we are. We hope you like it as much as we do. 3
WORRELLS PARTNERS It s our people that deliver Plain talk, straight answers and fast results. WorRells are a team of full time specialists. Solvency Management, Restructure or Insolvency Administration can be a period of great stress. An experienced and specialist team can ease the process, ensuring a fair outcome for all parties concerned. At Worrells we re specialists - Solvency Accounting is all we do. 16 Partners, 16 Registered & Official Liquidators, 13 Registered Trustees, 3 Certified Fraud examiners, 5 east coast major metro locations, we can have experienced staff at any location, quickly. Quick decisive action by a highly skilled team acting in a caring, respectful and fair manner does make all the difference. Established over 38 years ago, Worrells draws upon over 200 years of experience. Using proprietary technology, our team have successfully completed over 25,000 assignments. Specialist accounting services, delivered by dedicated fulltime specialists, on time, on budget every time. IVOR WORRELL brisbane FCA Official Liquidator Registered Trustee Member IPA Forensic Accountant Justice of the Peace 07 3225 4310 ivor.worrell@worrells.net.au Ivor Worrell is a Registered Trustee in Bankruptcy and Official Liquidator. Ivor is a leading Queensland insolvency practitioner and in a career spanning 38 years he has developed experience in Corporate and Personal Insolvency, Receivership and Litigation Support. 4 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU
Raj Khatri brisbane FCA Official Liquidator Registered Trustee Member IPA Commissioner of Declarations 07 3225 4320 raj.khatri@worrells.net.au Raj Khatri joined the firm in 1986 rising to become a Partner in 1994. His area of specialty is Corporate Insolvency and has over 26 years experience in the field. Raj is a fellow of the Australian Institute of Chartered Accountants, an associate of the New Zealand Society of Accountants and the Institute of Corporate Managers, Secretaries and Administrators. Morgan Lane brisbane CA CPA (Fellow) Official Liquidator Registered Trustee Member IPA Justice of the Peace 07 3225 4330 morgan.lane@worrells.net.au Morgan Lane joined the firm in 1992 and became a full partner in 1996. His wealth of experience gained in both the private and public sectors adds further depth to our insolvency division. Morgan is a Fellow of CPA Australia accredited as a Specialist in Insolvency & Reconstruction, an Associate of the Institute of Chartered Accountants and The Institute of Corporate Manager, Secretaries and Administrators. MICHAEL GRIFFIN brisbane CA Registered Liquidator Official Liquidator Registered Trustee Certified Fraud Examiner Member IPA Commissioner of Declarations 07 3225 4360 michael.griffin@worrells.net.au Michael is a Registered Liquidator, Official Liquidator and a Registered Trustee in Bankruptcy. Michael is also a Member of the Institute of Chartered Accountants and the Insolvency Practitioners Association. Michael s experience includes all forms of personal and corporate insolvency matters. 5
WORRELLS PARTNERS MICHAEL PELDAN brisbane FCA Registered Liquidator Official Liquidator Registered Trustee Certified Fraud Examiner Member IPA Commissioner of Declarations 07 3225 4370 michael.peldan@worrells.net.au Michael joined the firm as a graduate in 1991 after completing studies as a mature-aged student, and became a full partner in July 2000. Michael s experience includes all aspects of Corporate and Personal Insolvency and Financial Investigation. Michael is also engaged in Fraud Awareness Management and Education and is one of the firm s Certified Fraud Examiners. CHRIS COOK brisbane CPA CA Registered Liquidator Official Liquidator Member IPA Commissioner of Declarations 07 3225 4386 chris.cook@worrells.net.au Chris is an Official Liquidator, Chartered Accountant, Certified Practising Accountant and a member of the Insolvency Practitioners Association of Australia. Chris joined the firm in February 1999 and has considerable experience in both the Corporate and Personal Insolvency Fields. Chris is the partner and heads a team that specialises in Corporate and Personal Insolvency. ADAM WARD IPSWICH CPA Registered Liquidator Official Liquidator Registered Trustee Member IPA Commissioner of Declarations 07 3280 6201 adam.ward@worrells.net.au Adam Ward joined the firm in 2001 and became a partner in 2011. Adam is a Registered Liquidator, Official Liquidator and is a member of both CPA Australia and the Insolvency Practitioners Association. His experience includes all forms of Corporate and Personal insolvency matters. Adam is the Partner that leads a team at our Worrells Ipswich Office. 6 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU
JASON BETTLES GOLD COAST CA Official Liquidator Registered Trustee Member IPA Commissioner of Declarations 07 5553 3405 jason.bettles@worrells.net.au Jason is an Official Liquidator, Registered Liquidator, Registered Bankruptcy Trustee, Chartered Accountant and a member of the Insolvency Practitioners Association of Australia. He has worked exclusively in the field of insolvency since 1995, managing the Gold Coast Insolvency Division of a second tier accounting firm for two years before joining us in October 2001. Jason has experience in all forms of corporate and personal insolvency matters. He has provided recommendations on the most appropriate solutions to deal with insolvency issues to all types of parties. Jason s knowledge and experience allows him to consider informal arrangements to solve insolvency problems, as well as the formal insolvency administrations. Paul Nogueira sunshine coast CPA CA Registered Liquidator Official Liquidator Registered Trustee Member IPA Commissioner of Declarations 07 5459 1002 paul.nogueira@worrells.net.au Paul joined Worrells in 1999 after completing his degree with the Queensland University of Technology. He was appointed a Partner in 2006 and opened the Worrells Sunshine Coast office in 2007. Paul is experienced in all forms of Corporate and Personal insolvency administrations over various industries and specialises in small to medium business turnaround management and solvency solutions. Paul adheres to the firm s Plain Talk, Straight Answers, Fast Results approach and is available to provide no obligation advice to any party that may find themselves faced with solvency problems. JOHN CUNNINGHAM sunshine coast CPA Liquidator Registered Trustee 07 5459 1001 john.cunningham@worrells.net.au John joined Worrells as a partner in 2012. He is one of ten partners in Queensland and 16 nationally. John has over 23 years experience in the insolvency field having commenced with the then Official Receivers Office in Melbourne in 1989. John joined forces with Paul Nogueira as part of the Ramsay Clout merger with Worrells in 2012. Whilst John has taken appointments in a wide variety of areas and industries he has developed a particular expertise in the areas of building, retail and hospitality. 7
WORRELLS PARTNERS Nicholas Malanos sydney CPA Registered Liquidator Official Liquidator Registered Trustee Certified Fraud Examiner Member IPA 02 9249 1209 nick.malanos@worrells.net.au Christopher Darin sydney CA Registered Liquidator Official Liquidator Justice of the Peace 02 9249 1214 chris.darin@worrells.net.au Stephen Hundy CANBERRA CA Registered Liquidator Official Liquidator Registered Trustee Member IPA 02 6287 6000 stephen.hundy@worrells.net.au Nick has in excess of 27 years experience in all aspects of corporate insolvency. He has particular expertise in the areas of Voluntary Administration and Deeds of Company Arrangement which has now enabled numerous businesses to successfully continue on over the years. Chris is a Registered Liquidator, Official Liquidator and associate member of the Institute of Chartered Accountants in Australia. Chris joined the firm as partner of the Sydney firm in July 2008 having been in practice on his own account since 1996. Chris experience includes all aspects of corporate insolvency and adopts a consultative approach when exploring all financial avenues available to a distressed company. Chris also undertakes corporate advocacy appointments, assisting directors and companies in dealing with their debtors, creditors and other insolvency practitioners. Stephen Hundy joined Worrells Solvency & Forensic Accountants in 2011 as a partner and leads our Canberra office. Stephen has worked exclusively in the insolvency industry since 1995 and is able to provide assistance in all areas of personal and corporate insolvency. Stephen specialises in the provision of clear practical commercial advice on a wide range of business issues for individuals and small to medium enterprises. He adopts a hands-on approach being involved in all aspects of an appointment. In addition, Stephen also has experience in preparing fraud and financial investigation reports, undertaking financial viability reviews and has assisted with shareholder and partnership disputes. 8 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU
paul burness melbourne CPA Official Liquidator Registered Liquidator Registered Trustee Certified Fraud Examiner Member IPA 03 9613 5510 paul.burness@worrells.net.au matthew jess melbourne CPA Registered Liquidator Official Liquidator Registered Trustee Member IPA 03 9613 5513 matthew.jess@worrells.net.au Con Kokkinos melbourne CPA Registered Liquidator Official Liquidator 03 9613 5502 con.kokkinos@worrells.net.au Paul Burness is a Certified Practising Accountant, an Official Liquidator and a Registered Trustee in Bankruptcy. He is also a member of the Insolvency Practitioners Association of Australia. Paul has considerable experience in all forms of Corporate and Personal Insolvency and Reconstruction, specialising in insolvency since graduating. Paul is the managing partner of the Melbourne firm. Matthew is an Official Liquidator and Certified Practising Accountant, who has considerable experience in the Insolvency, Commercial Accounting and Corporate Finance fields. Matthew s experience includes due diligence investigations, sale of business transactions, corporate reconstructions and financial turnarounds. Matthew has also completed the Advanced Insolvency Course with the Insolvency Practitioners Association of Australia. Con Kokkinos joined the Melbourne office on a full time basis in April 2008. Con has been a Liquidator since November 2001 and is a member of CPA Australia. Con brings with him over 15 years of insolvency experience with an emphasis in all aspects of corporate insolvency. 9
LATEST PERSONAL INSOLVENCY STATISTICS Insolvency figures as released by THE Insolvency AND Trustee Service Australia (ITSA). Release No: 127 Date issued: 10 July 2012 ADMINISTRATIONS UNDER THE BANKRUPTCY ACT 1966 STATISTICS (PROVISIONAL*) JULY 2011 - JUNE 2012 Bankruptcies (Parts IV and XI) 10/11 11/12 Debt Agreements (Part IX) % Change 10/11 11/12 Personal Insolvency Agreements (Part X) % Change 10/11 11/12 Total insolvency activity % Change 10/11 11/12 % Change NSW 8127 7623-6.20% 2661 3093 16.23% 126 115-8.73% 10914 10831-0.76% ACT 186 171-8.06% 98 146 48.98% 1 4 300.00% 285 321 12.63% VIC 4521 4253-5.93% 1733 1757 1.38% 106 97-8.49% 6360 6107-3.98% QLD 6145 6253 1.76% 2244 2476 10.34% 74 79 6.76% 8463 8808 4.08% SA 1603 1517-5.36% 338 358 5.92% 7 16 128.57% 1948 1891-2.93% NT 106 80-24.53% 54 56 3.70% 0 2 160 138-13.75% WA 1701 1569-7.76% 625 769 23.04% 55 60 9.09% 2381 2398 0.71% TAS 713 697-2.24% 301 292-2.99% 6 5-16.67% 1020 994-2.55% Total 23102 22163-4.06% 8054 8947 11.09% 375 378 0.80% 31531 31488-0.14% Note 1: Note 2: Note 3: All the above figures refer to personal administrators under the Bankruptcy Act only (and not corporate insolvency). All the above figures refer to personal administrations under the Bankruptcy Act only (and not corporate insolvency). There were 5,058 (22.8%) business related bankruptcies and 17,105 (77.2%) non-business bankruptcies during the financial year. A business related bankruptcy is defined as being one in which an individual s bankruptcy is directly related to his or her proprietary interest in a business. *Verified annual figures are published in the ANNUAL REPORT ON THE OPERATION OF THE BANKRUPTCY ACT 1966 for each financial year, released by the office of the Inspector-General in Bankruptcy, Insolvency and Trustee Service, Australia, 42 Macquarie St, BARTON ACT 2600. Telephone (02) 6270 3400 Fax (02) 6270 3413 These figures, together with some historical data, may be found on ITSA s homepage on the Internet at www.itsa.gov.au 10 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU
Bankruptcy 2010/11 2011/12 NSW 8127 7623 10000 8000 BANKruptcy 2010/11 BANKruptcy 2011/12 ACT 186 171 VIC 4521 4253 6000 QLD 6145 6253 SA 1603 1517 4000 NT 106 80 WA 1701 1569 2000 TAS 713 697 0 NSW ACT VIC QLD SA NT WA TAS Personal Insolvency Agreements (Part X) 2010/11 2011/12 NSW 126 115 ACT 1 4 VIC 106 97 150 120 90 PERSONAL INSOLVENCY AGREEMENTS (PART X) 2010/11 PERSONAL INSOLVENCY AGREEMENTS (PART X) 2011/12 QLD 74 79 SA 7 16 60 NT 0 2 WA 55 60 30 TAS 6 5 0 NSW ACT VIC QLD SA NT WA TAS Total Insolvency Activity 12000 TOTAL INSOLVENCY ACTIVITY 2010/11 2010/11 2011/12 NSW 10914 10831 ACT 285 321 10000 8000 TOTAL INSOLVENCY ACTIVITY 2011/12 VIC 6360 6107 QLD 8463 8808 6000 SA 1948 1891 NT 160 138 WA 2381 2398 4000 2000 TAS 1020 994 0 NSW ACT VIC QLD SA NT WA TAS 11
PERSONAL INSOLVENCY NUMBERS REMAIN CONSISTENT, THAT S WHY AN UNDERSTANDING IS THIS AREA IS VITAL. WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU
1 PERSONAL INSOLVENCY 5 PHASES OF FAILURE 14 BANKRUPTCY 18 DIVISIBLE PROPERTY IN BANKRUPTCY 21 BANKRUPTCY AND THE FAMILY HOME 26 GETTING OUT OF BANKRUPTCY 29 INCOME CONTRIBUTIONS IN BANKRUPTCY 30 VOID TRANSACTIONS IN BANKRUPTCY 32 PREFERENCES IN BANKRUPTCY 36 VOIDING SUPERANNUATION CONTRIBUTIONS 38 PART X PERSONAL INSOLVENCY AGREEMENTS 45 SECTION 73 PROPOSALS 47 REVESTING OF PROPERTY 49 DISCHARGE & ANNULMENT 50 13
1 5 PHASES OF FAILURE 14 5 PHASES OF FAILURE 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. Based on our past experience dealing with business failures, we have prepared the following information which identifies what we call the Five Phases to Failure and the elements which are likely to be found at each phase. 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. 1. CONFIDENT PHASE (THE RISE) 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 fulfil the expected continued growth. 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 effect on the business and the owner s personal life, in the future. 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. During this phase we can expect to see: (i) Good trading with a reasonable demand for the product or services offered. (ii) Increasing turnover. New business is won at the expense of more established competitors, mainly by discounting. (iii) Suppliers offering discounts and credit to win supply contracts. (iv) The business products and the staff are innovative and ahead of competitors. (v) Directors willing to sign personal obligations and guarantees. (vi) Financial statements and budgets are prepared, although not necessarily thoroughly analysed. (vii) New premises and/or plant are brought online. (viii) Expansion and trading are often being funded on finance, because of limited capital. (ix) Growth of turnover is considered all important but the cost of making these sales is not fully understood. (x) Regular drawings by owners. (xi) Great plans for future expansion being confidently discussed. (xii) Staff bonuses and incentives are offered. 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. WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU
PERSONAL INSOLVENCY 1 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: (i) Sales getting harder to win and increased competition. (ii) Turnover becoming stagnant or reducing for two or more consecutive periods. (iii) Current asset ratio weakening. (iv) Closer attention from the bank and investors. (v) Margins being squeezed as suppliers end their early discounts and prices have to be dropped to get sales. (vi) Credit being harder to obtain from suppliers who require guarantees from directors. (vii) An intermittent inability to meet all commitments - the overdraft balance increases. (viii) Grand plans quietly downgraded to more realistic levels or are dropped entirely. (ix) Uncertainty about the business ability to trade profitably in the future. (x) Preparation of financial statements becoming less regular and less rigorous. (xi) Directors and owners becoming less enthusiastic. (xii) 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. 3. DEBT PHASE (THE DECLINE) 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. 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. 5 PHASES OF FAILURE 15
1 5 PHASES OF FAILURE 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. A business in the debt phase is usually characterised by: (i) Creative accounting being used for reporting to banks and investors. (ii) Spending is reduced on noncore activities i.e. marketing. (iii) Further and greater use of ATO funds and failure to remit superannuation monies. (iv) Further slippage in turnover, margins and profits. (v) Quality customers are lost as they find more stable suppliers. (vi) A need for longer term arrangements with some creditors. (vii) Some suppliers only supplying on COD basis. (viii) Planning is done on a day by day survival basis. (ix) Accountants consulted but advice generally ignored. (x) Internal systems and controls begin to break down. (xi) Management s main preoccupation is demands from creditors. (xii) 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 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: (i) A belief that problems that exist can be overcome relatively simply. Wishful thinking is the order of the day. (ii) Greater losses are incurred but the true extent is not acknowledged or known. (iii) Management s time allocated to non-core activities. (iv) Bank and investor relations make demands to reduce their exposure. (v) Management shows signs of complacency or arrogance. (vi) Blame for the situation is laid on everyone else. (vii) Preparation of any financial statements is all but abandoned. (viii) Demands from creditors are ignored and proceedings are issued. (ix) A refusal to recognise the existence of bad debts and redundant stock. (x) It becomes difficult to get supply on credit or at a reasonable cost. (xi) Management becomes unavailable to make decisions, or if decisions are made, they are regularly countermanded. (xii) 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. 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. 16 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU
PERSONAL INSOLVENCY 1 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. In this phase we expect to see: (i) All working capital has been exhausted. (ii) Non-adherence to any payment arrangements with the ATO. (iii) Directors and proprietors look to protecting themselves. (iv) Goodwill is lost. (v) Bank and investors are not interested in further extensions. (vi) Insufficient funds are available to pay wages, rent, or chattel leases. (vii) The ATO issues directors penalty notices. (viii) Administrators appointed and are expected to work miracles with virtually no working capital or reliable information. (ix) Creditors fail to accept the director s proposal or trading on and the business is closed. (x) Sole proprietors become bankrupt. (xi) Directors are subject to demands from guaranteed creditors and insolvent trading claims from liquidators, resulting in bankruptcy. (xii) 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. 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. 5 PHASES OF FAILURE By The Way... Bankruptcy trustees identify bankruptcy offences... but it s the regulators who decide whether a prosecution is warranted. 17
1 BANKRUPTCY BANKRUPTCY WHAT IS BANKRUPTCY? 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 his 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. 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: (i) Can t act as a company officer; (ii) Can t trade under a registered business name without advising people that they are bankrupt (they can trade under their own name); (iii) Must make all of their divisible assets available to the trustee; (iv) Can t incur credit over an indexed amount without advising the lender that they are bankrupt; (v) Must surrender their passport(s) and will have limitations on overseas travel; and (vi) Must make all books and records and financial statements available, including those of associated entities such as companies and trusts. CAN A BANKRUPT CONTINUE TO EARN INCOME? Yes, a bankrupt may continue to earn income and is encouraged to do so. 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. 18 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU
PERSONAL INSOLVENCY 1 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: (i) Necessary clothing and household items; (ii) Tools of trade to an indexed amount; (iii) A motor vehicle to an indexed amount; (iv) Life assurance or endowment policies (subject to some limitations); (v) Certain damages and compensation payments; (vi) Sentimental property (as defined in the Bankruptcy Act); (vii) Superannuation payments (subject to certain limitations). CAN THE TRUSTEE RECOVER PROPERTY THAT WAS SOLD BEFORE BANKRUPTCY? 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. 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 EFFECT 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. There are few exceptions to this rule that are not covered here. WHAT THE RIGHTS OF SECURED CREDITORS AFFECTED? 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 and will not be released at the end of the bankruptcy. These debts include: (a) Some portion of a HECS debt; (b) Court imposed fines; and (c) 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. 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. BANKRUPTCY 19
1 BANKRUPTCY 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: (a) By an order of the court on the basis that the bankruptcy should not have occurred; (b) By the bankrupt s debts and the costs of the administration being paid in full; or (c) 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 a consent from a trustee to become the trustee of the estate. 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. In summary, the trustee will: (a) Find and protect the assets of the bankrupt; (b) Realise those assets; (c) Conduct investigations into the financial affairs of the bankrupt and any suspicious transactions; (d) Make appropriate recoveries; (e) Report to creditors; (f) Report offences to ITSA; and (g) 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 dies or retires. GOVERNMENT CHARGES (ARC AND IRC) Bankrupt estates attract a government charge. This charge is payable at the rate of 4.4% 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. 20 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU By The Way... Don t confuse a bankrupts discharge with the end of the bankruptcy. Discharge usually happens after three years and relates to control over the bankrupt personally, but the identification and realisation of assets can take place for many years after discharge.
PERSONAL INSOLVENCY DIVISIBLE PROPERTY IN BANKRUPTCY 1 INTRODUCTION 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. VESTING OF THE PROPERTY OF THE BANKRUPT Vesting Property 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. BANKRUPTCY ACT 1966 - SECTION 58 Vesting of property upon bankruptcy-general rule (1) Subject to this Act, where a debtor becomes a bankrupt: (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 (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 after-acquired property does not vest in the trustee. The two important factors are: 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. 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. 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 Vesting of property upon bankruptcy-general rule (3) Except as provided by this Act, after a debtor has become a bankrupt, it is not competent for a creditor: (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. There are two exceptions that allow creditors to commence or continue action against property: 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. 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. DIVISIBLE PROPERTY IN BANKRUPTCY 21