ALTERNATIVES TO BANKRUPTCY DEBT AGREEMENTS CONTENTS Debt Agreement Defined 2 Mutually Exclusive with Bankruptcy 2 Eligibility to Enter a Debt Agreement 3 Eligible Administrators 4 Basic Eligibility Test 4 Registration of Administrators 5 Duties of Administrators 5 Fees 6 Fees of Administrators 6 Process with Debt Agreements 7 Proportionate Returns to Creditors 7 The Proposal 8 Acceptance for Processing 9 The Freeze 9 Considering the Proposal 9 Lapsing & Non Acceptance of Proposal 10 Acceptance by Creditors 10 Effect of Acceptance by Creditors 10 End of Debt Agreement & Release from Debt 11 Default in regard to Debt Agreement 11 Automatic Termination of Debt Agreement 11 Varying or Ending A Debt Agreement 12 Varying a Debt Agreement 12 Ending a Debt Agreement 13 Comparison with Bankruptcy 14 1
ALTERNATIVES TO BANKRUPTCY DEBT AGREEMENTS Debt Agreement Defined Debt agreements are arrangements between a debtor and creditors to deal with unsecured debts that would be provable if the debtor were to become bankrupt. They are legally binding arrangements regulated by the Bankruptcy Act. Debt agreements are intended for people with modest levels of income, unsecured debt and unprotected assets. References in this paper such as (s. 185 (c) (4) ) are references to sections of the Bankruptcy Act 1966 (Commonwealth). Mutually Exclusive with Bankruptcy Though debt agreements are regulated by the Bankruptcy Act, a debtor who enters a debt agreement does not become bankrupt. This is important for some debtors. However, details of a debt agreement are entered on the National Personal Insolvency Index, which is a permanent record: (Regulation 13.03). This means entering a debt agreement does have a life-long adverse effect on a person s financial reputation. Debt agreements and bankruptcy are mutually exclusive alternatives. A person who is bankrupt cannot enter a debt agreement (s. 185 C (4) ), and a person who is a debtor in a debt agreement cannot petition in their bankruptcy without permission from the Federal Court or the Federal Magistrates Court (s. 55 (5A) ). Breaching these provisions is an offence, for which a person can be prosecuted. (s.265). There is now a provision for the automatic termination of a debt agreement if no payments have been made in the last six months (ss 185 LC and 185 QA), however it is most important that anyone who has been in a debt agreement 2
checks their situation carefully before considering bankruptcy, to ensure the debt agreement has been terminated. Eligibility to Enter a Debt Agreement Debtors are ineligible to enter a debt agreement if they: 1. Are solvent and able to pay their debts as they fall due: s.185 C (1) 2. At any time in the past ten years have been bankrupt, or a debtor in a debt agreement, or have given an authority under section 188 of the Act to a registered trustee, the Official Receiver or a solicitor to call a meeting of creditors and to take control of the debtors property: s. 185C (4) 3. Have unsecured debts totalling more than $77,021.00 which is referred to as the threshold amount: s. 185 C (4). The threshold amount is an inflationadjusted figure, which is twice the base income threshold amount (BITA), which changes twice a year in March and September. 4. Have unprotected property, which could be distributed amongst the creditors if the debtor becomes bankrupt, of more than the threshold amount: s. 185 C (4) 5. Are likely to earn an after tax income, that is, gross income less tax and Medicare levy, in the first year of the debt agreement of more than three-quarters of the threshold amount: s.185 C (4). The current income upper limit for eligibility is $57,765.75 net. (Liability to pay child support is not taken into account in this calculation: (s. 185C (5)) 3
6. For the purpose of calculating a debtor s level of unsecured debt, the amount by which the value of a debt exceeds the value of the security given for it is included. That is, any likely shortfall is added in. For example if a debtor owns a house worth $100,000 and $120,000 is owing on it, the sum of $20,000 is included in the amount of unsecured debt: s. 185 C (5). Eligible Administrators Any person who passes the basic eligibility test may be the administrator of up to (and including) five debt agreements. Only a person who is a registered debt agreement administrator or a registered trustee in bankruptcy can be the administrator of more than five debt agreements: (s. 185E (2A) and (2B) ). A person can administer their own debt agreement if they pass the basic eligibility test (s. 185 C (2c) and 185E (2A)). Basic Eligibility Test The following persons are ineligible to be a debt agreement administrator: * a person who, in the preceding ten years, has been a bankrupt, or a debtor in a debt agreement or Part X administration; * a person whose registration as a bankruptcy trustee has been terminated on certain grounds in the preceding ten years; * a person who is prohibited from taking part in the management of a company; * a person who has been deregistered as a Corporations Act liquidator in the last ten years; 4
* a person convicted of fraud or dishonesty in the preceding ten years; * a person whose registration as a debt agreement administrator has been cancelled on certain grounds, or who has been declared ineligible to act as an administrator: (s. 186 A (1) ). Similar tests apply in relation to the eligibility of companies to be debt agreement administrators. Registration of Administrators Persons and companies who wish to administer more than five debt agreements can do so only if they are registered as debt agreement administrators or bankruptcy trustees: ( s 185E (2A) and (2B) ). To become registered as a debt agreement administrator, a person or company must pass the basic eligibility test, have the knowledge and ability to perform satisfactorily the duties of an administrator, and have such qualifications and experience as are prescribed from time to time by the regulations to the Bankruptcy Act: (s. 186C ). Duties of Administrators A debt agreement administrator must certify, as part of accepting the nomination to administer the debt agreement that the debtor has received information about alternative means of dealing with financial difficulty; based on information available at the time of the proposal, that the debtor can afford to make the promised payments; and that the administrator has a reasonable basis for believing that the debtor has properly disclosed their affairs to creditors: (s. 185 C (2D) ). 5
A debt agreement administrator must deal with the debtor s money and property in accordance with the debt agreement, and must give to the debtors and creditors information about the debt agreement which they reasonably request: (s. 185 LA). If a debtor is in default of a payment required by the debt agreement for three months, the administrator must notify creditors of this in writing: (s. 185 LB). If a debtor is in default for six months, the administrator must notify the Official Receiver (at ITSA): (s. 185 LC). This triggers an automatic termination of the debt agreement: (s. 185 QA). An administrator must keep a separate bank account for monies received from debtors, keep accounts of dealing with the money of each debtor, and co-operate with any inquiries made by the Inspector-General in Bankruptcy: (s.185 LE). Fees There are no fees on filing a debt agreement proposal, however there is a realizations charge of 3.5% of the amount realized under the debt agreement. This is usually the amount paid by the debtor under the debt agreement. It is paid to the Federal Government as a fee under the provisions of the Estate Charges Act. Fees of Administrators If a debt agreement provides for payment of the administrator, the agreement must set out: a) the percentage which the total of fees payable to the administrator represents of the total amount payable by the debtor under the debt agreement; 6
b) that where the debtor pays an amount towards their obligations under the agreement, a sum which does not exceed that percentage must be paid to the administrator as part of their fee. The effect of this is that a steady and proportionate amount of the debtor s payments under the agreement go to the administrator as a fee, rather than a large up-front amount. Process With Debt Agreements The first step is to identify something that the debtor has to offer to creditors. Because it is an agreement it is of no use to propose something which is unlikely to appeal to creditors. The most common arrangements are schemes by which debtors make regular payments from their income for the benefit of creditors. In putting together a proposal of this sort, it is vital to ensure that the payments offered are realistic in the light of the debtor s income and necessary living expenses. The main cause for failure of debt agreements is the inability of the debtor to keep up with the payments required by the agreement. Other examples of possible agreements are asset sales, for example the sale of a house and distribution of the net proceeds amongst creditors. The essence of a good proposal is one which the debtor can realistically comply with, despite the normal ups and downs of daily life, but which offers the creditor something worthwhile which they would not receive if the debtor became bankrupt. A debt agreement cannot provide for the transfer of property, other than money, to a creditor: (s. 185 C (2A) ). Proportionate Returns to Creditors There are a number of requirements relating to the form and contents of a debt agreement proposal. One is that all of the debtor s debts which would be provable in a bankruptcy rank equally, and if the total amount to be paid by the 7
debtor is less than the total amount of the debt, then each creditor is paid the same proportion of its debt: (s. 185 C (2) (d) ). No creditor is entitled to receive more than the amount of its debt: (s. 185 C (2) (e). The Proposal There is a prescribed form for a Debt Agreement Statement of Affairs and Proposal. This is form 17, available on the ITSA website, which is www.itsa.gov.au. Go to Debt Agreements and then Forms. This form must be used: (s. 185 C (2) ( a a) ). The debt agreement proposal may provide for any matter relating to the debtors financial affairs: s. 185 C (3), should be in writing: s.185 C (1), and should identify the debtor s property to be dealt with under the agreement, indicate how the property is to be dealt with, and by whom: s. 185 C (2). See the section above relating to Eligible Administrators and Registered Administrators. The proposal is sent to the Official Receiver at ITSA. No filing fee is currently payable. No stamp duty is payable on a debt agreement or a variation of one: s. 185 X. If the Official Receiver is of the view that the debtor and the proposal meet the criteria in the Act, it accepts the proposal for processing: s. 185 E (2). The Official Receiver must refuse to accept a debt agreement proposal if it names an ineligible person as administrator: s. 185 E (2 A) The Official Receiver must decide whether the creditors interests would be better served by not accepting the proposal: s. 185 E (3). Debtors who are dissatisfied with the Official Receiver s decision can apply to the Administrative Appeals Tribunal (Commonwealth) for review of the decision: s. 185 E (4) 8
Acceptance for Processing If the proposal is accepted for processing, the acceptance is recorded in the National Personal Insolvency Index ( NPII ) kept by ITSA. The NPII is a permanent and publicly accessible record, and it is important that debtors realise that one of the effects of proposing a debt agreement is this form of publication of their insolvency. The act of acceptance for processing brings into operation a freeze on enforcement action against the debtor for all provable debts except maintenance and proceeds of crime debts: s.185 F. In this context maintenance includes child support. The Freeze The freeze on enforcement which comes into operation on the acceptance by the Official receiver of a proposal for processing is a very powerful and wide-ranging freeze. Unlike most provisions of the Bankruptcy Act, it applies similarly to secured and unsecured debts: s. 185 (definition of frozen debt ). During the freeze, no creditor can enforce a remedy against the person or property of the debtor: s. 185 F. The freeze lasts until the applicable deadline. This varies depending on the date the Official Receiver accepts the proposal for processing. If this is in December, the deadline is the end of the forty-second day after the acceptance. If the proposal is accepted for processing in any other month, it is the end of the thirty-fifth day: (s. 185 definition of applicable deadline ). Considering the Proposal The Official Receiver circulates the proposal to the creditors by sending to each of them a copy of the Debt Agreement Proposal and Explanatory Statement. The Official Receiver must ask each creditor to give a written statement in an approved form setting out whether or not the proposal should be accepted, and tell the creditor to whom they should reply, and by when: (s. 185 EA (2) and (3) ). 9
Lapsing and Non Acceptance of Proposal If a proposal is circulated by the Official Receiver, but no replies are received by the applicable deadline, or if the debtor dies before the proposal is accepted, it lapses: (s. 185 G). If a proposal is circulated, and a majority in value of the creditors who reply in writing before the applicable deadline rejected the proposal, it is not accepted. In either case the proposal is at an end, the freeze on enforcement ends, and everyone reverts to the unregulated position they were in before the proposal was accepted for processing: s. 185 F (1). Debtors suffer the detriment of loss of any fees they have paid, and the fact that the proposal is recorded on the NPII. Acceptance by Creditors A proposal is accepted if a majority in value of the creditors who reply before the applicable deadline accept it. The time of the acceptance is the date of the applicable deadline, and the value of each debt is its value at that time. For voting purposes, a secured creditor is only counted at the value of the extent to which (if any) the amount of that debt exceeds the value of the security: (s. 185 EC). Effect of Acceptance by Creditors If a proposal is accepted by the creditors, the debt agreement becomes operative: s.185 H. Details of it are entered in the NPII. While a debt agreement is in force, creditors cannot present a creditor s petition against the debtor, or take or enforce any legal proceedings against a debtor in regard to any provable debt other than a maintenance debt or a proceeds of crime matter: s 185 K. In this context maintenance includes child support. 10
End of Debt Agreement and Release From Debt When all the obligations of the debtor under the agreement are done, the agreement comes to an end. If there is any surplus money or property left over, it goes back to the debtor. The Official Receiver must be notified of the completion by the administrator, and the Official Receiver then gives the debtor a certificate of completion: (s. 185 N). When the debt agreement ends by being completed, the debtor is released from all provable debts (which existed at the time the acceptance of the proposal was recorded on NPII. The release does not release a joint debtor, or a guarantor: (s. 185 NA). Default in Regard to Debt Agreements As mentioned above, if a debtor is in default of a payment required by the debt agreement for three months, the administrator must notify each creditor, in writing of this. This notification must be within ten working days of the default: (s.185 LB). A six month default means that six months have passed from when a payment was due, and it has not been paid in that time. If a six month default occurs, the administrator must notify the Official Receiver of this within ten working days: (s. 185 LC). Automatic Termination of Debt Agreement If the Official Receiver is satisfied that there is a six-month default, he must declare in writing that the agreement is terminated, and record this on NPII. The debt agreement is then at an end: ( s. 185 QA). 11
If the debt agreement came to an end in this way, creditors are then free to resume action against the debtor (s. 185 K). VARYING OR ENDING A DEBT AGREEMENT Varying a Debt Agreement A debtor or creditor who is a party to a debt agreement may set about varying a debt agreement by giving the Official Receiver a written proposal to vary the agreement. The proposal must be in the approved form, and accompanied by an explanatory statement in the approved form: (s. 185M (1) ). The Official Receiver must process this proposal, which means the Official Receiver circulates the proposal and explanatory statement to the creditors and a request that they advise in writing if they wish to accept it, and tell them of the person to whom they should reply and the deadline for replying. If the proposal to vary the agreement is accepted by a majority in value of the creditors who reply before the deadline, then the debt agreement is varied accordingly: (s. 185 MC ). Ending a Debt Agreement a) By Completion - A debt agreement ends when all of the obligations under it have been discharged: s.185 N (1). If a debt agreement ends in this way and there is some superfluous property left that was not required to be distributed, that superfluous property reverts to the debtor: s. 185 N (2). The Official Receiver is required to give the debtor a certificate stating that the debt 12
agreement is ended: s. 185 N (3). As noted above, a debt agreement will automatically terminate after six months default in payments. This is applicable only to debt agreements proposed on or after 1 July 2007. b) By Proposal - Just as a debt agreement can be varied by a proposal put forward by the debtor or a creditor who is part of it, so also can a debt agreement be terminated by a proposal: s. 185 P. The process is similar to that outlined above for variation. A written proposal to terminate and an explanatory statement is given to the Official Receiver, who must process this proposal by circulating it to the affected creditors in a way similar to that for varying a debt agreement. A decision is made by a majority in value of affected creditors who reply before the deadline: (s. 185 PC). c) By The Federal Court - A debtor, a creditor or the Official Receiver may apply to the Federal Court or the Federal Magistrates Court for an order terminating a debt agreement: s. 185 Q (1). A creditor making an application of this sort can also, at the same time, apply to the Court for a sequestration order: s. 185 Q (2). If a creditor does this, the Court can both terminate the debt agreement, and declare the debtor bankrupt in the same proceeding: s 185 Q (5). This possibility should be drawn to the attention of a debtor who has very strong reasons for wishing not to become bankrupt. A number of stages in the debt agreement process constitute an act of bankruptcy: (s. 40 (ha) (hd) ). The making of a proposal for a debt agreement and the making of a debt agreement, are recorded in the National Personal Insolvency Index: s. 185 F. (Regulation 13.03 and Schedule 8). If debtors do not wish to become bankrupt, or to have their insolvency made publicly known, they should be cautioned about the implications of a debt agreement. 13
Comparison With Bankruptcy For a debtor with a very low income, no property other than protected property, and no particular future financial prospects, bankruptcy is quicker, easier and does not require anything to be given to creditors. There are no filing fees on a debtor s bankruptcy petition. For a debtor who is relatively young and with good financial prospects, or a debtor whose work may be adversely affected or ended by bankruptcy, debt agreements are attractive. The extra time and effort, giving to creditors income and property otherwise protected is justified by the benefits of not being bankrupt. For those debtors in between these clear positions, it may be useful to propose a debt agreement which is not too onerous. If the debt agreement proposal is rejected they could become bankrupt, and leave an interval for creditors to give up hope, then propose a composition under section 73 which could produce an annulment. If that is refused, a debtor can allow a further lapse of time, and then if finances improve, arrange an annulment by payment out in full under section 153 A. However some categories of employment, such as service in the Police Force, may be adversely affected by a debt agreement or a personal insolvency arrangement. Counsellors should always point out to debtors considering their alternatives the importance of finding out the effect of the alternatives on their employment. Ian Macdonald Solicitor FCRP August 2007. 14
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