If you are looking to recover a debt from an individual that has been declared bankrupt, you may be wondering what happens following a declaration of bankruptcy.
This article sets out what debts are and are not recoverable from a bankrupt person, including specific debts which survive bankruptcy and remain recoverable by creditors even after the bankruptcy ends.
Understanding the effects of bankruptcy
The general intention of bankruptcy is to free an insolvent person from their financial obligations arising from debts incurred prior to that person becoming bankrupt.
Upon being declared bankrupt, the bankrupt person is released from many of their debts. The bankruptcy operates to prevent creditors of these debts from taking action to recover their debts from the bankrupt personally. Instead, creditors must lodge claims in the bankrupt estate and be paid via dividends in order according to the priority of their debt, as is provided for in the Bankruptcy Act 1966 (Cth).
Once a person is declared bankrupt, they no longer have (nor do their creditors) the authority to decide how their debts will be treated. This is dictated entirely by the Bankruptcy Act 1966 (Cth).
The provisions of the Bankruptcy Act 1966 (Cth) determine which debts are and are not recoverable from a bankrupt person.
The general position as to recoverable debts
The Bankruptcy Act 1966 (Cth) specifies that all debts and liabilities that the bankrupt incurred prior to their declaration of bankruptcy are ‘provable’. This means that the creditor of that debt will receive dividends paid from the bankrupt estate (if any are paid), provided that the debt was incurred prior to the declaration of bankruptcy.
Most of these debts and liabilities are also ‘extinguished’, meaning the bankrupt does not have a liability to pay the debt after going through the bankruptcy process. Put simply, the debts end when the bankruptcy ends.
This includes common debts such as:
Credit card debt;
Unsecured personal loans and pay day loans
Gas, electricity, phone and internet bills
Overdrawn bank accounts and unpaid rent
Medical, legal and accounting fees.
This means that for the vast majority of debts incurred prior to bankruptcy, the bankrupt person does not have any obligation to pay those debts once the bankruptcy is discharged.
Creditors can receive dividends from the bankrupt estate during the bankruptcy, but the debt essentially ‘evaporates’ following the bankruptcy, leaving the bankrupt person debt-free.
There are, however, a number of debts which are not extinguished at the end of the bankruptcy, which the bankrupt person still has to pay following bankruptcy.
Exceptions: Non-extinguished debts
Non-extinguished debts are those for which the bankrupt person remains personally liable both during the term of the bankruptcy and after the bankruptcy has ended. In other words, the debt does not go away after bankruptcy, and is still owed to the creditor.
These include the following:
unliquidated damages arising otherwise than by reason of a contract, promise or breach of trust. This refers to damages awarded by a court to a party (creditor) for loss caused by the bankrupt’s actions, the value of which has not been predetermined contractually;
penalties and fines imposed by a Court in respect of an offence against a law;
an amount payable under an order made under section 1317G of the Corporations Act 2001 – this relates to penalties for fees charged for financial services;
certain student debts such as HECS, HELP, VETSL, ABSTUDY etc.
amounts payable under proceeds of crime laws (i.e. assets gained from criminal activity);
council or local government property rates / charges;
debts incurred by fraud; and
child support and maintenance debts;
If you are a creditor with one of these debts, you will not be entitled to any payments from the bankrupt estate. You may nonetheless take action to recover the debt yourself directly from the bankrupt person.
This is with the exception only of debts incurred by fraud and child support and maintenance debts, for which creditors will be entitled to dividends during the bankruptcy, yet the bankrupt person will also remain liable for the debts after the bankruptcy has ended.
Secured debts, such as mortgages and car loans, will also not be extinguished, and creditors have the right to enforce any securities over the bankrupt’s property.
Timing of when a debt or monetary obligation arises
Bankruptcy also does not extinguish debts or liabilities incurred after bankruptcy is declared. This means that bankrupt persons remain liable for debts incurred at any point after the date they were declared bankrupt.
However, there is some ambiguity as to when a debt or monetary obligation is considered to be ‘incurred’. Bankrupt persons may seek to argue that a debt ‘incurred’ after the date of bankruptcy was in effect incurred prior to bankruptcy due to it arising in respect of obligations owed prior to the date of bankruptcy.
In addressing this ambiguity, the court in Darwin Food Pty Ltd v Gray (2018) 361 ALR 377 emphasised that the date on which the obligation to pay monies came into existence is the relevant date which is considered.
As identified in Foots v Southern Cross Mine Management Pty Ltd [2007] 241 ALR 32, it appears that the relevant question to be considered is whether there was any certainty or even contingent expectation prior to bankruptcy that the debt would be incurred.
This line of thinking was seen again more recently in Resilient Investment Group Pty Ltd v Barnet and Hodgkinson as liquidators of Spitfire Corp Ltd (in liq) [2023] NSWCA 118, in which it was held that a tax refund was only a ‘monetary obligation’ once tax returns were lodged, determined by the ATO and communication of that refund availability made to the taxpayer.
On balance, when determining whether a debt is ‘incurred’ before or after bankruptcy, you should have regard to:
whether the obligation to pay the monies (e.g. a contractual obligation) existed prior to the bankruptcy occurring;
whether there was any sense of certainty or contingent expectation that the debt would be incurred that existed prior to bankruptcy;
whether there were additional steps that needed to be taken by the creditor to actually apply or levy the debt which did not occur prior to bankruptcy.
In summary, most debts incurred prior to bankruptcy will be extinguished upon discharge of the bankruptcy, meaning the debt is no longer recoverable and the bankrupt is under no obligation to repay. However, some debts are not extinguished, and the bankrupt will remain liable for these debts even after the bankruptcy ends.
The bankrupt person will be liable for any debts that they incur after the bankruptcy starts. To determine whether the debt was incurred before or after the date of bankruptcy, you must consider the date on which the obligation to pay arose, and the extent of certainty of the debt prior to bankruptcy.
Please contact us if you would like more information or would like to discuss any of the above:
Alicia Hill
Principal
T: +61 3 9611 0180 | M: +61 484 313 865
E: ahill@sladen.com.au
Inshani Ward
Senior Associate
T: +61 3 9611 0110 | M: +61 413 557 157
E: iward@sladen.com.au
Millie Swan
Law Clerk
T: +61 3 9611 0177
E: mswan@sladen.com.au