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Like the famous Churchill quote: “democracy is the worst form of government, except for all the others”, bankruptcy is the worst form of debt collection, except for all the others. Accepting that bankruptcy is a last resort for creditors, why is it that consumer advocates and media continue to oppose the sale of property by bankruptcy trustees, despite significant reform and lack of viable alternatives? Consumer advocates suggest that creditors should use a warrant for seizure and sale of land instead of bankruptcy. Is this a cost effective and practical enforcement method for creditors? This article looks at the reform history surrounding this controversy, examines alternative enforcement processes, debunks popular myths about the bankruptcy process and questions the popular view that bankruptcy is the worst enforcement process available to creditors.

 

Reform History

A 2007 consumer advocate’s paper titled Homes at risk: using bankruptcy to collect small debts identified a small number of vulnerable debtors (who did not understand the bankruptcy process) at risk of losing their homes due to bankruptcy resulting from small debts. The costs of administering the bankruptcy exceeded the value of their debts, consumed the equity in their homes with limited rights for the debtors to question the trustee or review costs. The paper made recommendations and in 2009 the Bankruptcy Act was amended to raise the minimum debt to commence bankruptcy from $2,000 to $5,000, change the approval of trustee’s remuneration to a transparent three step process and introduce a free mechanism for trustee’s fees to be reviewed by the Inspector-General in Bankruptcy.

The IPAA (now ARITA) also introduced standardised remuneration reporting for its members in its Code of Professional Practice from 21 May 2008. Consumer advocates continue to espouse the virtues of alternative collection methods, in particular, warrants for seizure and sale of land, as they are perceived to be a cheaper alternative than bankruptcy; but is cheaper a better outcome for debtors? It is difficult to see how the sale of land by a sheriff assists the original goal of protecting ‘Homes at risk’ and as the Sheriff is generally not resourced or experienced in the sale of real estate, it may even produce a result far worse than paying trustee’s fees, as the following case indicates. In May 2012 the Supreme Court of Victoria overturned the sale of a family home valued at more than $600,000 which had been sold by the Sheriff at a no-reserve auction for $1,000 and decimated any equity the debtor had in their property. Zhou v Kousal & Ors [2012] VSC 187 (10 May 2012). Bankruptcy Trustees’ considerable experience and fiduciary duties would prevent such an absurd result.

 

Enforcement Alternatives

Where a creditor has obtained a judgment (a court order that a debt is due) each State has its own system for enforcing that judgment. Generally the options are:

1. Garnishee Order

A garnishee order seeks to have the money taken from the debtor’s bank account or wages ; To be effective a creditor will need to know the debtor is employed, the employer and their wages are sufficient to pay the debt; Garnishee will not be effective for the unemployed, self-employed or otherwise unless the source of funds is known by the creditor.

2. Examination Notice

An examination notice allows a creditor to summon the debtor to court to find out information about the debtor’s financial position and may assist in determining which enforcement option is likely to be most effective. It does not otherwise assist to recover the debt.

3. Writ for levy of property

A warrant which authorises the Sheriff to seize and sell property of the debtor to pay the judgment debt; A warrant may be defeated by applying to pay by instalments or more typically is defeated by the debtor claiming all of the property at the address for service belongs to some other person. Warrants for levy of property are usually returned unsatisfied.

4. Writ of Execution for Real Property

In NSW a judgment creditor can apply for a sheriff to take possession and sell real property if the judgment debt exceeds $10,000 and a Writ for levy of property (3. above) has been returned unsatisfied; In Victoria a similar process is known as a Warrant for seizure and sale of land and in Queensland it is known as a Writ of Execution; A writ is current for a limited period of time (6 months in NSW, 3 in Vic and Qld) and may be extended with further registration; The sheriff places a single public notice in a newspaper and sells the property ‘as is, where is’ without an agent or further marketing. The sheriff may only sell the debtor’s interest and it is therefore ineffective for selling jointly owned property; Writs of execution are therefore complex to obtain, effective in only limited circumstances, and whilst the costs of the Sheriff are minimal they are nevertheless expensive for the judgement creditor; In each alternative, Judgment creditors run the risk of being unable to recover their costs of enforcement if the debtor goes bankrupt prior to the recovery. Alternatively any recovery from the sale of the property by the Sheriff may have to be repaid to a subsequent trustee in bankruptcy.

 

Bankruptcy

Bankruptcy Act 1966 is a Commonwealth Act which therefore applies in all Australian States and Territories. Bankruptcy is not a debt collection method. It is for the administration of an insolvent individual’s estate such that creditors generally share equally from a debtor’s assets. Debtors are released from their debts, may retain reasonable income, essential assets and are able to make a fresh start. Creditors do not generally know nor are they usually able to prove in court whether a debtor is insolvent. Publicly available information, such a lands title searches and credit histories provide only some indication of assets and indebtedness. In bankruptcy proceedings the court generally tests a debtor’s solvency using a bankruptcy notice which determines whether the debtor can pay the creditor’s debt within 21 days. A debtor who fails to deal with the notice commits an act of bankruptcy and is presumed to be insolvent which the creditor can then rely on to file a petition to have the debtor made bankrupt.

Arguably a debtor who cannot pay a relatively small debt within a short period of time is at least as insolvent as someone who can’t pay a large debt. To the creditor, at the time of commencing bankruptcy proceedings a debtor with one debt of $10,000 looks the same as a debtor with 20 overdue debts totalling $1,000,000. Bankruptcy critics assume their creditors can distinguish between them before bankruptcy. Bankruptcy proceedings are expensive; the filing fee alone is more than $5,000 for a listed company. Creditors can expect to invest at least $8,000 in costs for a creditor’s petition. Bankruptcy is risky; creditors often receive no dividend and may not even receive a return on the petitioning creditor’s costs. Considerable time may elapse before any dividend is paid. In our experience working with a wide variety of creditors, bankruptcy proceedings are commenced as a last resort after considering and exhausting all alternatives, and having considered whether it is likely there will be a dividend from the estate. Creditors are increasingly introducing screening processes to reduce the need to file creditor’s petitions and balance that against expected returns. PPB Advisory works with a number of creditors to implement and improve screening systems.

 

Sequestration (Bankruptcy) Orders are not made lightly

The Court’s creditor’s petition process outlined below, involves multiple opportunities for the debtor to be heard and generally takes 3 to 6 months to complete.

  1. Obtaining a judgment of a court for a debt with the usual rights to defend any claim
  2. Service of a Bankruptcy Notice. A bankruptcy notice very clearly states, the amount of the debt, the creditors name, where and how to pay the debt, how to set aside the notice and the consequences for failing to pay the debt.
  3. Creditors Petition. At a hearing the creditor will have to prove, the creditors petition was served, the act of bankruptcy was committed and the debt is still outstanding. If a debtor proves solvency they may not be made bankrupt even if they have not paid the debt.
  4. A bankrupt has a right of Review or Appeal and the Court may annul the bankruptcy if the Sequestration Order ought not to have been made.

 

Post Bankruptcy Process

The trustee commences the bankruptcy by:

  1. Notifying the debtor (now called a bankrupt).
  2. Obtaining a Statement of Affairs (sets out the bankrupt’s assets and liabilities).
  3. Providing an annulment calculation (if it appears the debts can be paid). The calculation includes all of the debts and costs to be paid.

 

The trustee will give a generous time period to make the payment and if the debtor pays the amount calculated the bankruptcy is annulled promptly and most cost effectively. If the debtor does not pay the calculation the trustee will have to obtain possession of any real property and market the property for sale. If the debtor does not cooperate with the trustee the costs of administration will necessarily be much higher. A bankruptcy trustee has the power and fiduciary duty to maximise the value of the estate, will present the property for sale appropriately (including necessary cleaning, maintenance and repairs), conduct a proper marketing campaign and achieve a better outcome compared to a ‘as is, where is’ sheriff’s sale. PPB Advisory’s experience over the last three years demonstrates that in bankruptcy creditors are likely to receive a dividend in approximately 35% of all screened bankruptcies and that the expected return on those dividends is more than 75 cents in the dollar.

 

Summary

Bankruptcy is not a quick fix debt collection solution. It is however the proper method of dealing with insolvent estates ensuring a consistent national approach, balancing the interests of debtors and creditors, ensuring sufficient assets are properly realised to pay creditors (including from jointly owned property) and a pro-rata distribution where assets are insufficient. Bankruptcy should be avoided wherever possible and collection costs minimised, by seeking early advice, continued communication between debtor and creditor, ensuring debts that can be paid are paid and if necessary cooperating with the trustee. Debating what the creditor should have known or done based upon hindsight is not helpful where the debtor refused or failed to engage with creditors or frustrated the debt collection process.