The Turnbull Government’s insolvency law reform agenda is headlined by the Insolvency Law Reform Bill 2015 (‘ILRB’) (which has now passed through both houses of parliament and received royal assent on 29 February 2016) and the National Innovation Statement (flanked by the Productivity Commission’s Inquiry Report into Business Set-up, Transfer and Closure (‘PC Report’) which was submitted to Treasury in September 2015 and released publicly in December 2015).
One of the key reform recommendations as it applies to the personal insolvency sector is a reduction of the current default bankruptcy period from three years to one year. The Government highlights the retention of the Trustee and Courts’ powers to extend a bankruptcy by up to 8 years as a means of preventing abuse of the contemplated amendments. The Reforms also seek to bring Australia in line with other economies who have recently adopted such measures, such as Ireland, where their draconian automatic discharge date has been slashed from 12 years down to 12 months.
Personal insolvency legislation is no stranger to reform. In 1996, amendments were made to the Bankruptcy Act 1966 (‘BA’) which saw the introduction of a new form of personal insolvency administration, known as Debt Agreements. Further refinement came in the form of the Bankruptcy Legislation Amendment Bill 2002 (‘BLAB 2002’), which was enacted in 2003. In addition to refinement, BLAB 2002 was the catalyst for the abolition of the ‘Early Discharge’ (i.e. eligible Bankrupts being discharged at any time after 6 months from their Bankruptcy commencing). The Explanatory Memorandum to the BLAB 2002 (at 42-43) addressed the abolition of Early Discharge, stating:
“These provisions are most often cited as the cause of concern that bankruptcy is too easy. The reduced period of bankruptcy is seen to discourage debtors from trying to enter formal or informal arrangements with their creditors to settle debts, and provides little opportunity for debtors to become better financial managers.”
Responding to the 2002 BLAB, the former Minister for Justice and Customs, (then) Senator Amanda Vanstone, explained the abolition of Early Discharge provisions by saying:
“many creditors feel that the possibility of being released from bankruptcy after six months does not reflect the serious nature of the decision to become bankrupt. It was also felt that early discharge provisions discourage debtors from trying to enter formal or informal arrangements with their creditors to settle debts, and provide little opportunity for debtors to become better financial managers.”
Fast forward to 2016 and we have the much anticipated PC Report. Its findings included that:
- Around 98% of business are small (fewer than 20 employees) and 70% had no employees;
- Small businesses account for 99% of all set-ups and closures;
- Few new businesses in Australia are innovative;
- On average, from 2003-04 to 2014-15, non-business related personal insolvencies were around five times more common than business-related personal insolvencies;
- 94 percent of bankrupts had unsecured debts exceeding $10 000, whilst 77 percent had unsecured debts exceeding $20 000 in 2011. A large proportion of these unsecured debts related to credit card liabilities (21 percent);
- For business-related bankruptcies discharged in 2014-15, creditors received an average rate of return of 1.7 cents per dollar. Rates of return were similar for non-business related bankruptcies (2.2 cents per dollar) over the period; and
- Rates of return are significantly higher for Debt Agreements, with creditors receiving 58.9 cents per dollar for agreements completed in 2013-14 (AFSA 2014).
The PC Report is at pains to point out the advantages of Debt Agreements (including but not limited to the absence of restrictions on overseas travel and company directorship as well as avoiding the stigma attached to bankruptcy). It highlights:
“As a proportion of all personal insolvencies and in absolute terms, bankruptcies have declined over the past five years, whilst use of debt agreements has increased to unprecedented levels. These trends suggest that the agreement alternatives to bankruptcy may have been underutilised previously, but are becoming more popular.“
Consider an average consumer debtor with no divisible assets, 2 dependent (school age) children, earning an after tax income of $65,000 per annum (or $1,250 per week) and who has 6 credit cards and an unsecured personal loan that all together carry a combined unsecured debt of $85,000. Taking the averages published by AFSA, this Debtor, under a 3 year Debt Agreement, may be expected to repay $50,065 (58.9 cents in the dollar). Under the Reforms proposed by the PC, rather than fork out $50,065 over 3 years, this consumer debtor would almost certainly file a Debtor’s Petition and wear 12 months’ worth of travel, financial, employment and company directorship restrictions – and more importantly, come out the other side debt free!
Debt Agreements are not a ‘one size fits all’ solution to the problematic equation of balancing the interests of creditors, debtors and the public at large. But one can’t help to conclude that for all the rhetoric on rehabilitation, stigma, entrepreneurism and innovation, two important concepts – being behavioural change and debtor accountability – have largely been ignored. Consumer bankruptcy reform ought to have focused on expanding the parameters of the very instrument which the statistics tell us is producing the most equitable outcome for creditors, debtors and the public alike.
History tells us that early discharge does not promote rehabilitation and reduce the stigma attached to bankruptcy, nor does it help Bankrupts obtain better credit or gain other advantages. It does however carry extra costs and financial and administrative burdens for Government and Creditors alike. The UK cited similar issues when repealing Early Discharge in 2013. Moreover, statistics contained in the PC Report discredit the link between bankruptcy reform and a positive effect on entrepreneurism and innovation. There are unfortunate by-products to bankruptcy. Bankruptcy is an objective socio economic & conclusive status, it does not matter if you owe $5,000 or $500,000 in debts, the declaration and consequences of bankruptcy do not discriminate.
Debt Agreements generate returns and keep consumer debtors out of bankruptcy, thus avoiding those by-products. On the other hand, Bankruptcy is a necessary evil for certain individuals. Further reform to enhance and extend claw back powers to defeat and set aside certain asset protection strategies and structures is long overdue. Meanwhile, it will be interesting to see if the proposed reforms culminate in a spike in bankruptcy numbers (with a corresponding decline in Debt Agreements) and reduced financial returns to creditors. That will bring broader unfavourable economic impacts which we all subsidise in the form of higher borrowing costs and higher costs for goods and services.
SV Partners can assist you with any questions or advice relating to bankruptcy. Please contact one of our expert advisors if you would like more information on 1800 246 801.
Article written by Fabian Micheletto, Associate Director, Victoria