Debt consolidation versus bankruptcy

Debt consolidation is a commercial transaction. A lender advances funds, your creditors are paid out, and you repay the new loan. You still owe the money. Bankruptcy is a legal status under the Bankruptcy Act, administered by a trustee, in which control of your divisible property passes to that trustee and most unsecured debts are extinguished at the end of the period.

The question that separates them is solvency. If you can service a consolidated repayment out of real, sustainable income, consolidation is available to you and bankruptcy is not the tool for the job. If you cannot service any repayment on the total debt, no amount of restructuring changes that, and finance will only add cost to the same arithmetic.

Bankruptcy begins either voluntarily, by lodging a debtor's petition with AFSA, or involuntarily, through a sequestration order made by a court on a creditor's petition. A trustee is appointed. The standard period runs for three years and one day from the date the statement of affairs is accepted, though it can be extended where a trustee objects to discharge.

• Most unsecured debts are covered, including credit cards, personal loans, unsecured business debts and, generally, tax debt.
• Some debts are not released. Child support and maintenance, court-imposed fines and penalties, and debts incurred by fraud survive bankruptcy.
• Secured creditors keep their security. A mortgagee can still enforce against the property.
• The trustee takes control of divisible property. Certain assets are protected up to indexed limits, including ordinary household goods, tools of trade and a vehicle. The limits are indexed, so check the current figures with AFSA rather than relying on a number you read somewhere.
• If income exceeds an indexed threshold, compulsory income contributions are payable to the trustee. Again, the threshold is indexed and depends on the number of dependants.
• A bankrupt cannot act as a company director, or manage a corporation, while bankrupt.
• Overseas travel requires the trustee's written permission.
• The record is entered on the National Personal Insolvency Index permanently. That index is public and it does not expire, which is a separate and often overlooked point from the credit file retention period.

Standard period

Three years and a day

Acting as a director

Not while bankrupt

Overseas travel

Trustee's permission

Secured creditors

Keep their security

Insolvency index listing

Permanent

Asset protection limits

Indexed, check AFSA

Bankruptcy is not a moral failure and it exists for good reason. It is a legislated mechanism for ending an unpayable position and starting again. But it is a serious, largely irreversible step with permanent public consequences, and it deserves to be entered deliberately with proper advice, not as a reflex when a demand arrives.

Part IX of the Bankruptcy Act allows a debt agreement: a legally binding proposal to creditors to pay an agreed amount, usually over a set period, in full settlement. It requires a registered debt agreement administrator, and eligibility is limited by thresholds on unsecured debt, divisible property and after-tax income. Those thresholds are indexed and should be checked with AFSA.

Part IX debt agreement

A binding proposal to creditors to pay an agreed amount in settlement, administered by a registered debt agreement administrator. Eligibility turns on indexed thresholds.

Part X personal insolvency agreement

A more flexible arrangement under the same Act, used for larger or more complex positions and administered by a registered trustee.

Act of bankruptcy

The technical term for conduct that entitles a creditor to petition. Entering a Part IX or Part X arrangement is one, which catches most people by surprise.

Divisible property

The property that passes to a trustee in bankruptcy. Certain assets are protected up to indexed limits, so confirm the current figures with AFSA rather than a number read somewhere.

Sequestration order

A court order making a person bankrupt on a creditor's petition, as distinct from a debtor's own petition lodged voluntarily.

Statement of affairs

The document setting out debts, assets and income. Acceptance of it starts the clock on the bankruptcy period.

Part X allows a personal insolvency agreement, which is more flexible and used for larger or more complex positions. Both are acts of bankruptcy in the technical sense, both are recorded on the National Personal Insolvency Index permanently, and both restrict you in ways that catch people by surprise. A Part IX agreement is often described as an alternative to bankruptcy. It is more accurate to describe it as a different formal insolvency with a different set of consequences.

There is a straightforward test, and it is worth doing honestly on paper before speaking to anyone.

1. 01Total every debt, including tax, and get real payout figures rather than estimates.
2. 02Work out the monthly repayment that would clear that total over a realistic term on secured terms.
3. 03Subtract that repayment from your genuine surplus after living costs and after the business meets its ongoing obligations, including future BAS and superannuation.
4. 04If a meaningful surplus remains, consolidation is on the table and worth pricing properly.
5. 05If the number is negative, or survives only on optimistic revenue assumptions, that is a solvency question and it belongs with an accountant and an insolvency practitioner, not a broker.

The failure mode we see most often is borrowing to postpone a decision that has already been made by the arithmetic. That converts an unsecured position into a secured one, moves the family home into the firing line, and delays the outcome by twelve to eighteen months at considerable cost. If the numbers do not work, we will tell you.

If you trade through a company, the company's insolvency and your personal bankruptcy are different events. A company can be liquidated without its director becoming bankrupt. The bridge between the two is personal exposure: director guarantees given to landlords, suppliers and lenders, and director penalty notices from the ATO for unpaid PAYG withholding, GST and the superannuation guarantee charge.

A director penalty notice makes the director personally liable, and the options available depend on what type of notice it is and whether the underlying amounts were lodged on time. A notice has a short response window printed on it and the window does not extend. If one has arrived, read the date on the notice first and get advice the same week.

• Your accountant or registered tax agent, for the tax position and the true trading numbers.
• The National Debt Helpline, for free and independent financial counselling. It is not a sales channel and it costs nothing.
• AFSA, for the official position on bankruptcy, debt agreements and current indexed thresholds.
• A registered trustee or an insolvency solicitor, if solvency is genuinely in question or a formal demand has been served.
• A finance broker, once you know the business is viable and the question is how to fund the way through.

In that order. A broker who takes the call before the accountant has looked at the numbers is not helping you.