What Happens When a Debtor Goes Bankrupt?

Are you a creditor and small business owner who has recently discovered a debtor of yours to have declared bankruptcy and is wondering what your options are for collection if your debtor goes bankrupt?

If so, you may be feeling extremely stressed about this predicament, as debtor bankruptcy can be very damaging for a creditor and cause significant strain on yourself and your business.

You see when a creditor declares bankruptcy, they are assigned a bankruptcy trustee who is responsible for collecting as much money as is reasonable from the bankrupt individual and paying debts in order of priority.

This can mean that some debts remain unpaid, possibly including yours depending on the type of debt you provide.

This can be especially dire if the debt is unsecured, as this type of debt is much more difficult to recover when bankrupt. So, what is an unsecured debt and how can I recover one?

In this article our debt collection agency will discuss what it means to have an unsecured debt as a creditor and how one can be collected after a debtor has declared themselves to be bankrupt.

Table of Contents

What is an Unsecured Debt?

The first question or concern that you may have when discussing or collecting unsecured debt is what it means for a debt to be unsecured at all.

After all, this concept may not be something every creditor is entirely familiar with and is a crucial point when collecting debt after bankruptcy has been declared.

The term ‘unsecured debt’ refers to any form of debt or that is not backed by or supported by collateral. This means that in the event of the debtor declaring bankruptcy or simply cannot fulfil the debtor's obligations, the creditor does not have a specific asset that they are able to claim.

Some common examples of unsecured debt include credit cards, medical bills, utility bills, personal loans, and certain retail instalment contracts.

As a creditor, unsecured debts are much more risky for you to provide, so creditors will generally charge higher interest rates or undergo other precautions as security.

Can You Demand Payment if Debtor Goes Bankrupt?

So, your debtor has declared bankruptcy, and they hold a debt with your business that is unsecured.

You are probably highly stressed about this predicament and have one key question: can you demand payment of the debt?

The answer is generally no, you cannot demand payment for an unsecured debt once a debtor has declared bankruptcy.

In bankruptcy, all financial liabilities for the debtor will be managed through their trustee, meaning the debtor does not interact much with the debt or creditors once the process has begun.

The bankruptcy will continue over a 3-year period, which once over will result in the discharge of any debts included in the bankruptcy.

That means that the debtor is released of liability for the debts covered in the bankruptcy agreement. Under this principle, you may not

What Debts Are and Are Not Included in Bankruptcy?

As we briefly mentioned earlier, there are several debts that are not included in bankruptcy.

As a creditor, this is some important information for you to have, so what are the debts that are included in bankruptcy, and what are the ones that aren’t?

The debts that are included in a bankruptcy agreement, meaning they cannot be actively sought out or taken action upon by creditors, include:

  • Credit cards and store cards
  • Unsecured personal loans
  • Unsecured business debts (invoices)
  • Unpaid rent
  • Overdrawn bank accounts
  • Utility bills, and
  • Medical, legal, and accounting fees.

On the other hand, the debts that are not covered by bankruptcy include:

  • Court imposed penalties and fines
  • Child support payments
  • Government student loans (HECS and HELP debts)
  • Debts that are incurred after the bankruptcy period began
  • Unliquidated debts (debts where the amount has not been determined)

These debts will still be collectable, and the debtor will remain personally liable for the debt, even after the bankruptcy period has concluded. 

Recovering Unsecured Debt if your Debtor Goes Bankrupt?

So, you are the creditor of an unsecured debt where the debtor has declared bankruptcy.

This can be a dire situation to find yourself in, and it is often best to take preventative measures to avoid debtor bankruptcy in the first place.

If your debtor seems or suggests that they are at risk of insolvency, consider negotiating your current agreement or having a discussion about their options.

However, if they have declared bankruptcy, there is still action that you can take to try to recover your debt.

Creditors with unsecured debt may lodge claims with the bankruptcy trustee to be able to share in any funds in the bankruptcy.

This can be more difficult than it sounds, as the debt in question must be provable.

This means that you must be able to be able to provide the trustee with evidence that the debt is valid and in action. 

When your Debtor Goes Bankrupt - How to Prove a Debt?

As we discussed, you must be able to prove your debt to the bankruptcy trustee for you to apply to recover it. But how can a debt be proved?

Well, to prove a debt to a bankruptcy trustee, a creditor must follow several specific procedures. The creditor is required to submit a "Proof of Debt" form, which will be sent out by the official trustee of the bankruptcy.

The trustee is then obligated to investigate each claim and may admit it for dividend purposes, in whole or in part, or reject it.

Your proof, unless your debt is a certain type, must be in writing and include all of the necessary information.

The Form 8 Proof of Debt form can be used if the trustee of the bankrupt person's estate is a registered trustee, and it should be sent to the registered trustee.

It's important to adhere to these procedures and seek legal advice if needed, as this can be a complicated process. 

Key Takeaways - Debtor Goes Bankrupt

Dealing with bankrupt debtors and unsecured debts can be difficult for any creditor.

This can be made easier when you have the information you need so that you can weigh up your options and make the right decisions for your business.

If you are attempting to collect an unsecured debt, it is wise to seek the assistance of a lawyer, as they can advise you of your options and assist with the process.

What Happens When a Debtor Goes Bankrupt - FAQ

Navigating the complexities of debtor bankruptcy as a creditor, especially concerning unsecured debts, can be a challenging and stressful experience.

Below, we've compiled a list of frequently asked questions with comprehensive answers to help Australian small business owners understand their options and the process involved.

How can a creditor submit a proof of debt in an Australian bankruptcy case?

In Australia, creditors can submit a proof of debt by completing and submitting a formal claim form known as a "Proof of Debt" form to the bankrupt estate's trustee. This form should detail the amount and nature of the debt owed by the bankrupt individual or company. Along with the completed form, creditors must also provide supporting documentation evidencing the debt, such as contracts, invoices, or statements. The trustee will review the proof of debt to determine its validity and how it will be treated during the bankruptcy proceedings.

What rights do secured creditors have in the event of a debtor’s bankruptcy in Australia?

Secured creditors in Australia have the right to seize and sell any assets that are the subject of a security interest to satisfy the debt owed by the bankrupt debtor. Unlike unsecured creditors, secured creditors do not need to file a proof of debt for the secured portion of their claim in the bankruptcy proceedings, as their rights are protected by the security interest. However, if there is a shortfall after selling the secured asset, they may lodge a proof of debt for the unsecured portion of their claim.

How does the priority of payments work for creditors in Australian bankruptcy proceedings?

In Australian bankruptcy proceedings, the priority of payments is strictly governed by the Bankruptcy Act 1966. Costs and expenses associated with administering the bankruptcy estate are paid first, followed by employee entitlements, including wages, superannuation, and leave payments. Unsecured creditors are paid after priority claims but share equally in any remaining estate funds. Secured creditors, however, are not subject to these priorities for the portion of their debt covered by their security interest, as they have the right to directly recover from the secured assets.

What are the implications for creditors when a debtor enters into a Part IX Debt Agreement versus full bankruptcy in Australia?

When a debtor enters into a Part IX Debt Agreement, it allows them to reach an arrangement with their creditors to settle debts without being declared bankrupt. For creditors, this means they may receive a proportion of the owed amount over time, as agreed in the debt agreement, which can potentially be more favourable than the returns from a full bankruptcy proceeding. However, creditors have the right to vote on the proposal, and it must be accepted by a majority in value for it to proceed. In contrast, full bankruptcy typically results in the liquidation of the debtor's assets to repay creditors, often resulting in lower recovery rates for unsecured creditors.

How can creditors participate in or challenge the discharge of a bankruptcy in Australia?

Creditors can participate in the bankruptcy process by attending meetings, voting on proposals related to the bankruptcy, and making submissions to the trustee regarding the administration of the estate. If creditors believe that the bankrupt individual has not complied with their obligations or there are grounds to oppose the discharge from bankruptcy, they can lodge an objection with the Australian Financial Security Authority (AFSA) or the bankruptcy trustee. The objection must be based on specific grounds outlined in the Bankruptcy Act, such as failure to disclose assets or income. If the objection is upheld, the discharge can be delayed or extended, providing creditors with more time to recover the owed amounts.

What happens when a debtor goes bankrupt in Australia?

When a debtor declares bankruptcy, a trustee is appointed to manage their financial affairs. This includes collecting available assets and funds to repay debts in a prioritised order. The process aims to fairly distribute the debtor's available assets among creditors, but it often results in some debts being partially or fully unpaid, especially unsecured debts.

What is unsecured debt?

Unsecured debt refers to any debt that is not backed by collateral. This means if the debtor fails to meet their obligations, the creditor does not have a specific asset to claim as repayment. Common examples include credit card debts, personal loans, and medical bills. These debts carry higher risks for creditors and usually come with higher interest rates.

Can I demand payment for an unsecured debt if my debtor goes bankrupt?

Once a debtor declares bankruptcy, you cannot directly demand payment from them for an unsecured debt. The bankruptcy trustee takes over the management of the debtor's finances, and any repayment towards unsecured debts is managed through the bankruptcy process, which may limit or negate the debtor's obligation to repay the debt.

What debts are included in a bankruptcy agreement?

Debts typically included in a bankruptcy agreement are credit cards, unsecured personal and business loans, unpaid rent, overdrawn bank accounts, utility bills, and professional fees. These debts are addressed through the bankruptcy process and can be discharged upon its completion.

What debts are not covered by bankruptcy?

Certain debts are not discharged by bankruptcy, including court-imposed penalties and fines, child support and alimony payments, government student loans (HECS and HELP debts), debts incurred after the bankruptcy period begins, and unliquidated debts. Debtors remain personally liable for these even after bankruptcy.

How can I recover an unsecured debt if my debtor goes bankrupt?

To attempt recovery of an unsecured debt after a debtor declares bankruptcy, you can lodge a claim with the bankruptcy trustee. This involves proving the validity of the debt and may result in receiving a portion of any distributed funds, although full recovery is not guaranteed.

How do I prove a debt to a bankruptcy trustee?

To prove a debt, creditors must submit a "Proof of Debt" form to the bankruptcy trustee, providing evidence that the debt is valid. The trustee will then assess the claim and decide if it qualifies for a dividend. It's a detailed process requiring accurate documentation and sometimes legal advice.

What should I do if my debtor goes bankrupt?

If you suspect a debtor is at risk of bankruptcy, it's advisable to negotiate your agreement or discuss their financial situation proactively. This could include restructuring the debt or finding a payment plan that reduces the risk of total loss.

Is it possible to negotiate with a bankruptcy trustee?

While direct negotiation with the debtor is not possible once they declare bankruptcy, creditors can communicate with the bankruptcy trustee regarding their claims. This does not guarantee repayment but allows for the possibility of recovering a portion of the debt.

What are the risks of providing unsecured loans?

Providing unsecured loans carries significant risks, especially if the debtor declares bankruptcy. Without collateral, there's a higher chance the debt will be partially or completely unrecoverable, making it crucial for creditors to assess risk and take precautions.

Can legal action help recover an unsecured debt during bankruptcy?

Once bankruptcy is declared, legal action against the debtor for unsecured debts is generally not possible. The bankruptcy process limits the actions creditors can take, focusing on the trustee's distribution of the debtor's available assets.

How does a debtor going bankrupt affect a small business owner who is a creditor?

Bankruptcy can significantly impact small business owners who are creditors, especially if they hold a substantial amount of unsecured debt. It can lead to financial losses and strain business operations, highlighting the importance of risk management and legal advice.

What should I do if my unsecured debt is not included in the bankruptcy?

If your unsecured debt is not included in the bankruptcy for specific reasons, such as being incurred after the bankruptcy began, you may still pursue collection efforts outside the bankruptcy process. Legal advice can guide these actions.

Can a discharged bankruptcy debtor still owe me money?

Once a debtor's bankruptcy is discharged, most of their debts included in the bankruptcy are considered settled, and they are no longer liable. However, debts not covered by the bankruptcy, like certain fines and support payments, remain the debtor's responsibility.

What role does a lawyer play after a debtor goes bankrupt?

A lawyer can provide crucial advice and assistance in navigating the complex process of attempting to recover an unsecured debt after a debtor declares bankruptcy. They can help submit claims, provide legal representation, and advise on the likelihood of debt recovery.

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