Can you spot the warning signs of bankruptcy before it’s too late to pivot? Photo: SpaceOak.
Imagine a business already operating on thin margins, like many in the current cost-of-living crisis, locked into the delivery of services or goods, when an unexpected external pressure, such as a sudden spike in fuel costs, hits.
For them, a path to insolvency can be paved with the optimistic belief that the next big contract will save the day.
When it doesn’t, it can be tempting to see bankruptcy, liquidation or another formal insolvency process as a reset button — a way to walk away from debt and start again.
But few people understand the long-term implications of bankruptcy, according to Lancaster Law & Mediation principal Graham Lancaster.
“Bankruptcy was essentially intended to relieve somebody of debts and to recognise, a bit like no-fault divorce back in the 70s, that people not being able to pay their debts is not always their fault,” Graham says.
“Bankruptcy is not a criminal offence, but the implications are still serious. It can be something professional and licensing bodies take into account. Building Commission NSW, the Law Society or Council of the Law Society, and the Tax Practitioners Board may all need to consider bankruptcy or insolvency events when assessing licensing, registration or practising entitlements.
“Although it’s not criminal, there is still a degree of stigma about it, and it can seriously affect, and in some cases end, a career.”
It’s important to note that while bankruptcy is often used interchangeably with insolvency, they are not the same thing. Insolvency is a financial state, and there are ways to come back from it with your business intact.
Bankruptcy, by contrast, is a formal legal status for individuals. Companies do not become bankrupt; they enter forms of external administration, such as liquidation, voluntary administration or small business restructuring.
But why do most people leave it too late to act?
The signs can be easy to miss. But Graham points to the ‘Waterwheel case’ (ASIC v Plymin, Elliott & Harrison), which yielded warning signs that judges use to decide if someone is legally insolvent, and which can be seen as practical symptoms of a business in financial distress.
“You have cashflow issues, and start missing payment deadlines, and then you start making instalment payments of your debts. And when you start missing those, you’ve got a double whammy,” he says.
“Your taxes may be overdue, you may have trouble raising capital and you may start making late or dishonoured payments. Ultimately, your relationships with creditors and lenders start to break down and people start sending letters of demand.
“You may then get debt collectors contacting you, and although they are regulated, they can often use harassing tactics like regular phone calls and text messages. It tends to put psychological pressure on you.”
For an individual, bankruptcy can usually begin in one of two ways.
The first is if the debtor applies for a ‘debtor’s petition’. But a creditor who is owed money can also pursue legal proceedings. Once they get a judgment, they can issue a bankruptcy notice giving the debtor 21 days to pay, reach an arrangement or apply to set the notice aside, after which they can issue a creditor’s petition and ask the court to make a ‘sequestration order’.
“That’s when you’re officially declared bankrupt,” Graham says.
Once you go bankrupt, most property, subject to statutory exceptions, vests in the bankruptcy trustee — the manager of your financial life from the moment you are declared bankrupt. They take control of your assets, investigate your history and pay back your creditors as best they can.
“A bankruptcy trustee takes control of divisible property and certain rights. They also have powers of investigation into your history and power to do what’s necessary to pay back your debts,” Graham says.
“They can require your passport to be surrendered and control overseas travel in some circumstances, and if you think you’re being clever by transferring a property or asset to a spouse, depending on when you did it, the reason and the amount, that can be clawed back.”
Other downsides include reputational damage and relationship breakdowns.
Graham says when it’s not too late, alternatives to bankruptcy are worth exploring. As with most things, the earlier you act, the more options you will have.
“If you have good relationships with your creditors, lenders or investors, and they believe in you, they may be willing to accept a lesser amount,” he says. “Just don’t fall into the trap of thinking that the next big contract or payment is around the corner. Recognise the signs of trouble, and get advice early.”
For more information, visit Lancaster Law & Mediation.
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