Is Bankruptcy Inevitable?
While many small business owners facing pressure from creditors will ponder the risks of potential personal bankruptcy, it is not an inevitable outcome of the failure of a business. This month we set out some of the issues and options.
For a sole trader, bankruptcy is usually the result of a creditor’s petition to the Court. Your first steps in such a situation should be to enter negotiations with the creditor. Bankrupting you will involve the creditor incurring legal and Court costs. This is often a factor that creditors consider and should assist you in negotiating a settlement. We strongly suggest that you seek professional assistance in negotiations.
If you are trading through a limited company, there is some statutory protection for the directors. The liquidation of the company does not automatically result in directors’ personal bankruptcy. However, if you have outstanding loans due to a company in liquidation, the liquidator may pursue you personally, with a threat to petition for your bankruptcy. This will typically be a last resort, since the liquidator’s prime aim is to recover money for the company’s creditors rather than expending funds in bankrupting the directors.
Even Inland Revenue take a pragmatic view of these matters. It will negotiate settlements with taxpayers, and has the ability to remit some penalties. We strongly recommend you have professional assistance in such negotiations. Tax is a complex area. And it is important to ensure any settlement arrangement is confirmed in writing by the Department. Telephone assurances from an IRD staffer are not debt settlements.
For protection from other creditors there is the possibility of a Creditors Pool or Debt Management Plan. Under these arrangements you commit to pay regular amounts into a pool fund, which is periodically distributed to creditors. Such arrangements can be managed for you by a budget advisory service, community law office, lawyer, accountant or insolvency practitioner.
The problem with Creditors Pools or Debt Management Plans is that they are only binding on those creditors who are party to the scheme.
In the event that these options fail and a creditor proceeds to the Courts to petition for your liquidation under the Insolvency Act, bankruptcy can still be avoided through an application by you. The procedure is termed a Proposal under Part 5, Subpart 2 of the Insolvency Act.
The Proposal, which must be lodged with the Court, will include a background to your situation, a proposed trustee to administer the scheme, and detailed terms of the payments you are prepared to make in order to avoid bankruptcy. Formal consent to act by the proposed trustee is required.
While creditors are permitted to oppose the Proposal application in Court, a final determination will be given by the presiding Judge. If approved, the Proposal will be binding against all creditors who have been given prior notification of your application to the Court.
Providing you adhere to the provisions of the approved Proposal, none of the notified creditors will be permitted to apply to the Court for your bankruptcy. However, if you fail to adhere to the Proposal, any creditor may proceed with a petition to bankrupt you.
Other alternatives, if your unsecured debts are less than $40,000, are a Summary Instalment Order, or a No Asset Procedure. The Summary Instalment Order is a formal arrangement between you and your creditors to pay back all or part of your debts by instalments. These can be supervised by approved advisers under the Official Assignee.
The No Asset Procedure can be approved by the Official Assignee if your unsecured debts are proved not to exceed $40,000 and you have no assets. Under the procedure, which lasts for approximately 1 year, you are subject to significant restrictions by the Official Assignee.
If none of the options above are unacceptable to you, or should they fail, it is possible to apply personally for your own bankruptcy. This is known as a Debtors Application. Your assets will vest in the Official Assignee, and the bankruptcy term is for three years. You cannot be a director of a company during the term of the bankruptcy.
Gerry Rea Partners are experienced in Creditors Pools and Proposals under the Insolvency Act. If you would like to discuss your options, please give us a call.