Dealing with unmanageable personal debt – settlements with creditors

This article follows on from our previous edition discussing the options available to individuals facing unmanageable personal debt (including personal guarantees for company debts).

In this edition, we discuss Settlements / Compromising Debts.

When an individual (Debtor) is unable to repay their debts in full and does not wish to be subject to bankruptcy, they can seek to settle / compromise their debts with creditors, by repaying some of the debt they owe. There are a number of ways this can occur, requiring different levels of acceptance from creditors:

An informal settlement privately negotiated with creditors.

A formal settlement with creditors (pursuant to the Bankruptcy Act – the references being to provisions of the Act):

a) Part IX Debt Agreement;

b) Part X Personal Insolvency Agreement; or

c) Composition or Scheme of Arrangement pursuant to Section 73 (settlement after bankruptcy).

Informal Settlements

Individuals that are not able to repay all of their debts can contact creditors directly (or with the assistance of a third party, such as SV Partners or another professional) to negotiate a smaller payment to settle the debt.

There is no requirement for creditors to accept a settlement and there is no specific amount / percentage that creditors will accept to settle debts; each case is different and depends on the individual circumstances, including previous dealings with creditors, the Debtor’s financial position and the attitude and position of creditors.

Informal settlements require agreement or settlement with all creditors to be effective. If this does not occur, creditors who have an unsettled debt can continue to pursue recovery of their debt (see our next edition for recovery of debts by creditors).

Informal settlements are easier to negotiate when dealing with a small number of creditors, as there is often a limited pool of funds available to offer to creditors and separate agreements are more difficult to negotiate with a larger number of creditors.

The main benefits of informal settlements are:

  • They can assist in maintaining your credit rating (beneficial for future finance applications);
  • Debtors avoid some of the restrictions of a formal arrangement (disclosure of their details on a National insolvency database, limitations on being a company director, etc);
  • It can allow the Debtor to preserve assets;
  • It provides relief from debt problems and extinguishes existing debts; and
  • It is often less expensive than a formal arrangement.

Informal settlements can be difficult to implement in situations where:

  • There are a large number of creditors, as it can be difficult to negotiate a settlement with all of them;
  • The Australian Taxation Office (ATO) is a creditor – the ATO is likely to require a compromise to be via a formal arrangement; and
  • Secured creditors are involved, especially if they hold security over assets that exceed the amount of the debt owed.

Part IX Debt Agreement

A Part IX Debt Agreement is a formal agreement with creditors for the repayment of some or all debts owed. A Debt Agreement involves an offer to creditors (a lump sum of money or payment over a period of time, a transfer of assets, proceeds from the sale of assets or a combination).

To be eligible to submit a proposal, a Debtor must:

  • Not have been bankrupt in the last 10 years;
  • Not have been a party (as a Debtor) to a Debt Agreement in the last 10 years; or
  • Not have signed an authority pursuant to Section 188 (to submit a Personal Insolvency Agreement proposal) in the last 10 years;
  • Meet the following financial criteria (as prescribed by the Bankruptcy Act and Regulations, which are indexed periodically in line with CPI movements):
  • Have an estimated after tax income below $82,104.75; and
  • Have unsecured assets and debts each below $109,473.00.

A Debt Agreement proposal is either accepted or rejected by creditors. It is accepted if a majority in value (greater than 50%) of unsecured creditors that vote on the proposal vote to accept it. If the proposal is not accepted by creditors, they are able to pursue the Debtor for the recovery of their debt.

The benefits of Debt Agreements include:

  • It allows the repayment of some or all of the debts owed to creditors (which often is a more commercial and higher return than in a bankruptcy scenario);

It is binding upon all unsecured creditors – a Debtor does not have to obtain 100% agreement from creditors (unlike an informal agreement);

  • Some of the restrictions of a bankruptcy are avoided;
  • It provides relief from debt problems and extinguishes existing debts – the Debtor just needs to comply with the terms of the Debt Agreement;
  • It is less expensive than a Part X Personal Insolvency Agreement.

Part X Personal Insolvency Agreement

A Personal Insolvency Agreement (PIA) is similar to a Debt Agreement, in that it is a formal agreement between a Debtor and creditors for the repayment of some or all debts owed. Similar to a Debt Agreement, it can involve the payment of money and/or the transfer or sale of assets.

There are no financial restrictions on an individual to be eligible to submit a PIA proposal (unlike a Debt Agreement). A Debtor cannot however submit a proposal if they have done so within the previous 6 months, unless permission of the Court is obtained.

A Controlling Trustee (such as a registered Trustee from SV Partners) is appointed to:

  • Investigate the Debtor’s affairs;
  • Consider whether the acceptance of proposal would be in the creditors best interest (compared to the Debtor’s bankruptcy);
  • Report their findings on the Debtor’s financial affairs and their recommendation on the proposal to creditors;
  • Call and hold a meeting to allow creditors to vote on the proposal.

A PIA is accepted if creditors pass a special resolution at the above mentioned meeting – a special resolution is a resolution passed by a majority in number and at least 75% in value of the creditors that vote at the meeting.

If the proposal is not accepted, creditors are able to pursue the Debtor for the recovery of their debt.

The benefits of a PIA are similar to that of a Debt Agreement, particularly in that it allows the Debtor and creditors to enter into an agreement to repay some (or all) of the debts owed in a commercially acceptable manner. Upon completion of the PIA, a Debtor is again able to be a director of a company.

Composition or Scheme of Arrangement pursuant to Section 73

A proposal pursuant to Section 73 is similar to a PIA, but conducted after the date of a bankruptcy. It is a means for a Debtor that is declared bankrupt to reach an agreement and settle debts with creditors.

The process for submitting and accepting a Section 73 proposal operates the same as a PIA proposal, in that:

  • A proposal is submitted;
  • It is reviewed, investigated and considered by the Trustee;
  • A report is issued to creditors by the Trustee, providing a recommendation on whether the proposal would benefit creditors (compared to the bankruptcy continuing);
  • A meeting is held, allowing creditors to vote on the proposal; and
  • The proposal is accepted if a special resolution is passed by creditors at the meeting (if it is not passed, the Debtor remains in bankruptcy).

If creditors accept the Section 73 proposal, the bankruptcy is annulled; it is as though the bankruptcy never occurred. The Debtor must then comply with the terms of the proposal.

The benefits of a Section 73 proposal include:

  • The Debtor is released from the restrictions of bankruptcy;
  • The Debtor is released from their debts;
  • The Debtor’s unrealised property reverts to them (unless it forms part of the Section 73 proposal);
  • Creditors often receive a higher return; and
  • It is binding upon all unsecured creditors – you do not have to obtain 100% agreement from creditors (unlike an informal agreement).

Article written by Jason Cronan, Director, of SV Partners. Shartru Wealth Management in conjunction with SV Partners can assist when dealing with unmanageable debt.