Control before Bankruptcy

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Control over assets before Bankruptcy

Can creditors protect their interests before the bankruptcy of a debtor?

Yes. The Bankruptcy Act provides two ways for creditors to protect their interests by stopping the debtor's assets and records from being hidden or the debtor leaving the country.

Both may be done prior to a Sequestration Order being made. Neither is widely used due to the difficulty in convincing the Court that the assets or records are in such danger that the Court needs to take action to protect them.

What are the alternatives?

The two options are set out in the Bankruptcy Act:

1. Section 78 (Arrest of debtor or bankrupt); and
2. Section 50 (Taking control of debtor's property before sequestration)

What is the difference between these alternatives?

The main difference is the target of the Orders.

Section 78 is used to stop the debtor from fleeing the country before being made bankrupt. It targets the person and can be made before or after the commencement of the bankruptcy. It is primarily used to restrict the movement of the debtor or bankrupt, though there is provision for the Order to also deal with property and financial records.

Section 50 is used to restrict the debtor's ability to deal with their assets to ensure they will be available to the trustee of the estate. It does this by placing an interim receiver in control of the debtor's property. The section does not restrict the movements of the debtor physically, and can only be made before the bankruptcy of the debtor. Once the debtor is bankrupted, the property vests in the trustee in bankruptcy and the need for an interim appointment ends.

What is required to get an Order under section 78?

The Federal Court will only issue a warrant for the arrest of a debtor and Orders for the seizure of the debtor's assets and records in very limited circumstances.

Firstly, a Bankruptcy Notice must have been issued against and served on the debtor. The debtor must have clear knowledge that a bankruptcy is imminent.

Secondly, the Court must be convinced that the debtor is absconding or has the intention of absconding with a view of avoiding paying their debts, or preventing or delaying the proceedings against them. The Courts will usually be reluctant to grant these Orders without sufficient evidence of these matters.

The Court may also grant an Order if the debtor tries to conceal or remove assets or records from the jurisdiction with the same intention.

What orders can the Court give under section 78?

The Court may issue a warrant for the arrest of the debtor and may commit them to goal until the Court believes that the danger of the debtor fleeing or the danger to the assets or records has passed, or a bankruptcy trustee has taken control of the affairs (and passport) of the bankrupt.

In appropriate circumstances the Court will just order that the debtor's passport be held by the Court until the bankruptcy hearing.

The Court may Order that any property or records of the debtor be seized and placed into the custody of a person until the bankruptcy hearing and the Court gives further Orders.

What is a section 50 receiver?

Prior to the debtor becoming bankrupt the Court may appoint someone to act as an interim receiver of a debtor's assets to protect and maintain the debtor's property. This appointment will last until a further order is made. This person will usually be the trustee who has consented to act as the bankruptcy trustee.

When can a Court make this appointment?

Before the Court will appoint a section 50 receiver:

(a) a bankruptcy notice must have been served on the debtor;
(b) the Bankruptcy Notice must have expired, so that there is an act of bankruptcy for noncompliance under that notice;
(c) a creditor must have made an application to the Court for such a Sequestration Order; and
(d) the Court must be satisfied that it is in the interests of the creditors to appoint a receiver due to the danger that the assets or records will be lost before the sequestration order is granted.

The main point and the most difficult to do is satisfying the Court that the debtor's assets or records are in such danger of being lost and that they will be unavailable to the creditors by the time of the bankruptcy.

When does a section 50 receivership end?

The Court must specify in the Order when control of the property is to end. Usually this will occur when the application for the Sequestration Order has been heard and either a trustee in bankruptcy has been appointed or the application has been dismissed.

What protection does the debtor have?

If the debtor does not become a bankrupt and his assets have been subject to the control of a section 50 receiver, they may have some recourse under Regulation 4.08 of the Bankruptcy Act against the creditor that applied for the appointment for any damage that they suffered because of the appointment.

Within 21 days after the control period ends, the debtor may apply to the Court for an assessment of damages suffered resulting from the appointment and an Order for payment of those damages by the Creditor that requested the appointment.

The application is not against the section 50 receiver, it is against the creditor that applied for the appointment. Creditors will have to keep this potential liability in mind when deciding whether to apply for such an appointment.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 11.01.2011

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