When starting a business, a sole trader structure is the most simple and most frequently used. However, just as they receive all profits, they alone are liable for all the debts of the business.
Under the law as a sole trader, you and your business are essentially the same entity. So, what does this mean then if your business can’t pay off its debts?
Bankrupt or insolvent?
‘Insolvent’ refers to a company unable to pay off money owed to its creditors. The payments for these debts will come from company assets.
‘Bankrupt’ is the equivalent term for a sole trader’s business. Like with insolvency, this will occur when the business is unable to pay off its debts.
However, because the business is tied directly to the sole trader’s income, all the debt owed will need to come from the sole traders’ assets. Where ASIC deals with insolvency, the Australian Financial Security Authority (AFSA) deals with bankruptcy.
How is bankruptcy declared?
A sole trader may declare bankruptcy in one of two ways:
- They declare it themselves (volunteer)
- Creditors can apply to have a debtor (the sole trader) declared bankrupt
Bankruptcy can be applied for regardless of the size of the debt. It only requires that you are unable to pay it and that you reside or conduct business within Australia.
Paying of debts
A trustee is appointed to manage the individual’s finances once bankruptcy is declared. This trustee may be nominated by the sole trader or they will be appointed by AFSA.
They will work with both the bankrupt individual and the creditors to develop a fair system to repay all outstanding business debts. To do so, they may sell the individuals assets, such as real estate property, and establish payment plans from future expected income.
However, there are limits to what property can be claimed. The government threshold guideline states what can and can’t be seized.
Following this, the trustee will propose a debt agreement. Throughout, the bankrupt individual will provide any relevant documentation, such as balance sheets, bank statements and ledgers, to the trustee where necessary.
A benefit to bankruptcy is that you will be released from unsecured debts. These include:
- Credit cards
- Outstanding utility bills
- Overdrawn bank accounts
- Legal, accounting and medical bills
However, other debts may not be covered. These include things like:
- Child support payments
- Court imposed fines
It is important to confirm with the individual creditor of each debt what is and isn’t cleared.
Likewise, some service providers may refuse service while the debt exists. In cases like this, you may make voluntary debt payments to ensure the service continues.
For secured debts, you will still be liable to pay that debt.
How will bankruptcy affect an individual?
Being classified as bankrupt will affect an individual’s life in several ways. These include:
- Being barred from directing or managing a company
- Potentially being disqualified as the trustee of a Superfund
- Requiring the trustee to grant permission for them to travel overseas
- You may lose your right to legal action
- Registering your name permanently in the National Personal Insolvency Index (NPII)
As a sole trader, the NPII registration will likely affect your future business the most. It is not against the law to run your own business while bankrupt. So, the good news is that you can still act as a sole trader.
However, while bankrupt, legally, your business’s name must contain your full name in it so it can be looked up in the NPII. If it doesn’t, legally you must inform anyone you do business with that you are bankrupt.
Normally bankruptcy lasts for a period of three years and one day from when it is accepted. The trustee may request to extend this to up to eight years.
Likewise, as your name is registered permanently it can be searched after the bankruptcy period. Most creditors are likely to do this prior to any agreements.
When you need to declare bankruptcy
Contacting a financial planner is the first step. They can assess your situation and outline all the options. Bankruptcy isn’t the only solution.
Declaration of intention and debt agreement options also exist.
If declaring bankruptcy seems like the best option, then contacting a bankruptcy lawyer is your next step.
Bankruptcy serves as a last resort to sole traders who have unfortunately found themselves with insurmountable debt. While it relieves many stresses, it also imposes restrictions that may affect your ability to function as a sole trader. Consider all your options before applying.