It’s time for bankruptcy law reform

When Susan (not her real name) set up an internet account for her son many years ago, she had no idea the modest Telstra account would see her nearly lose her home. Susan’s son never paid the account and, once the small debt had grown to just over $2,000, Telstra’s debt collector forced Susan into bankruptcy. Once fees for the bankruptcy trustee were added, Susan - whose sole income is the carer’s pension - owed more than $23,000.

It’s precisely this sort of grossly unfair outcome that proposed reforms to Australia’s bankruptcy laws are designed to prevent, by raising the current $2,000 bankruptcy threshold to a more realistic $10,000. However there is more to be done if vulnerable consumers like Susan are to be protected from the misuse of our bankruptcy system in the future.

What the present law allows is the modern day successor to a Dickensian era debtor’s prison - where bankruptcy is used by creditors to “collect” small amounts of money, in the process racking up enormous trustee and other fees. Where once a debtor faced incarceration, today they face losing their home over a debt that may have begun as a trifling amount.

Yet bankruptcy is intended to be an alternative to this previous ruthless treatment of debtors, imposing serious consequences but allowing debtors to make a fresh start and become a productive member of the community again. For this reason, most bankruptcies in Australia are initiated by debtors themselves.

In a small number of cases, creditors also send debtors bankrupt if they cannot pay their debts. The original policy intent of giving creditors this right was to stop an unscrupulous person from running up debts they had no ability to pay. It was not, as opponents of raising the threshold would argue, to give businesses another debt collection tool to wield over people who might be struggling to pay one relatively small bill.

However this is the unintended consequence which has occurred - fringe (but vocal) elements of the debt collection industry are able to use the current bankruptcy laws to collect small debts rather than using the many other and cheaper available tools intended for debt collection: for example accepting payment by instalments, garnisheeing wages or even asking the Sheriff to sell the debtor’s home. As drastic as this last option is, the costs are much less than those of a bankruptcy trustee.

Instead, where the debtor has equity in their home, bankruptcy has become a lucrative first option, generating extensive fees for both the debt collector and the bankruptcy trustee, while leaving the debtor owing an amount that is often out of all proportion to the original small debt.

The Government's proposal to raise the threshold is a crucial first step, however, additional reforms are urgently needed to address the issue of these remuneration amounts. For too long they have been money for jam, with little effective scrutiny of the way in which trustees operate or the fees they can charge. Lifting the bankruptcy threshold to $10,000 is a long overdue reform that will stop the most egregious cases - without impacting on the vast majority of bankruptcies. However, the regulator also needs broader powers to review not just the level of these fees, but whether the work undertaken for them is reasonable and proportionate.

As further evidence that bankruptcy has spawned its own “industry” in Australia, the current proposals will expand the availability of debt agreements.

Introduced in 1996, debt agreements are an alternative to bankruptcy that allow a person to negotiate a repayment arrangement with their creditors. While they work for some debtors, many have been saddled with agreements they cannot afford only to end up bankrupt anyway - it just takes a little longer and costs a lot more. Many of the businesses that market, set up and administer these agreements for debtors also collect some fees up front, regardless of whether the creditors approve the agreement.

Any bankruptcy reforms must consider imposing stronger sanctions for companies charging huge fees for advising people to enter into unsustainable debt agreements and the government should make good on its promise to comprehensively review these arrangements in 2010.

Australia’s bankruptcy laws are out of step with today’s credit market place and the current reforms need to acknowledge this. Debtors may not be the most popular cause but they are unfairly vulnerable to unscrupulous debt collection practices and to businesses offering to help them. When the current laws came into play in 1966 the humble credit card did not exist, store credit was still the stuff of science fiction and debt collectors were not listed on the stock exchange. You certainly wouldn’t have lost your house over the price of a television.