The Bankruptcy Process Explained

18 August 2025 in Bankruptcy Lawyers | 6 min read | skip to FAQs

This article explains the four stages involved in the bankruptcy process in the most common form of bankruptcy which is involuntary. This occurs when the individual finds themselves subject to a sequestration order, commonly known as a creditors petition. Bankruptcy can also be initiated voluntarily by the individual themselves, commonly known as a debtors petition. The term bankruptcy only applies to people. If a company is unable to pay their debts, known as insolvency the company may be placed into liquidation.

What is Bankruptcy?

Bankruptcy is a legal process where an individual is declared unable to pay their debts. It can occur when a person is the involuntary subject of a sequestration order, or voluntarily submits a debtor’s petition pursuant to the Bankruptcy Act 1966 (Cth). Essentially the Court recognises that an individual is incapable of paying their debts and a trustee must take control over their property to realise (sell) their property and pay creditors the dividends in proportionate shares.

The most common form of bankruptcy is the involuntary variety involving a sequestration order. That process can be broken down into several stages:

The Legal Stages of the Bankruptcy Process

1. A creditor commences legal proceedings against a debtor in an Australian Court and obtains a Final Judgement in respect of a debt. 
2. This Final Judgement is not complied with, and the creditor applies to have the debtor issued with a bankruptcy notice.
3. The bankruptcy notice is not complied with, and the creditor applies to have the debtor rendered bankrupt.
4. Once rendered bankrupt, the debtor’s property vests with a trustee and is realised to repay outstanding debts.

Stage 1: 

A Final Judgement (otherwise known as a Final Order) in respect of a debt is essentially an order by a Court that compels a person to pay a debt they owe. It is the first stage in the bankruptcy process. A creditor can obtain a final judgement by commencing legal proceedings in an Australian Court against a debtor to recover a debt that has not been paid.

Stage 2:

The issue of a bankruptcy notice is the second stage of the bankruptcy process. It is an official demand for payment of a debt. Once a creditor has obtained a final judgement, and if it is not complied with, a creditor may petition for the issue of a bankruptcy notice. Bankruptcy notices are issued by the Official Receiver, a position filled by the Australian Financial Security Authority (AFSA), following an application by a creditor. Bankruptcy notices state that the debtor must repay their debt within 21 days (unless the Official Receiver stipulates a different compliance period). The debt must be $10,000 or more and no more than six years old. Failure to do this will result in an act of bankruptcy, which allows creditors to commence bankruptcy proceedings in the Federal Circuit and Family Court of Australia.

Stage 3:

The third stage in the involuntary bankruptcy process involves a creditor making an application to the Court to make the debtor bankrupt. The Court does this through a sequestration order. This can be done when a person commits an act of bankruptcy. The relevant act of bankruptcy in this case is when that person owing a debt does not repay that debt pursuant to a bankruptcy notice issued on behalf of a creditor. That creditor can then apply for a sequestration order from the Federal Circuit and Family Court of Australia, (FCFCOA). This renders a person bankrupt for three years and one day after the debtor’s statement of affairs was filed. This application must include proof that the debt is still owing among other procedural requirements. 

Stage 4:

The final stage of the bankruptcy process revolves around the trustee realising the debtor’s property and repaying creditors. When a person is bankrupt, much of their property or assets vest with a trustee appointed by the Court and a trust is created to hold that property. Being a trustee means that they acquire a legal interest in that property and can dispose of it according to the terms of the trust. The trustee must be either a private registered trustee-in-bankruptcy or the government Official Trustee in Bankruptcy, a role filled by the Australian Financial Security Authority (AFSA). Their purpose is to investigate the affairs of the bankrupt person, report to creditors and realise (sell) their assets to repay the creditors the debtor owes money to. Once a debtor is rendered bankrupt, they must file a statement of their affairs with the Official Receiver and the trustee. This is a document that details a person’s assets and liabilities. The trustee will then proceed to realise the debtor’s property to repay creditors in amounts proportionate to the size of their outstanding balances, otherwise known as the pari passu principle. 

Additionally, whilst bankrupt a debtor must declare their bankruptcy any time they pay for goods or services by cheque or attempt to obtain credit over a certain amount from a person or financial institution. Often people and financial institutions will refuse to loan money to or take payment by cheque from a bankrupt person. Additionally, if a debtor is earning an income whilst bankrupt, they must pay a portion of that income to the trustee if the income is over a certain level. Any property that a person acquires whilst bankrupt also vests with the trustee. This legal status will continue for three years and one day after the date of filing of their statement of affairs. In some cases the trustee can lodge an application to extend the bankruptcy for up to 8 years.

Voluntary Bankruptcy

This occurs when an individual, either alone or jointly with someone else or as a member of a partnership applies to become bankrupt, also known as a debtors petition. This involves applying to the Australian Financial Security Authority (AFSA) by completing a Debtor’s Petition form and a Statement of Affairs form.

Some Consequences of Bankruptcy

1. The bankrupt person’s name will appear on a publicly accessible register called the National Personal Insolvency Index.
2. The trustee has the right to claim and realise the bankrupt person’s assets to pay creditors. These assets include real estate, including your home, life insurance or compensation received prior to bankruptcy, vehicles and cash or money in your bank account.
3. The trustee must be paid by the bankrupt person throughout the duration of their bankruptcy.
4. There are limits on the value of vehicles that the bankrupt person can own. At the time of writing, this value is $9,600.
5. The bankrupt person must request written consent from their trustee to travel overseas.
6. The bankrupt person cannot continue as a company director or own shares in the company.
7. There are some professions or trades that don’t allow or limit a bankrupt person’s ability to work. This includes accountants, lawyers and builders.
8. There are limits on the amount of credit the bankrupt person can apply for without telling the lender about your bankruptcy status. This value is indexed and increases twice a year. At the time of writing, it is $7,173
9. If a bankrupt person is earning an income, they must pay a portion of that income to the trustee if earning over a certain amount. At the time of writing, a person earning over $74,064 with no dependents must pay half of the income over this to the trustee.
10. Although a bankrupt person can keep income earned during their period of bankruptcy, they are unable to purchase property or assets with this money.
11. The bankrupt person must report all changes in employment or income to their trustee.
12. If a bankrupt person receives an inheritance at any time prior to or during the period of bankruptcy, the trustee is able to claim this money
13. Not all debts are covered by bankruptcy. Importantly, secured debts such as bank mortgages or finance over vehicles are not covered. Some unsecured debts are also not covered, including HECS debts and child support debts. Nevertheless, most unsecured debts are covered by bankruptcy.

Concluding Remarks

Bankruptcy is a complex legal process that has severe financial implications for individuals who find themselves subject to a sequestration order for involuntary bankruptcy. The bankruptcy lawyers at BSM Sydney Lawyers are skilled at navigating this area of law and can assist clients facing bankruptcy legal proceedings. Contact Brander Smith McKnight Sydney Lawyer for a free 20-minute consultation.

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