Diana Clement: Bankruptcy no easy answer to debt spiral

Bankruptcy leaves a black mark on your credit record that can make it hard to borrow money. Photo / Thinkstock

Every year thousands of people give up all hope of paying back their debts and petition for bankruptcy or the lesser No Asset Procedure (NAP).

In the 2010 calendar year there were 1876 bankruptcy adjudications and 2709 people accepted for the NAP, some as young as 16.

The NAP is a simple way of clearing debts. To qualify you need to have debt and no realisable assets. You remain in NAP for one year and it stays on the public register for four more.

Not all applications for the NAP are accepted. For example, 203 applications were accepted last December and 74 rejected, a fairly typical ratio.

If your debts are over $40,000 you can't use the NAP and bankruptcy is the other option, which comes with tougher consequences. Both of these procedures wipe clean most debts owed by a bankrupt in one fell swoop. But they're not quite the get-out-of-jail-free card that they might appear.

For bankrupts the consequences include:

* Your past financial transactions will be investigated and gifts you have made in the past three years might be clawed back.

* You'll be denied credit cards.

* You can't manage a business, be a business partner, self-employed or employed by family.

* You must disclose that you're an undischarged bankrupt to apply for more than $1000 of credit.

* Travelling overseas requires the Official Assignee's consent.

* The Official Assignee can sell your share of an asset owned by your spouse and/or children if it is determined that you have a legal entitlement to part of it.

Nor does bankruptcy free people from fines, court-ordered reparation, maintenance, child support, student loans and debts based on fraud.

During the bankruptcy period, the Official Assignee can take inheritances to pay debt and order that regular superannuation payments you would have made be directed to your bankruptcy estate to pay off debts.

Bankruptcy and NAPs last for a relatively short period. It's one year for NAP and three years before being discharged from bankruptcy, although it's possible to apply to the High Court for early discharge.

Even once you're discharged or the order is terminated, bankruptcy and the NAP are noted on your credit record for a further four years, which will hamper you from getting credit.

Your name also remains on the Insolvency and Trustee Service website for the same period. A discharged bankrupt's name can remain on this database indefinitely if it's their second bankruptcy or the person has used the NAP and then bankruptcy.

Anyone from landlords to employers and potential creditors can check the database and make decisions on your suitability for tenancy, work, or credit.

Even once your name is wiped off, the bankruptcy or NAP doesn't go away. For example, ANZ asks on its application to become a mortgage broker if the applicant has ever "entered into bankruptcy, insolvency, receivership, administration or liquidation".

Likewise Fonterra's background check form for potential employees includes the question: "Have you ever committed an act of bankruptcy, been declared bankrupt or entered into any form of bankruptcy agreement with your creditors?"

And AIG Life's life insurance proposal form asks the question as well. The big problem, says Murray Tingey, partner at Bell Gully, is getting credit once you've been declared bankrupt.

As a result, some business people do anything they can to avoid bankruptcy. That may include taking money from a family trust to give to creditors, even though the trust is not legally liable.

The abolition of gift duty later this year will have an impact on business owners who are facing bankruptcy. They may be able to transfer assets to a trust, but risk having the transaction becoming void, says Tingey.

Even being discharged and going overseas doesn't always get rid of your bankruptcy.

Credit agencies operate internationally.

You might be discharged and the bankruptcy cleaned from your credit record, but the stigma does still follow you around. In the digital era mention of a bankruptcy may remain online for many years on websites such as BDCentral.co.nz, which lists bankruptcies and liquidations of companies.

People can, however, change their names to escape such linkages online. Banks, landlords, employers, insurance companies and others are within their rights to ask you on an application form if you have ever been bankrupted. It's common for finance companies to ask this before advancing mortgages, says Kris Pedersen, mortgage broker at Property Financial Solutions.

Unless a bank asks, you don't need to tell. Typically, banks will do a credit check and search their own records if you have been a customer, but won't ask directly if you have been bankrupted.

Bankruptcy can follow you around like a bad smell for years and years. The former chief executive of the Maori Television Service, John Davy, was bankrupted twice in Canada before being hired here. Once it became known publicly, the bankruptcies came back to bite him.

Big names who are bankrupted get front-page treatment, such as Mark Bryers, May Wang and former National MP Trevor Rogers. Most others slip under the radar and may not even tell friends and family.

There is a strong culture in New Zealand of expecting penance from people who have done wrong. I once wrote an article about people who had lost all and come back financially.

The mention of Olly Newland, whose property empire imploded (although he was never declared bankrupt) irritated readers and I got pointed emails denouncing me for mentioning his story.

Many people feel strongly, as one forum poster put it: "[Bankruptcy] SHOULD follow you around for the rest of your life. It shows the calibre of a person - someone who can happily dust off their hands and walk away from their debts without a thought for others is someone many individuals and companies would prefer to avoid in the future."

But Official Assignee David Harte points out that the Insolvency and Trustee Service assesses the reasons for bankruptcy. In most cases, he says, people are bankrupted for business risk, business gone bad, or life circumstances. In 42 per cent of cases, it was due to becoming unemployed.

If there are elements of criminality or incompetence involved, Harte's office has the power to punish bankrupts and/or stop them going into business again.

Our attitude to bankruptcy is very different from North America's, where it's viewed almost as a finishing school for business, says Harte.

Bankruptcy and NAP have consequences for the creditors - especially if they are small business owners and landlord. Over and above that, all customers of a company such as GE Money or even the ASB Bank end up paying for the customers who choose bankruptcy or NAP.

Despite the strong public feeling towards bankrupts, some people overcome the stigma and move on.

One former bankrupt who has bounced back is Paul Webb, who became a judge on Dragons' Den New Zealand. Webb was declared bankrupt in 2000 after the collapse of the CityJet passenger airline service.

There are alternatives to bankruptcy, but they don't wipe away the debt. You can ask your creditors if they will accept part-payment as final settlement, restructure your debts by extending your mortgage or consolidating them (but beware of debt consolidation companies, which can be expensive), get a summary instalment order, which keeps your creditors off your back while you pay off the debt, or if you're in business, trade out of the problems.

If you choose that last course of action, get guidance from an accountant or business adviser.

It's very easy to fool yourself, especially when you've put your heart and soul into building up a business.

Links:

Insolvency and Trustee Service comparison tool

http://tinyurl.com/3lo2g5b

Insolvency data

http://tinyurl.com/3bw869d