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Dividends: The process for paying creditors in bankruptcy

Dividends are the conclusion to most external administrations and cannot be finalised until dividends are distributed in accordance with statutory time limits and investigations to admit or reject proofs of debt.

The Bankruptcy Act 1966 sets the minimum period to pay a dividend. If there are no complications, a personal insolvency dividend will take about two months to distribute.

If there is a complexity in relation to the admissibility of proofs of debt, the payment of the dividend can be delayed, particularly if a creditor applies to the court for a review of the bankruptcy trustee’s decision to reject their proof of debt.

Dividends in detail
When there are funds to distribute, the payment of a dividend is often the only tangible output from an insolvent estate.

A bankruptcy trustee withholds sufficient monies to complete the estate. They also determine the most appropriate time to pay dividends when considering any further anticipated realisations and the costs related to paying a dividend.

Dividends must be declared in accordance with the requirements of the Bankruptcy Act, and be paid to creditors in order of their priority.

Steps in paying dividends
The four basic steps required to pay dividends are as follows:

Calling for proofs of debt—every known creditor must have the opportunity to lodge a proof of debt and participate in the dividend.
2. Admitting proofs of debt—verify that the debt is proper and has been ‘proved’ to the trustee’s satisfaction.
3. Rejecting proofs of debt—to ensure only legitimate creditors participate in the dividend.
4. Paying the dividend—the trustee distributes the cheques.
  1. Calling for proofs of debt
    All creditors must be given the opportunity to lodge their claim in the form of a proof of debt. A proof of debt is a formal document used to prove that a debt exists and it sets out the amount of the debt. Without sufficient proof that the debt exists, it will not be admitted for the stated amount—or might not be admitted at all.

Proofs of debt are a prescribed form under the Bankruptcy Act. A trustee may not admit claims that are insufficiently detailed on the correct form, which may result in a creditor being excluded from a dividend.

Creditors can lodge proofs of debt at any stage in an administration. They do not need to wait until a dividend is called. Creditors should ensure that their claim has been lodged and appears in any list of proofs of debt received by the bankruptcy trustee. If creditors are in any doubt that their claim has been lodged, they should contact the trustee’s office.

Periods for calling for proofs of debt
The bankruptcy trustee must formally notify all known, or potential, creditors of the intended dividend and request that proofs of debt be lodged by a certain time.

The Bankruptcy Act states that creditors must be given ‘a reasonable period’ to lodge proofs of debt. Usually a 21-day period is considered reasonable.

Definite periods to lodge proofs of debt are important to expedite dividend payments or to ensure dividends are not challenged while cheques are being drawn. The cut-off date for proofs of debt is final and the Bankruptcy Act provisions set out the creditors’ and bankruptcy trustee’s rights if a proof of debt is not lodged in time.

Notices to be issued for calling for proofs of debt
The Bankruptcy Act does not require bankruptcy trustees to advertise a dividend; it only requires a notice to be sent to all known creditors that have not lodged proofs of debt. A bankruptcy trustee advertises a dividend when they suspect there may be creditors not disclosed—particularly when a Statement of Affairs has not been lodged, and when a bankruptcy trustee applies to the court to pay a dividend.

Dates for payment of dividends
The Bankruptcy Act does not set a maximum period after the intended date of declaring a dividend, but says that dividends cannot be paid until 21 days after the lodgement date for proofs of debt. Therefore a bankruptcy trustee must wait 21 days to receive proofs of debt and, without further complication, wait another 21 days before they can issue dividend cheques.

Non-lodgement of proof of debt
Under section 144 of the Bankruptcy Act creditors that miss the proof of debt cut-off date can lodge a proof of debt for the next dividend distribution, and they will be paid the first dividend they missed out on (a catch-up dividend), as well as the upcoming dividend. If there are insufficient funds to pay a second dividend (a second dividend is never declared), creditors will not receive a dividend at all. Therefore, it is imperative that creditors lodge their proofs of debt before the cut-off date.

2. Admitting proofs of debt
Under section 83 of the Bankruptcy Act creditors have the burden to prove the existence and amount of their debt. The bankruptcy trustee does not need to disprove a debt, only determine the validity and amount of the debt from the creditors supporting evidence.

If the trustee believes that all or part of the debt is not sufficient, they will seek further clarification and material from the creditor. Without further information, the trustee may reject the proof of debt in full or in part. The trustee is not required to locate sufficient information.

Creditors should attach copies (not originals) of all appropriate documents to their proof of debt.

Trustees must review proofs of debt within 14 days of the lodgement date and decide to admit or reject the claim, or seek further information.

Creditors should attach copies (not originals) of all appropriate documents to their proof of debt.

Trustees must review proofs of debt within 14 days of the lodgement date and decide to admit or reject the claim, or seek further information.

3. Rejecting proofs of debt

Under section 102 of the Bankruptcy Act, if a proof of debt is rejected because a creditor does not provide sufficient evidence, a trustee will provide a notice outlining the reasons for rejecting the proof of debt. The creditor has 21 days to appeal the decision.

Appeals against decisions
Creditors’ rights are set out in section 104 of the Bankruptcy Act. Creditors can have the court review the trustee’s decision to reject their proof of debt, but have a strict and limited time to apply for adjudication. A trustee can amend their decision to reject a proof of debt when sufficient information is given if it is still within the required timeframe.

The court may allow an application for adjudication after the time limit period expires, but creditors should not rely on it being granted. Creditors should seek legal advice as soon as a rejection is received.

Creditors have the burden to prove to the court that the claim should be admitted in the bankruptcy. Creditors must show that the decision to reject the proof of debt was incorrect based on the information provided to the trustee.

Revoking a decision to admit or reject
A trustee can reverse their admittance or rejection of a proof of debt under section 102 of the Bankruptcy Act.

When a trustee reverses their initial decision to reject a proof of debt, they must give the affected creditor notice of the new decision and, if appropriate, adjust the dividend to be paid or, if necessary, pay a catch-up dividend.

4. Paying the dividend

Dividends are paid after the proof of debt lodgement date expires, after all the proofs of debt have been admitted or rejected, and after any appeals on rejections have been heard in court. The trustee will forward a cheque to the creditor with a Form 2, which outlines the realisation and distribution of the bankruptcy estate.

If dividend cheques are not banked within a reasonable period, or if creditors cannot be located, the trustee will hold monies for six months following payment, and then forward these monies to the Australian Financial Security Authority (AFSA). The creditor must then request the money from AFSA.

Priorities in the payment of dividends
Subject to specific priorities under section 109, all creditors will rank equally in insolvent estates and will be paid ‘pro-rata’ dividends. If there are insufficient funds to meet the estate’s debts in full, they are paid proportionately.

The Bankruptcy Act gives priority to outstanding employee limited wages (e.g. $1,500 per employee or such greater amount as prescribed by the regulations), long service leave, annual leave, sick leave etc. An employee creditor must clearly indicate that they are claiming as an employee and use the required proof of debt form for that purpose.

Joint bankruptcy estates
Section 110 of the Bankruptcy Act provides for joint and separate bankrupt estates. It applies when two or more bankrupts have joint and several assets and liabilities. For example, bankrupt business partners have joint partnership assets (i.e. held together), and individual assets (i.e. held separately). They may also have individual and joint creditors. How joint and individual assets are divided among the joint and individual creditors in bankrupt estates is sometimes complex. Joint assets are used to pay joint creditors, and each bankrupt’s individual assets are used to pay their individual creditors. When there are no surplus assets in either estate, the issue is irrelevant.

If there is a surplus in either individual estate, it can be used to pay joint creditors to the necessary limit of joint claims. When there is a surplus after paying both individual and joint creditors, the bankrupt is annulled from bankruptcy, and the surplus money is paid to them.

Alternatively, if there is a surplus in the joint estate, it is divided proportionately to the individual estates, and can be used to pay individual creditors. If either individual estate has sufficient monies to pay the individual creditors and still has a surplus, that bankrupt will be annulled from bankruptcy and the surplus is paid to them.

Surplus assets in one individual estate cannot be used to pay creditors in the other individual estate.

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: 7.11.2017