Suing a Bankrupt: A Creditor’s Guide to Proceeding Against a Bankrupt
- Justeen Dormer
- Jan 21
- 4 min read
Debt Recovery, Bankruptcy
When a debtor is declared bankrupt, many creditors assume that all legal actions against them must cease permanently. While bankruptcy does impose an automatic stay on most legal proceedings, it is not an impenetrable shield. For creditors with specific types of claims, the law provides a pathway to continue or commence litigation against a bankrupt individual.
Understanding when and how to apply for leave to proceed from the Court is crucial for protecting your rights. This guide provides practical guidance on navigating the Bankruptcy Act, outlining the factors the Court considers and the steps you can take to strengthen your application. For creditors, knowing these rules is key to determining if you can pursue your claim beyond a standard proof of debt.
The Automatic Stay: Understanding Section 58(3)
The moment a person becomes bankrupt, Section 58(3) of the Bankruptcy Act 1966 comes into effect. This provision imposes an automatic stay, preventing creditors from commencing or continuing most legal actions to recover a provable debt. A "provable debt" is essentially any debt or liability that would entitle a creditor to receive a dividend from the bankrupt estate.
The purpose of this stay is to protect the bankrupt from being harassed by multiple lawsuits and to ensure an orderly administration of their estate. Instead of pursuing individual claims, creditors are generally required to lodge a formal "Proof of Debt" with the Bankruptcy Trustee, who then adjudicates the claim and distributes available funds proportionally. However, this is not always the end of the matter.
When Can You Sue a Bankrupt? The "Leave to Proceed" Application
The stay imposed by the Bankruptcy Act is not absolute. The same provision that creates the stay also gives the Court the power to grant a creditor "leave" (permission) to commence or continue legal action against the bankrupt.
This application is not granted lightly. The creditor must present a compelling case demonstrating why their situation warrants an exception to the general rule. The Court undertakes a careful balancing act, weighing the creditor's right to pursue their claim against the objectives of the bankruptcy regime.
Key Factors the Court Considers
When deciding whether to grant leave to proceed, the Court assesses several critical factors. A successful application will clearly and persuasively address these points.
1. The Purpose and Merits of the Claim
The Court will first examine the nature of your legal action. Is its primary purpose to recover a provable debt, or is there another legitimate objective? For instance, a claim seeking to establish liability for fraud, which is not extinguished by bankruptcy, has a stronger basis than a simple debt collection action. You must demonstrate that your case has a reasonable prospect of success.
2. The Effect on the Bankrupt Estate
How will your lawsuit impact the administration of the bankruptcy? If the litigation is complex and costly, it could drain resources from the estate that would otherwise be available to all creditors. The Court is unlikely to grant leave if the action primarily benefits one creditor at the expense of the collective pool.
3. Prejudice and Hardship
The Court weighs the prejudice to the creditor if leave is denied against the hardship the bankrupt would face if the litigation proceeds.
Prejudice to the Creditor: Would denying leave prevent you from pursuing a right that cannot be addressed through the Proof of Debt process? For example, if your claim is for damages that are difficult to quantify without a court hearing.
Hardship to the Bankrupt: The Court considers the stress, cost, and time the bankrupt would have to dedicate to defending the lawsuit.
4. Consent of the Bankruptcy Trustee
While not decisive, the position of the Bankruptcy Trustee is highly influential. If the Trustee consents to the legal action proceeding, the Court is more likely to grant leave. The Trustee may consent if, for example, the litigation could help clarify a complex claim or uncover assets for the benefit of all creditors.
A Practical Checklist for Seeking Leave to Proceed
Investing time and resources into a leave application, you should assess your position.
Define Your Objective: Is your claim for a simple provable debt, or does it involve elements like fraud, breach of fiduciary duty, or a claim that won't be released upon the bankrupt's discharge?
Assess the Merits: Do you have strong evidence to support your case? A speculative or weak claim is unlikely to receive the Court's permission to proceed.
Consult the Bankruptcy Trustee: Engage with the Trustee early. Explain the nature of your claim and why you believe litigation is necessary. Securing their support, or at least their neutrality, can significantly improve your chances.
Evaluate the Costs vs. Benefits: Consider the potential legal costs against the likely recovery. Is pursuing the action commercially sensible?
Seek Expert Legal Advice: Navigating a leave to proceed application requires specialist knowledge. An insolvency lawyer can provide a realistic assessment of your prospects and prepare a persuasive case for the Court.
By carefully working through these steps, you can make an informed decision about suing a bankrupt and build a stronger application.
Secure Your Position with Expert Insolvency Lawyers
Pursuing legal action against a bankrupt individual is a complex process that requires a strategic approach. Whether you are seeking to establish liability for fraud, set aside a bankruptcy, or simply understand your rights as a creditor, specialist legal guidance is essential.
The Insolvency, Restructuring & Debt Recovery team at Dormer Stanhope Lawyers provides authoritative advice to creditors and litigants. Our insolvency lawyers in Sydney can assess your claim, advise on your prospects of obtaining leave to proceed, and represent you in Court. Contact us today for a confidential consultation to ensure your rights are protected.
