02 May 2016

An alternative approach to the treatment of penalties and fines in bankruptcy

By Peter Sise

In 2013-2014, 81% of all people who became insolvent did so for personal rather than business reasons.[1]  Approximately 34.4% of such people became insolvent due to unemployment, 28.6% due to excessive use of credit, 12.5% due to domestic discord or a relationship breakdown and 8.8% due to ill health.[2]  In light of these figures, the law of bankruptcy is clearly relevant to people suffering from social and financial disadvantage.  It has been noted that people suffering from such disadvantage are disproportionately susceptible to receiving fines.[3]  For this reason, the treatment of fines and penalties during the term of a person's bankruptcy is an important issue for those suffering from social and financial disadvantage, as well as others.  How fines and penalties should be treated involves weighing various policy aims, such as the aim of bankruptcy law of giving a person a fresh start from previous financial difficulties and the aim of criminal law of holding a person to account for transgressions.  

Currently, certain fines and penalties are not ‘provable’ in bankruptcy. This article will examine the policy behind this.  It will then propose that such fines and penalties should be provable provided they (i) rank behind other unsecured debts in relation to the payment of any dividend and (ii) are not released upon the discharge of the bankrupt person. 

The current position regarding penalties and fines

For those who do not deal with bankruptcy, there are some basic concepts that are necessary to understand how fines and penalties are treated in bankruptcy.  The most important concept is that of a ‘provable’ debt.  A creditor who is owed a ‘provable’ debt may receive a payment from the bankrupt’s estate in respect of that debt.  The creditor may submit a ‘proof’ of such a debt to the trustee who administers the bankrupt’s estate during the term of their bankruptcy.  If there are sufficient assets in the bankrupt’s estate, a dividend may be distributed to creditors owed provable debts but not to creditors owed non-provable debts.  Creditors owed non-provable debts will receive no distribution from the trustee.  When the bankrupt is discharged from bankruptcy, they will be released from provable debts but not non-provable debts.  

Section 82(3) of the Bankruptcy Act 1966 (Cth) (Act) addresses the treatment of fines and penalties.  It provides as follows:

Penalties or fines imposed by a court in respect of an offence against a law, whether a law or the Commonwealth or not, are not provable in bankruptcy.

The key phrases in s 82(3) are ‘offence against a law’ and ‘imposed by a court’.  In Mathers & Anor v Commonwealth[4] (Mathers), Heerey J concluded that an ‘offence against a law’ does not have to be a criminal offence but may simply be the failure to do something prescribed by statute which results in a pecuniary penalty.  His Honour said that a criminal offence is only one form of offence.[5]  Mathers concerned s 553B(1) of the Corporations Act 2001 (Cth), which is the corporate insolvency equivalent of s 82(3).  Section 553B(1) also contains the phrase ‘offence against a law’ and is hence relevant. 

Whether a fine or penalty is ‘imposed by a court’ depends on the procedure for imposing the fine and will vary from case to case.  The Full Federal Court decision of State of Victoria v Mansfield[6] (Mansfield) provides an instructive analysis of whether 72 parking fines were ‘imposed by a court’.[7]  In that case, the Court concluded that a parking fine was ‘imposed by a court’.[8]

It is unclear whether a ‘law’, for the purposes of s 82(3), must be a statute or may also be a rule of the common law.  There is nothing in the wording of sub-s 82(3) which suggests that ‘law’ is limited to statute and no case law which suggests that it is.  For that reason, it appears that a penalty imposed for a common law offence, such as bribing a public official or misconduct in public office, falls within s 82(3). 

Based on the overview of s 82(3) above, it can be seen that s 82(3) may apply to a wide array of fines and penalties.  Some may punish egregious criminal activity and hence be vigorously pursued by the relevant regulator while others, such as the 72 parking fines considered in Mansfield, may simply be imposed to ensure the orderly operation of public facilities.  Despite this difference, all fines and penalties are intended to (i) deter behaviour which the state considers undesirable and (ii) punish transgressions.  This distinguishes fines and penalties from other liabilities.  Most liabilities are compensatory in nature whether they are providing compensation for goods or services provided by the creditor to the bankrupt or are compensating the creditor for a civil wrong committed by the bankrupt, such as breach of contract, tort, or misleading or deceptive conduct.[9] 

Section 82(3) has several ramifications.  First, the regulator who issued the fine or penalty will not receive any dividend that might be distributed by the trustee.[10]  Secondly, there will be no stay preventing the regulator from pursuing the bankrupt for the fine or penalty.[11]  Thirdly, the bankrupt will not be released from the penalty or fine upon their discharge from bankruptcy.[12] 

The policy behind penalties and fines not being provable

The providence of s 82(3) is not entirely clear.  In Mansfield, the Full Federal Court observed that s 82(3) was introduced into the draft bill, which became the Act, before its second reading.[13]  The Court assumed that the provision was included to implement the policy espoused in Re Bradbury; Ex parte The King[14] which was that bankruptcy should not be allowed to free someone from a penalty or fine.[15]  The Court noted that s 82(3) is based upon two further objectives: (i) fines and penalties are imposed to meet the public interest in punishing an offender and (ii) the interests of ordinary creditors should not be adversely affected by the wrongdoing of the bankrupt.[16]  These two objectives were noted by the Australian Law Reform Commission (ALRC) in its report, Principled Regulation: Civil and Administrative Penalties in Australian Federal Regulation.[17]

Problems with penalties and fines not being provable

It is submitted that two problems arise from fines and penalties not being provable and a third problem arises from them not being subject to the rules regarding voidable transactions. 

Stay of Execution

Because penalties and fines are not subject to a stay during the administration of a bankruptcy, the regulator of the penalty or fine may pursue the bankrupt for the penalty or fine.  Allowing the bankrupt to be pursued by a creditor is contrary to the goal of freeing the bankrupt from harassment by creditors during the administration of their bankruptcy.  Section 58(3)(a) forbids a creditor from enforcing a remedy against a bankrupt in respect of a provable debt.  Further, s 60(1)(b) empowers the Court to stay any legal process, whether civil or criminal, brought against the bankrupt or their property in respect of a provable debt.  Since a fine or penalty is not provable, ss 58(3)(a) and 60(1)(b) do not apply.  This could expose the debtor to penal sanction as well as civil enforcement in relation to a fine or penalty.

In relation to penal sanction, a fine or penalty could be converted into a community service order or custodial sentence during the term of the debtor’s bankruptcy.[18]  This may not only be harsh to the bankrupt but could prejudice the interests of creditors because the bankrupt may find it difficult (or impossible in the case of a custodial sentence) to earn income that may be distributed to their creditors.

In relation to civil enforcement, s 118 provides some limited protection from a regulator enforcing a fine or penalty, but it is submitted that this protection is insufficient.  Section 118(1) forbids a creditor from retaining the proceeds of seizure and sale of property of the bankrupt or attaching a debt owed to the bankrupt.  This prohibition applies whether the sale and seizure or attachment occurred in relation to a provable debt or non-provable debt, and hence fines and penalties are captured.  However, s 118(1) does not forbid the seizure and sale of property or the attachment of a debt, just retaining the proceeds of these actions.[19]  It is possible that a court may refuse to grant a warrant for the seizure of property or the attachment of a debt on discretionary grounds, namely that the regulator cannot retain the proceeds and hence the enforcement actions are futile.  However, a more comprehensive protection would be provided if fines and penalties were provable and hence fell within ss 58(3)(a) and 60(1)(b). 

Inefficiencies

The regulator who issued the fine or penalty will not share in the benefits of the work performed by the trustee of the bankrupt’s estate.  This is because the regulator is not entitled to prove in respect of a fine or penalty.  The trustee will administer the estate of the bankrupt for 3 years or perhaps longer in order to satisfy provable debts.  During this period, creditors with non-provable debts are unlikely to take enforcement measures.  This is because they will be compelled to disgorge any proceeds obtained from seizure and sale or attachment of a debt due to s 118(1), which is discussed above.  Upon discharge, the creditors with non-provable debts are likely to repeat the actions taken by the trustee during the term of the bankruptcy, such as examine the now-discharged bankrupt, seize and liquidate assets and attach a portion of their income.  If creditors with non-provable debts are allowed to share in the benefits of the trustee’s work, it may reduce the need to repeat that work themselves at a later stage.  A situation where certain creditors may repeat work already performed by the trustee seems inefficient. 

Voidable transactions

Penalties and fines are not subject to the rules regarding preferences under s 122 of the Act or transfers to defeat creditors under s 121.  This is due to s 123(4) which states that nothing in the Act invalidates a payment in respect of a fine or penalty that is made by the bankrupt on or before the date on which they became bankrupt.[20]  Allowing a regulator of a fine or penalty to retain a preference may disadvantage other creditors while allowing the regulator to retain a transfer that defeats creditors will almost certainly disadvantage other creditors.  The risk of a preference arising is not to be dismissed lightly given that the bankrupt may be keen to pay a fine ahead of other debts due to the risk of the fine being converted into a community service order or custodial sentence.[21]  Overall, there is good reason to remove s 123(4) from the Act.

An alternative way to deal with fines and penalties

An alternative way to deal with fines and penalties during bankruptcy is as follows:  (i) fines and penalties should be provable, (ii) s 123(4) should be removed so that the regulator of a fine or penalty is subject to the rules regarding preferences and transfers to defeat creditors, (iii) the right of the regulator to receive a dividend should rank beneath that of other unsecured creditors, and (iv) the bankrupt should not be released from any unpaid portion of the fine or penalty upon their discharge.

Why penalties and fines should be provable

There are two reasons why the regulator of a penalty or fine should be permitted to prove.  First, allowing the regulator to prove may encourage them to fund recovery actions brought by the trustee of the bankrupt’s estate.  This point was noted by the ALRC.[22]  Many bankrupt estates contain few assets.  This may result in the trustee being unable to finance actions to gather assets of the estate, such as investigating voidable transactions.  A regulator may have greater resources than other creditors since it is a government entity and hence may be better placed to provide funding to the trustee. 

Secondly, if the regulator is forbidden from pursuing the bankrupt during the administration of the bankruptcy and is forbidden from retaining an unfair preference, it seems only fair that the regulator should be permitted to prove.  For the reasons stated earlier, the regulator should be prevented from pursing the bankrupt in respect of fines and penalties during the administration of the bankruptcy and sub-s 123(4) should be removed so that the regulator is subject to the provisions regarding preferences and transfers to defeat creditors.  If these amendments are made and the regulator is not allowed to prove, the regulator will have no prospect of recovering the fine or penalty during the administration of the bankruptcy.  This would be unfair to the regulator.  Admittedly, the regulator could still pursue the bankrupt after their discharge, but that is likely to require the regulator to wait at least 3 years.

Why a regulator should rank behind other unsecured creditors

The ALRC has previously recommended that fines and penalties be provable,[23] but has made no recommendation as to whether they should be given a lower or higher priority than other unsecured debts.  It is submitted that fines and penalties should be subordinated to other unsecured debts.  If fines and penalties rank equally with other unsecured debts, unsecured creditors will bear the consequences of the bankrupt’s wrongdoing, which is unfair to unsecured creditors.  How this injustice arises can be illustrated by the following simple example.  Consider a bankrupt has $5,000 of assets and two unsecured creditors each owed $5,000.  The bankrupt also owes a penalty of $90,000 to a regulator.  If the penalty ranks equally with the two unsecured debts of $5,000, the unsecured creditors will each receive $250 in respect of their two $5,000 debts, while if the penalty ranks below those two debts, the unsecured creditors will each receive $2,500.[24]  If the penalty is allowed to rank equally with the two unsecured debts, the unsecured creditors will receive a lesser dividend simply because the bankrupt has committed a wrong.  In this way, the punishment which ought to be borne by the bankrupt is imposed on the unsecured creditors through making them effectively pay a penalty of $2,250 each. 

It is acceptable for an unsecured creditor to receive a dividend of less than 100 cents in the dollar due to financial imprudence on their behalf, such as lending money to the bankrupt without taking security or without performing adequate due diligence.  In those circumstances, the unsecured creditor is the author of their own misfortune.  However, it is submitted that it is unacceptable for an unsecured creditor to receive a lower dividend due to the punishment that ought to be borne by the bankrupt being passed to the unsecured creditor.  Admittedly, the problem of a punishment intended for the bankrupt being passed to unsecured creditors may exist in other circumstances, such as a judgment debt for exemplary damages.  However, that is no reason for not addressing the problem in the case of fines and penalties.

One undesirable outcome that may arise from subordinating fines and penalties to other unsecured debts is that it may discourage the regulator from funding recovery proceedings brought by the trustee of the bankrupt’s estate.  If a regulator is to receive any dividend, unsecured creditors must receive complete repayment of their debts.  This is unlikely to occur.[25]  This difficulty may be partially alleviated by s 109(10) of the Act which permits the Court to order that a creditor, who has indemnified the trustee against recovery costs, be given an advantage over other creditors regarding the distribution of proceeds from the recovered property.   

It may seem unfair to subordinate a regulator to other unsecured creditors, but any unfairness is mitigated by the following three factors.  First, the regulator will not have its debt (being the fine or penalty) released upon the discharge of the bankrupt and hence has an advantage over other unsecured creditors in that it may still pursue the bankrupt after their discharge.  Secondly, the regulator is a government-funded entity and is hence unlikely to be as financially vulnerable as other unsecured creditors.  Thirdly, the regulator is not a commercial enterprise and is hence unlikely to be as concerned as other unsecured creditors by the prospect of receiving a lesser dividend.  In relation to this third point, many unsecured creditors are likely to have provided goods or services to the bankrupt in the expectation of receiving payment and may be relying upon such payment for their continued existence.  A regulator, however, is unlikely to have provided any goods or services to the bankrupt and is unlikely to be relying upon the payment of a fine or penalty for its continued existence.

Why fines and penalties should not be released upon discharge of the bankrupt

It is submitted that fines and penalties should not be released upon the discharge of the bankrupt for two reasons.  First, a discharge from bankruptcy is intended to give the bankrupt a fresh start free of previous financial difficulties but is not intended to exonerate them from previous misconduct.  In this regard, a bankrupt is not discharged from a debt incurred by fraud or fraudulent breach of trust.[26]  This is consistent with the policy that a bankrupt is not exonerated from misconduct, whether it be fraudulent or otherwise. 

Secondly, the opportunity to gain exoneration from previous misconduct could lead to debtors using bankruptcy to avoid the payment of fines and penalties.  This could undermine the goals of punishment and deterrence which are inherent in fines and penalties.

The ALRC has previously recommended that fines and penalties be released upon discharge of the bankrupt with the regulator having the option of applying to the Court, prior to the discharge of the bankrupt, for an order that the outstanding fines or penalties not be released.[27]  The ALRC considered it appropriate for the regulator to bear the onus of making the application because it will be ‘comparatively better resourced than a bankrupt’.[28]  The regulator may be better resourced but it is undesirable that it be made to bear the onus of upholding a fine or penalty when it previously bore the onus of having the fine or penalty imposed to begin with.  The bankrupt is effectively being given a further appeal against the imposition of the fine or penalty where the onus is borne by the respondent of the appeal rather than the appellant. 

The ALRC also considered it appropriate that the court exercise ‘judicial discretion’ when considering whether to release the penalty or fine and should consider the ‘severity of the penalty, the nature of the offence, and the conduct of the bankrupt.’[29]  There is nothing objectionable about ‘judicial discretion’ but such discretion should be exercised by the court that imposed the penalty or fine at first instance (and preferably the same judge).  The judge who imposed the fine or penalty is likely to be better acquainted with the facts justifying the imposition of the fine or penalty than another judge sitting several years later.  Further, the proposal of the ALRC could lead to the strange situation where a lower court is reviewing a penalty or fine imposed by a higher court.  In an earlier report, the ALRC recommended that fines and penalties should not be automatically discharged because the imposition of fines and penalties is a matter better dealt with by the original sentencing court.[30]  It is submitted that this earlier recommendation of the ALRC is preferable.

Conclusion

Fines and penalties are not ordinary debts and a regulator is not an ordinary creditor.  For this reason, they should be treated differently during the administration of a bankruptcy.  At present, they are treated differently but in a way which is not entirely satisfactory.  Currently, fines and penalties survive bankruptcy.  It is submitted that this should continue since providing a release would exonerate the debtor from misconduct rather than simply provide them with a fresh start free from previous financial errors.  Currently, fines and penalties are not provable.  It is submitted that they should be provable so that the regulator of the fine or penalty (i) is restrained from pursing the bankrupt during the term of their bankruptcy, (ii) has an opportunity to share in the benefits of the work performed by the trustee and (iii) is given some incentive to provide financial assistance for recovery proceedings brought by the trustee.  Section 123(4) should be removed so that fines and penalties are subject to the rules regarding preferences and transfers to defeat creditors.  Fines and penalties should rank behind other unsecured debts so that the punishment imposed on the bankrupt is not effectively transferred to unsecured creditors. 

This article was originally published in (2016) 16(2) QUT Law Review 82.



[3] For example, see Homeless Persons Legal Clinic, Youthlaw & West Heidelberg Legal Service, Submission to the Victorian Government, Disadvantage and Fines, August 2003, 7.Back to article

[4] (2004) 134 FCR 135.Back to article

[5] Ibid 139. Back to article

[6] (2003) 130 FCR 376.Back to article

[7] Ibid 385-391.Back to article

[8] Ibid 391.Back to article

[9] Please note that a demand for unliquidated damages arising other than by reason of a contract, promise or breach of trust is not provable (s 82(2)).  However, a judgment debt for a fixed amount of damages is provable. Back to article

[10] Section 140(1) of the Act.Back to article

[11] Sections 58(3) and 60(1)(b) of the Act.  Back to article

[12] Section 153(1) of the Act.Back to article

[13] Mansfield (2003) 130 FCR 376, 386.Back to article

[14] (1931) 3 ABC 204.Back to article

[16] Mansfield (2003) 130 FCR 376, 386.Back to article

[17] ALRC Report No 95 (2003), [32.147].Back to article

[18] For example, Division 3 of Part 3B of the Sentencing Act 1991 (Vic) allows the conversion of fines to community service orders or custodial sentences.  Back to article

[19] The creditor is required to disgorge the proceeds of the enforcement action to the trustee, less the taxed costs of the action.  The creditor may then prove for the disgorged amount even if the debt which the enforcement action related to was not provable:  see s 118(3) and O’Mara Constructions Pty Ltd v Avery (2006) 151 FCR 196, 206-207.Back to article

[20] This concern was noted in the report of the ARLC, Securing Compliance: Civil and Administrative Penalties in Australian Federal Regulation, Discussion Paper No 65 (2002), [32.153].Back to article

[22] ARLC, Securing Compliance: Civil and Administrative Penalties in Australian Federal Regulation, Discussion Paper No 65 (2002), [32.155].Back to article

[23] Law Reform Commission, General Insolvency Law Inquiry, Report No 45 (1988), [792] and ARLC, Securing Compliance: Civil and Administrative Penalties in Australian Federal Regulation, Discussion Paper No 65 (2002), recommendation 32-3.Back to article

[24] This example is an over-simplification as it ignores the remuneration of the trustee amongst other things, but it still illustrates the point.Back to article

[25] For the 2012-2013 financial year, the Australian Financial Security Authority reported that only 8.81% of bankruptcies paid a dividend to unsecured creditors and for those that did pay a dividend, the average dividend was 7.07 cents per dollar (see Veronique Ingram, ‘AFSA Update’ (2013) 25(4) Australian Insolvency Journal 44, 45).Back to article

[26] Section 153(2)(b) of the Act.Back to article

[27] ALRC, Securing Compliance: Civil and Administrative Penalties in Australian Federal Regulation, Discussion Paper No 65 (2002), recommendation 32-3.Back to article

[28] Ibid, [32.168].Back to article

[30] Law Reform Commission, General Insolvency Law Inquiry, Report No 45 (1988), [792].Back to article

Related Knowledge

Get in Touch

Get in touch information is loading

Disclaimer

Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.