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Bankruptcy can happen to both individuals and organisations. People usually fall foul of bankruptcy law when they are in a position where they cannot pay their outstanding debt obligations.

To prevent these situations being a free-for-all and people simply declaring they can't pay without consequence, bankruptcy law is set in place to define how such problems are dealt with. The two main purposes of bankruptcy are: 1) to give a debtor who is in a difficult or hopeless financial position a fresh start by wiping most of their debts; and 2) to fairly distribute the debtor's assets among creditors.

This approach allows for some level of protection for all parties. Otherwise, it would be back to how it was when you used to play Monopoly and your older brother ended up with all the money by cheating the system!

Declaring bankruptcy won't wipe out all debts, you will still be required to pay court-ordered penalties and fines.

Instead, what it does do is take away the stress and pressure of needing to pay there and then. The court may still order small monthly payments to debtors, for instance, but taking into account income and expenses along with all accrued debt.

However like we mentioned, some debts do not go away with bankruptcy. One of the most common of these is taxation. As a preferred debtor, if you owe your state or government tax, then you will still owe it post-bankruptcy. That old saying, 'The only certainties in life are death and taxes', is more true than you think.

There are two ways you can become bankrupt, either through a voluntary bankruptcy, where you fill in the bankruptcy form yourself, or by sequestration order, where a creditor makes you bankrupt through the courts.

Whichever way you find yourself bankrupt, the first thing that happens is a trustee is appointed to oversee the bankruptcy process. This may be an official or registered trustee appointed by the court or you can choose your own registered trustee if you prefer.

At this point, you have a number of legal obligations:

The bankruptcy usually expires after 3 years and 1 day, but until then you will need to liaise with your trustee to manage your financial situation. During the bankruptcy, you may find that your income, employment or business is affected, and you cannot ravel overseas without written permission from your trustee.

Further, your name is permanently placed on the National Personal Insolvency Index (NPII), which will directly affect your ability to obtain credit in the future. A trustee may decide to sell your assets to repay certain debt, while they will consult with you to keep you aware of the bankruptcy process, you will not have any influence on such choices.

Declaring bankruptcy doesn't prevent you from applying for a loan after your bankruptcy is over, however it does affect your ability to be accepted for said loans. Everyone who declares bankruptcy is recorded on the National Personal Insolvency Index (NPII), and credit reporting agencies will keep a record of your bankruptcy for 5 years. That means credit checks for any loan will identify your previous issues, and that can have a significant impact on loan decisions.

In addition, if you apply for a loan above a specified amount, you must notify the creditor of your bankruptcy history. Currently, that is $6,144, but this value is updated quarterly so always check with the latest information at www.afsa.gov.au to be sure. It is a criminal offence to seek loans above the current limit without informing the creditor of your bankruptcy.

Having a cost to become bankrupt may seem a little odd, but in some countries it does actually cost money to become bankrupt. In Australia though, there are no fees to apply for bankruptcy, although if you use a bankruptcy specialist to help you through the process you may have some costs to cover.