The insolvency industry fears government rules keeping failing businesses alive during the COVID-19 economic crisis could lead to a massive wave of phoenixing and create a stockpile of non-viable businesses.
The concerns come as insolvency firms themselves are on their knees due to a lack of work – with half the country’s firms on JobKeeper – raising fears there may not be enough practitioners around to deal with the stockpile once creditors and the Australian Tax Office start chasing unpaid debts again.
Changes to insolvency laws has become a key tool for the government in staving off business collapses and supporting the economy.
This week Treasurer Josh Frydenberg flagged further reforms to the insolvency sector, opening the door to US Chapter 11 style corporate bankruptcies for small business. These proposals would cap fees paid by small business seeking restructuring services and “leave the keys” to the business in the hands of directors rather than in the hands of administrators.
This is on top of temporary rules put in place in March and extended in September for another six months, including relief for directors from any personal liability for trading while insolvent.
Those temporary rules also included a provision that made it harder to issue a statutory demand for unpaid bills. The threshold was increased from $2000 to $20,000 and debtors were given six months instead of 21 days to respond to a statutory demand. Despite concerns back in June about the growing stockpile of non-viable businesses, these protections were extended in September until the end of this year. That extension was a bad idea according to the head of the credit managers’ peak body and will lengthen the economic shock, while small business representatives applauded the move.
“These necessary measures give otherwise viable small businesses more time to recover,
preventing a wave of unnecessary insolvencies,” the Australian Small Business and Family Enterprise Ombudsman, Kate Carnell, says.
“While we support this temporary relief for financially distressed businesses, there will also be a number of zombie businesses kept artificially afloat as a consequence.”
In a normal year, Australia sees about 8000 companies go through the liquidation process with about 15 per cent of insolvencies, or 1200, initiated by the ATO.
According to the latest data published by the Australian Securities and Investments Commission, so far this year only 6398 businesses have been wound up, a decline of 21 per cent. But the difference is getting worse as time passes: in August, court applications to wind up a company and administrations fell 65 per cent compared to August 2019. In the first week of September just 44 companies went into administration, down 75 per cent from the same week in 2020. Most were voluntary winding up applications.
Frydenberg said in September the extension would “help to prevent a further wave of failures before businesses have had the opportunity to recover”.
But the insolvency industry worries company debts could keep growing while protections remain in place. And that the sector could be swamped next year with Deloitte Access economics estimating up to 240,000 companies could fail due to COVID-19, a nearly 3000 per cent increase on a normal year.
Chief executive of the Australian Institute of Credit Management, Nick Pilavidis, says the government should not have extended the insolvency protections in September, saying his 2600 members could tell the difference between a zombie and a struggling-yet-viable business.
“Definitely the extension, we feel, was unnecessary and has a bigger potential downside,’’ he says.
“One of the issues is that any payments that our members recover [now], could be later clawed back through the insolvency process.
“While [insolvency] numbers are down, the risks are not down.’’
His members were now reporting longer payment times and lower cash receipts, he says.
As debt builds, this increases the likelihood that small businesses could end up losing assets used in loan collateral, such as the family home, he warned.
Chief executive of the Australian Restructuring Insolvency and Turnaround Association, John Winter, worries the insolvency industry won’t be able to handle next year’s stockpile. All the relief designed to help businesses stay frozen meant work for insolvency firms had ”evaporated” and about half Australia’s insolvency firms were currently using JobKeeper assistance themselves, he says. There was also a risk debts could could outweigh assets if insolvency went on for too long.
“By the time an insolvency practitioner is appointed to close that business down, there is less than nothing left. There is no chance to recover anything for any creditors, there’s certainly no chance to save the business and the liquidator is unlikely to even get paid themselves,’’ Winter says.
“If a bad business is being propped up and they are not paying good businesses, what they do is place that good business at risk itself.
“If you want to come out of this recession, you want good businesses protected, not the bad ones.’’
Asked why the government couldn’t just create a mass grave for 2020’s failed companies and move on, Winter says creditors would be left out of pocket.
“If nobody goes and looks at what has happened to those businesses that have failed we are going to see the amount of phoenixing in this country absolutely explode,’’ he said.
He suggests the federal government increase the funding the Assetless Administration Fund that was designed to clean up phoenixing. However, he added it needs about $80 million to clean up 2020’s mess, 10 times what is currently available.
Director of international insolvency firm Rodgers Reidy, Brent Morgan, says he has not seen any applications from the ATO to wind up a Victorian-based business over unpaid taxes since March. He suspects the tax office was now sitting on a stockpile of statutory demands that could be released in the first half of 2021.
Banks and landlords have also been lenient to businesses forced to close by COVID-19 restrictions. And coupled with JobKeeper the ”pressure points” that normally force un-viable companies to the wall had disappeared.
“They [the insolvencies] might all happen at the same time, which is probably going to be early next year,’’ Morgan says.
A spokesperson for the ATO says it has no ‘’formal moratorium’’ on submitting winding up applications, but was “mindful of taking actions which may unnecessarily cause further financial difficulties at a time when the community continues to experience the health and economic impacts of COVID-19”. They would not say when the ATO would start issuing statutory demands again.
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