Corporate insolvency rates are rising in Australia and are tipped to increase further over the 2024 calendar year, according to analysts. The trend is reflected in the latest figures from ASIC. Here we speak to experts on what boards and directors can do to prevent insolvency and how to also look at the process of safe harbour which can be used if a company falls into distress.

    With economic pressure intensifying due to higher interest rates and other causes, Australian insolvencies are on the rise again, highlighting a lag in the impact of the COVID-19 pandemic on small business, according to ASIC’s latest corporate insolvency statistics, published in December.

    According to reports lodged by external administrators, for the period 1 July 2022 to 30 June 2023, SMEs dominated corporate insolvencies, with 83 per cent owning assets of $100,000 or less, 82 per cent employing fewer than 20 staff, and 68 per cent owing liabilities of less than $1 million.

    The construction industry received the highest number of reports (28 per cent), followed by the accommodation and food services industry (15 per cent).

    The most common reported causes of business failure were inadequate cash flow or high cash use (52 per cent), trading losses (49 per cent) and the pandemic (19 per cent). Most reports were received for insolvencies in NSW (41 per cent), followed by Victoria (27 per cent) and Queensland (18 per cent).

    Data from restructuring consultancy Worrell’s shows that corporate insolvencies for the 2022-2023 financial year numbered 10,366, the highest level since 2019, when there were 11,224. “It’s clear to me that corporate insolvencies will continue to rise in FY2024, likely ending the year well above the long-term average,” writes Worrell’s principal Brendan Giles.

    “Interest rate rises are going to bite in particular industries and in overleveraged businesses this year,” says Maria O’Brien, chair of the Turnaround Management Association (TMA) and a partner at
    Baker McKenzie. “So you would have to say with some confidence it's probably going to be busier this this year in insolvencies than it has been in the past few years.”

    Other pressures include the rising cost of living, a squeeze on credit availability and increased court action by the Australian Tax Office (ATO) to claim unpaid small business tax, she says.

    The ATO has reportedly ramped up Federal Court actions to recover $30 billion in overdue small business tax. It started 476 wind-up proceedings in the first seven months of 2023, compared with 14 in the same period of 2022.

    An ATO amnesty on penalties for SMEs which have failed to lodge income tax returns, fringe benefits tax returns or business activity statements expired on 31 December. The amnesty applied to tax obligations that fell due between the start of December 2019 and the end of February 2022. The ATO issued 31,000 Director Penalty Notices towards the end of last year.

    “The ATO has taken the gloves off now and is pursuing unpaid corporate tax. And that is a policy position that they are now fairly squarely articulating...that they are not going to cop this massive unpaid tax debt anymore and that they expect progress. So that will lead to more smaller business failures,” says O’Brien.

    She added that other economic pressures are also squeezing business costs and margins. “Businesses are facing supply chain issues and staffing issues. And in 2023 there was speculation around a lot of the fixed rate residential mortgages which came off last year - speculation that this would lead to an increase in insolvencies.”

    Safe harbour provisions

    Corporate insolvencies fell during the pandemic, due to government assistance packages, cheap credit, tax relief, lower interest rates and separately the introduction of insolvency safe harbour provisions in 2017. The safe harbour enables directors to pursue restructuring or a turnaround of a distressed company without fear of personal liability, providing certain conditions are met. Safe harbour applies to a director if:

    • The director begins to suspect the company is, or may become insolvent.
    • The director then starts developing one or more courses of action reasonably likely to lead to a better outcome for the company (that is, a restructuring plan) than an immediate voluntary administration or liquidation.
    • The company incurs a debt in connection with the course(s) of action.

    “Safe harbour is important,” O’Brien says. “I believe it's been very successful as a tool to enable boards to be comfortable to continue to trade when a company is in a distressed situation, with the appropriate parameters in the legislation being satisfied.”

    Early intervention is critical, in order to seek help from restructuring professionals, however, she adds. “If you have cashflow or liquidity or business challenges, or if interest rates are becoming problematic or you suspect the company is insolvent, you're quite a long way down the path. So ideally, you need to secure your intervention earlier.”

    Safe harbour is a path that is likely to result in a better outcome for the company than the immediate appointment of an administrator or liquidator, she says. “So to go into safe harbour, you have to have done the work to analyse the financial situation of the company and plan the way out.” A safe harbour plan should be approved by the board.

    “The directors have to be responsible for constant monitoring about whether their plan remains appropriate and achievable.”

    O’Brien also said the federal government’s post-COVID Small Business Restructuring introduced in 2021 was becoming more popular and that more small businesses were using the process, which provides a framework for eligible small businesses to work together with a restructuring practitioner to develop and propose to creditors a debt restructuring plan. In order to be eligible, businesses need to have liabilities of no more than $1 million.

    Steps to take

    In order to enter safe harbour, directors and managers need to ensure that three basic compliance measures are in place first, says leading insolvency practitioner Jason Preston, chairman of McGrath Nicol and vice-president of the Turnaround Management Association.

    “It's really important that people have their employee entitlements up to date, obviously with wages. But probably the key one that people sometimes forget about is superannuation. You also need to have your tax lodgements up to date. If you have outstanding tax lodgements, that may stop you from accessing safe harbour.”

    Preston says company leaders need to stay on top of these items along the way, because it’s too late to think about them when the business is facing distress.

    They also need to fully understand their financial position. “The next steps are to engage a turnaround adviser and to have a plan for a better outcome than immediate insolvency.” That could be a plan that says they need to renegotiate with creditors, or they need to find some new funding, or they need to make some changes to how the business operates. “I've seen plans that involve a whole range of different strategies.”

    If they do think the business is, or is likely to become insolvent, they need to appoint a voluntary administrator unless they can access safe harbour.

    If a company is facing distress, company leaders need to analyse what their cash flow looks like over a daily and weekly basis for at least the next 12 weeks. “If you literally run out of money to operate, before you can implement the plan, then you know you've got a problem.”

    Banks can be “very supportive” of companies these days, he adds. “So if there's a path where a company is maybe generating positive cash flow from operations, but can't afford to pay down debt then often banks will say, ‘I'll give you a period of time where we can't give you any more money, but we'll give you a runway where you will hold off on your amortisation requirements, for example, or we will extend your maturity date.’ And all you have to do is service interest.”

    Preston says he has seen companies go into safe harbour, then exit and survive and continue trading. In other cases, businesses have wound up but creditors and customers have been left in a better situation than they would have otherwise been by entering safe harbour.

    In a couple of examples of renewable asset transactions, directors had been able to find solutions after about a six-month period of safe harbour, and the company had avoided insolvency. And there was clearly a better outcome for everyone - directors, employees, creditors and investors.

    “At the Big End of Town where you see directors bring in advisers, safe harbour works fairly well,” he told the AICD. “We've seen good examples where insolvencies have been avoided because of safe harbour. But there are challenges at the smaller end of the market. Often those directors particularly businesses in Australia, have borrowed effectively against their own houses, or given personal guarantees against their assets for their business liabilities.

    “That can drive some different behaviour because it's often an all or nothing proposition for those directors. And I think what’s unfortunate about that is sometimes it means those directors don't seek advice as early as they might to get a better outcome.”

    In terms of outlook, Preston says interest rates and inflation are likely to stay high. “It's a pretty complex scenario I think at the moment for directors generally. The macro settings are not particularly easy at the moment and I don't think that’s going to get easier over the next year or two.”

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