Many businesses are hurting as a result of the ongoing disruptions of COVID-19, but few are entering formal insolvency processes. Insolvency practitioners give their views on the seeming paradox.
COVID-19 has been challenging for boards and insolvency professionals alike.
“In my 20-plus years working in the insolvency and restructuring space this is by far the worst period I and many others in the sector have experienced,” says Bradd Morelli MAICD, national managing partner at specialist insolvency and business recovery practice Jirsch Sutherland, adding that during the past 18 months, the average number of insolvencies that the firm manages has fallen.
Indeed, 9829 companies entered into external administration and controller appointments in 2010–11, according to the Australian Securities and Investments Commission (ASIC) — the highest figure since the peak of 10,005 during the global financial crisis (GFC). In 2020–21, Australian Bureau of Statistics (ABS) figures showed the number had fallen to 4235.
“The number of insolvencies is still well below the 10-year average,” says David Mansfield, MAICD restructuring services partner at Deloitte Financial Advisory.
Where’s the wave?
During 2020, many commentators foreshadowed a wave of insolvencies. So far, that has not materialised, but given the severe stress on some sectors as a result of prolonged lockdowns, there is debate and opinions vary.
Carl Gunther GAICD, chair of the Turnaround Management Association Australia, says his association is not expecting a “wave”.
“The economy remains buoyant and there are high levels of liquidity and record ASX and property prices,” he says. “There remains acute pressure in sectors directly impacted by COVID-19 — for example, retail consumer goods, food services, commercial and retail property, airline-dependent tourism. However, it’s a state- by-state proposition. With ongoing government fiscal support, a compliant Australia Taxation Office (ATO), and a path out with vaccinations, we continue to see many directors conducting DIY turnarounds and avoiding insolvency.”
“The unprecedented combination of fiscal stimulus, bank moratoria, landlord moratoria and historically low interest rates has led to a trickle rather than a tsunami of insolvencies,” says Michael Sloan, a partner at Ashurst, who points to indicators like the sharemarket’s all- time high, rising house prices, low unemployment and manageable inflation. Sloan caveats his optimism, “That may be masking other issues, but we are yet to see those issues manifesting in an increase in companies facing financial distress. Naturally, a number of companies, particularly in the hospitality sector will be finding trading very hard and are struggling to survive. We should be doing whatever we can to help, but oddly most companies are doing okay.”
Mansfield expects insolvency numbers to rise again — a catch-up spread over time rather than an all-at-once tsunami. “The government stimulus and lenient approach of creditors, such as the ATO and banks, is supporting businesses and there’s no pressure for business owners to wind up their companies,” he says.
John Park, who heads FTI Consulting’s corporate finance and restructuring practice in Australia, notes banks have been supportive to their borrowers through the pandemic. “This is a very different environment to the 2008–12 GFC, when banks were enforcing on their borrowers,” he says. “Generally, the biggest creditor in all insolvencies is the ATO. Businesses use the ATO for working capital. When cash gets tight, they don’t pay. The ATO has been very accommodating to companies facing financial headwinds because of COVID-19. A lot of those enforcement actions have just been delayed and we don’t see the ATO taking any proactive steps to get more aggressive in the recovery of its exposure.”
Park believes the ATO will step up the pace in the next six months. “That will be the catalyst for an uptick. It certainly won’t be a tsunami, but you will see an increase in insolvencies. However, it will take some time to get back to pre-COVID-19 numbers. The ATO can’t continually allow borrowers to continue to default.”
Great Wall of capital
He stresses the impact of “a wall of capital”. “It’s very easy for companies to amend and extend their facilities or refinance their facilities with alternative borrowers,” he says. “The Australian economy is awash with both domestic and offshore capital. For businesses that were traditionally facing headwinds, there are a lot of capital solutions in the market at the moment. That’s very different to the GFC, when banks themselves were financially strapped. Our banks are very well capitalised. Their balance sheets are strong. There are all these international players and there are record levels of M&A (merger and acquisition) activity in the corporate market.”
For his part, Morelli expects a significant increase in corporate insolvencies, but not for another 12 months or so. “I believe this round of lockdowns is different from the last one and the impact will be much tougher on businesses,” he says. “The significant amount of support provided by the federal government last year and early this year is still splashing around and has allowed some businesses to significantly improve their balance sheets and cash positions. It will still take some time for that money to flow through the system. While government support is now lower, there’s still meaningful support being made available, and this will continue to delay the inevitable for some businesses, particularly the ‘zombie companies’.
Plus, it’s unlikely the economy will open up until vaccination levels reach 70–80 per cent, and this is unlikely to occur until later in the year, at best.
Simplified approach in practice
Billed as the most significant reform to Australia’s corporate insolvency regime in almost 30 years, the government’s simplified approach to dealing with insolvency of small businesses with liabilities of less than $1m came into effect on 1 January. According to Mansfield, uptake has been slow, with just five small business restructurings (SBRs) in the first quarter of 2021 and seven in the second quarter in total. SBRs provide an opportunity for small businesses to restructure and reach a compromise with creditors without the costs and loss of control that often accompanies voluntary administration.
“We were and still are fully supportive of a small business restructuring regime that is less costly than the other alternatives,” he says. “However, we still have some issues with the way the legislation is drafted and the insolvency profession generally would agree with these. But unless and until there is some significant uptake with this new regime, the chances of amending the legislation to address some of those shortfalls are remote.”
Brendan Giles, senior manager at solvency accounting firm Worrells, agrees the SBR process has been unsuccessful. Like Mansfield, he blames the low uptake on a lack of awareness among small business owners. “The eligibility requirements are difficult for many businesses to meet,” he says. “In particular, the requirement to have all employee entitlements paid, including superannuation, is one that many small businesses find difficult to meet. And the process does not deal with personal guarantees given by directors.”
“Like many of my colleagues, I think it’s still too early to say how well the SBR and simplified liquidations (SL) processes are working,” observes Morelli. “There haven’t been enough undertaken yet to be able to make a fair assessment at this time. Put simply, an SL is a streamlined CVL (creditors’ voluntary liquidation) for companies that have liabilities less than $1m. At this stage, it’s difficult to understand, in practice, how this process will significantly benefit the debtor, creditor or practitioner. The SBR also has its challenges and it’s hard to see many companies being eligible for the SL. The SL and SBR processes do not achieve the anticipated cost savings and I’m concerned how quickly the legislation was drafted, particularly as there was limited consultation with industry.”
What’s a board to do? “In certain circumstances and with the right advice the use of the insolvency safe harbour may be appropriate or, boards should be looking at using something like a voluntary administration as a way to restructure their financial affairs,” says Park. “Otherwise, they’ll come out the back of this pandemic with a huge amount of creditors that have been deferred and interest accruing on bank debt that has been under moratorium. That’s all got to be dealt with during the next five- to 10-year horizon if they don’t use the opportunity now to reset. They can come out of the pandemic with a well-capitalised balance sheet and be ready to hit the road.”
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