Discussion Paper Flags Issues in Insolvency Sector

Discussion Paper Flags Issues in Insolvency Sector

By Maxim Oppy, Law Clerk and Alicia Hill, Principal, MST Lawyers

 

The Australian insolvency sector is again being scrutinised as the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) carries out their Insolvency Practices Inquiry (Inquiry) to investigate insolvency practices in relation to small businesses.

The Inquiry follows the Federal Court’s ruling in Re Lock (No 3) [2019] FCA 879, which required two liquidators to pay back $1.9 million after finding they had overcharged for their services.

Late last year, the ASBFEO released a discussion paper outlining some initial findings and requesting additional input from small business owners. This article outlines the key issues described in the Discussion Paper and analyses potential reforms which may be recommended ahead of the final report being handed down in March 2020.

Background

The ASBFEO’s Small Business Loans Inquiry, released in 2016, initially identified a lack of transparency for small business owners after the commencement of debt recovery actions.

In announcing the Inquiry, ombudsman Kate Carnell further cited the low success rate in restructuring small businesses under external administration; framing the paper as an attempt to improve outcomes for small business owners who are often left bankrupt after external administration.

The terms of reference of the Inquiry are to examine:

1. The legislation, compliance and industry standards that govern insolvency practices and practitioners

2. The different outcomes depending on who initiates the action including the small business owner, a creditor by application through the courts or a secured creditor through receivership;

3. The transparency, timeframes and costs across the different insolvency actions

4. How conflicts of interest arising from the same practitioner undertaking several stages of an insolvency, are managed;

5. How practitioners decide the optimal process to maximise the return for creditors

         (a)  Where winding up is delayed – ensuring the necessary expertise is engaged to manage the business to maximise the value of the assets at a future point in time;

         (b)  Where the value of assets is to be realised immediately – what factors are taken into consideration to determine the target market and marketing campaign.

Discussion Paper

The Discussion Paper (Paper) released gives an overview of the key issues raised by small business owners to date. From these findings the Ombudsman presented 15 further questions that it seeks additional comment on.

 

Loss of control

The Paper begins by outlining Australia’s insolvency framework, which it describes as a pro-creditor system whereby the liquidator takes control of the company so that its affairs can be wound up for the benefit of all creditors.

Consequently, the most common experience recounted by small business owners was a loss of control, exacerbated by the fact that the liquidator has no obligation to inform of involve the owners and directors about the liquidation proceeding.

Many small business owners felt that after entering administration they were kept in the dark about the process, and unable to have any input in the operation of their business.

In relation to this issue the ASBFEO is seeking comments on whether liquidators should be required to provide small business with plain language materials outlining the liquidation process and the recommended course of action.

Excessive cost

The next key issue was the cost of external administration. Small businesses reported what they perceived to be excessive costs, which often far exceeded figures estimated by the liquidator prior to administration, particular concerns were raised about the opaque way in which disbursement costs were incurred by insolvency practitioners.

The Paper also considered that costs of administration are often higher than the total value of the business’s assets, causing creditors and liquidators to write off fees.

In relation to this issue the ASBFEO is seeking comments on whether there should be a mechanism to control the total costs of external administration from consuming the entire value of the company’s assets; whether creditors reports should include information about average court costs; and if it would be beneficial to automatically provide annual administration return reports with creditors, directors and owners.

Lack of transparency

The Paper then dealt with a lack of transparency, which was raised especially in relation to cases of receivership. Small businesses and creditors often reported being unaware of the valuation and marketing process of the business and assets. Additionally, the Paper explained how small business who had received payments from the now insolvent company felt blindsided by requests from liquidators to return those payments for constituting unfair preference payments.

In relation to this issue the ASBFEO is seeking comments on whether valuations and marketing strategies should require approval from creditors, and whether demands for the return of unfair preference payments should be required to include the evidence leading to the determination.

The need for education

The Paper next considered the severe imbalance of knowledge between small businesses and liquidation practitioners. Business owners’ inexperience with legal matters often led to them forming unrealistic expectations about the nature of the insolvency process, and contributed to them leaving it too late to seek professional help.

In response the ASBFEO is seeking comments on whether individuals seeking to be directors or register a company should be required to undertake education on running a business and the associated personal.

Potential for turnaround

The Paper went on to discuss the limited turnaround options business owners often encountered when the realised the business was under financial difficulty. The Paper noted the so called pre-insolvency adviser industry was largely unregulated.

In relation to this issue the ASBFEO is seeking comment on whether small businesses seeking advice for financial difficulty should be give plain language explanations of the external administration process and next steps; how safe harbour provisions could be improved to assist small business; how accountants and bookkeepers can best small business and whether the financial counselling sector should be funded to provide services to small business.

Mental health impacts of external administration

The Paper then dealt with was the impact of insolvency on the mental health of the directors and owners of business under administration. The paper emphasised the need to recognise and address the severe strain placed on owners and their family, friends, customers and suppliers.

In relation to this issue the ASBFEO is seeking comment on whether the mental health of small business owners should be a cause for a pause in insolvency proceedings, and whether there were any other changes that could assist parties suffering from mental health issues.

One size fits all?

The final issue considered was whether or not the ‘one size fits all’ framework to insolvency was appropriate. Looking at jurisdictions such as the United Kingdom and France, the Paper requests general submissions on whether insolvency processes should differ depending on the value of the assets of the insolvent companies.

Responses from key stakeholders

The Australian Restructuring Insolvency & Turnaround Association (ARITA), which represents around 85% all registered liquidators and trustees has not been supportive of the inquiry, suggesting that it too narrowly focuses on only the perspective of small businesses.

In a media statement released on 10 October 2019 ARITA labelled the goal of the inquiry to turnaround failed business “naïve”, stating that “By the time the vast majority small business reach a decision to appoint an insolvency practitioner, they are generally well beyond saving”.

ARITA blames the high cost of insolvency proceedings on government red-tape for insolvency practitioners, and is launching its own Financial Recovery Law Reform Commission to take an in-depth review of the issues affecting the industry. The association has its own 8 point plan for simplifying the sector which involves consolidating regulators and providing better education for small business as to how to react to financial stress. ARITA responded to the release of the Discussion Paper by stating that it will “lead an industry-wide response to the questions it raises”, and affirming that the paper highlights the need for reform in the industry.

Meanwhile, the Council of Small Business Organisations Australia welcomed the Inquiry. CEO Peter Strong said that the need for reform was “obvious” as the industry is not currently serving the needs of small business owners. Replying to the statement released by ARITA the previous day, Mr Strong decried the “poor uncooperative attitude of many insolvency practitioners”.

Conclusion

The Discussion Paper suggests that the ASBFEO is likely to recommend reforms focused on improving the experiences of small business owners in external administrations. These include improving the transparency and disclosure of the insolvency process and the costs involved, improving the education of small business owners and directors and attempting to accommodate their mental wellbeing through the external administration process. Although the upcoming ARITA commission may lead to competing reform suggestions, it is hoped that reform will be achieved to provide better outcomes for small businesses in financial difficulty and their creditors.

A common theme throughout all stages of the Inquiry has been that small business achieve the best outcomes when they seek professional advice as soon as possible if they suspect their business is at risk of becoming insolvent.

If you have any questions about this article or insolvency, please feel free to contact Alicia Hill on 8540 0200 or Alicia.hill@mst.com.au .