“We know there is a very low success rate in restructuring Australian businesses under external administration,” the small business ombudsman said in announcing an inquiry into Australia’s insolvency system.
Announcing the Insolvency Practices Inquiry to the media on Thursday morning (10 October), Kate Carnell, the Australian Small Business and Family Enterprise Ombudsman (ASBFEO), suggested that scrutiny of the sector is long overdue, and should have been done as part of last year’s banking royal commission.
“Unfortunately, the banking royal commission wasn’t asked to look at the role of insolvency practitioners, and that was a missed opportunity,” Ms Carnell said.
“We know there is a very low success rate in restructuring Australian businesses under external administration and the impact of the insolvency process is often devastating for the small business owner.
“This inquiry will shine a light on the insolvency system and uncover if it encourages practitioners, in the first instance, to restructure the small or family business to turn it around.”
According to Ms Carnell, the number of SMEs that successfully navigate through insolvency administration to reach a restructuring agreement is “few”.
“The latest data reveals more than 8,000 businesses entered external administration in 2018–19. Of those, small and family businesses in rural and regional Australia have been among the hardest hit,” she said.
Ms Carnell added that her office’s previous Small Business Loans Inquiry had “identified a lack of transparency for the small business owner” where creditors began debt recovery action, leading the business owner to feel cut out of the process.
“This inquiry will identify areas where practices can be improved and recommend changes to the system to achieve fairer outcomes for all parties involved.”
It comes after figures released earlier this year showed a significant spike in the number of corporate insolvency appointments over the past 12 months, particularly in the retail and food sectors.
A separate report in July backed up the findings, noting a “worrying spike” of 26 per cent in the volume of wind-up notices.
What will the inquiry investigate?
The ASBFEO, via a reference group chaired by former federal Nationals senator John Williams, will look into four key components of the insolvency sector:
- the existing insolvency system, through the experience of small business
- the level of transparency of governance, processes and costs of practitioners including legal advisers, valuers, investigating accountants, administrators, receivers and liquidators
- how the insolvency of a small or family business may lead to bankruptcy for the owners
- how the framework impacts the practices and fees of insolvency practitioners
The inquiry will analyse the existing regulatory and industry framework, how outcomes may differ depending on who initiates action, how conflicts of interest are managed by the sector and, crucially, how insolvency practitioners determine the route to maximise returns for creditors.
As part of the inquiry, SMEs are being urged to share their experiences with administrators and insolvency practitioners.
Mr Williams, the ASBFEO noted, already has experience looking into the space, having played a leading role in the 2010 Senate Inquiry into the regulation, registration and remuneration of liquidators.
“It is most important that small businesses and farmers who find themselves in financial difficulty are treated with respect and fairness,” he said as part of Thursday’s announcement.
The inquiry is due to hand down its interim findings on 11 December this year, before handing down its final report on 18 February 2020.
Business owners can share their experiences through the dedicated Insolvency Practices Inquiry page on the ASBFEO website.
Businesses crying out for scrutiny
As Ms Carnell noted, the insolvency sector was not examined by the banking royal commission, during which at least one instance of alleged poor conduct on the part of insolvency practitioners was raised.
A Tasmanian property developer testified at the commission in May 2018 that liquidators had spent thousands of dollars “refurbishing” a hotel owned by the company prior to its sale — despite the hotel being brand-new and never occupied — and that they had also failed to act on a $3 million bond held with another business.
Several months later, in August 2018, Professor Janek Ratnatunga, head of the Institute of Certified Management Accountants (ICMA), expressly called for a review of external auditors, stating “perhaps it’s best to have a royal commission on the auditing profession to evaluate if auditors have been short-changing their clients, who are the shareholders and not the directors and management”.
Other My Business readers have queried the effectiveness and outcomes delivered by the sector in recent years, such as those who called for a royal commission to examine the Australian Financial Security Authority (AFSA) and others in the sector, with one reader collectively labelling liquidators as “crooks”.
Patrick Coghlan, CEO of CreditorWatch, welcomed the inquiry as a win for businesses of all size.
“This is a positive initiative by the ombudsman. Shining a light on insolvency practitioners will be a benefit to all businesses — from small family enterprises right up to larger corporates. It should also include scrutiny of pre-insolvency consultants, whose practices are often responsible for the illegal phoenixing of companies,” he said.
“When it comes to restructuring a business, the success rate is currently too low. This doesn’t just have a negative impact on the small businesses involved, it also has a carry-on effect to creditors, who are lucky to receive cents to the dollar.
“My hope is this inquiry leads to regulation that improves transparency for small businesses going through restructuring or liquidation, as well as more education to help them understand the process.”
Inquiry ‘naïve’: Industry
The Australian Restructuring Insolvency and Turnaround Association (ARITA) hit back at the inquiry, however, which its CEO labelled “very naïve”.
“We find it extremely disappointing that this very narrow inquiry has been announced in the full knowledge that the Financial Recovery Law Reform Commission will more thoroughly address any issues it may uncover and much, much more,” said CEO John Winter.
“Given that the chair of this Carnell inquiry, the former Senator Wacka Williams, was involved in numerous insolvency-related Senate inquiries and failed to drive any positive change to our insolvency regime, we hardly see any value in his role here.”
Mr Winter also expressed criticism that the reference group is “poorly formed” and that the scope of the inquiry itself is short-sighted.
“The very pretext of the inquiry — seeking to turnaround failed small business — is unfortunately very naïve. By the time the vast majority [of] small business[es] reach a decision to appoint an insolvency practitioner, they are generally well beyond saving,” he said.
“That situation has been made worse by financial counsellors telling those in distress to stay away from registered liquidators and trustees and the growth of dodgy pre-insolvency advisers.
“We are also concerned that this inquiry is more about generating media attention than actually seeking to improve the insolvency regime.”
Mr Winter continued: “Our President, Scott Atkins, recently said that the urgency for our Financial Recovery Law Reform Commission is driven by a range of factors: the recent commencement of a new term of our Commonwealth government, ongoing criticisms of recent reforms which have created more red tape for our insolvency practitioners, the opportunity to innovate through the law as we have seen other countries do (most recently, Singapore), and the imperative to address the absence of a regime that properly deals with micro and small to medium enterprise (MSME) insolvency.
“In writing to every federal politician, ARITA has already outlined an 8 Point Plan for immediate action suggesting ways that policymakers and regulators can enhance Australia’s business rescue culture, better help indebted individuals back onto their feet, and ensure that creditors — from small businesses to the taxpayer — get a fairer deal from insolvency.”
Regulatory, legal changes
There have been several recent changes and legal determinations around insolvency practices prior to the establishment of this inquiry.
The federal government amended rules in December 2018 to restrict the voting rights of certain creditors in a bid to combat illegal phoenix activity.
Meanwhile, in June this year, the High Court delivered a landmark decision that prioritised employee entitlements in insolvency, regardless of whether the company had been trading in its own right or as a trustee.
Perhaps most pertinent to the ASBFEO’s inquiry, however, was the July Federal Court order for the liquidators of three companies to repay $1.9 million plus interest after ASIC raised concerns about the size of the liquidators’ remuneration.
Adam Zuchetti is the editor of My Business, and has steered the publication’s editorial direction since early 2016.