Do the Australian small to medium business insolvency reforms add up?

The numbers upon which the government is relying for the proposed SME reforms[1] don’t seem to add up. Apart from the fact that the reforms ignore around 60% of small business, less than 20% of the remainder might benefit from the process.

This is apparent from many available resources including a 2019 report of the Ombudsman as to the nature of small business – Small Business Counts, and ABS and other data. The government’s proposed reforms only focus on small businesses operating through companies, which comprise under 40% of small business; the remaining 60% being businesses operating as sole trader, partnerships and through trusts. The 40% is in fact rounded up from a figure of 37.9% (2018-19), still the largest proportion, but with sole proprietors accounting for 55.9% of total growth in businesses in that period. (ABS).  AFSA records also show an increasing proportion of personal business bankruptcies.

Inconveniently, small business does not separate itself out to meet the convenience of how government ministers and their departments divide up their tasks such that the insolvency of businesses is subject to separate regimes under the Treasurer and the Attorney-General.

Government business data generally focuses on factors of size, location, employee numbers, industry etc – and less so the legal structure.  Even when it does, ASFBEO notes that a small business might operate through several legal structures.[2]

So what regime does the 60% of SMEs have?

The 60% of small business has the three year bankruptcy, possibly resolved early by a composition, plus Part IX and Part X agreements and complex laws concerning the insolvency of trusts.  “Various factors make it difficult for a person who is bankrupt to start a new business: see ‘Reinforcing Stigma or Delivering a Fresh Start: Bankruptcy and Future Engagement in the Workforce’ (2015) 38(4) UNSW LJ 1529 Howell and Mason. There are no particular laws for addressing what may be a large number of personal insolvencies once the current protective reforms end on 31 December 2020.

One beneficial feature different from corporate insolvency is that the government Official Trustee in Bankruptcy is there to take bankruptcy matters in volume, and any companies of bankrupt owners.

And what do the 40% of SME companies have?

On top of the fact that 60% of SMEs are unassisted by the law reform, it seems that only a proportion of the remaining 40% will be assisted, say half, or 20%.  Figures recently extracted and presented by Professor Jason Harris of Sydney University are useful in explaining and substantiating that.[3]

To start with, the government says that, relying on ASIC data, only “76% of businesses subject to insolvencies today” will be assisted. That percentage is then progressively reduced by the realities of the proposed threshold compliance requirements in respect of tax and employee entitlements, the limited $1m threshold amount of liabilities, the low value of assets, the potential impact of personal liabilities, and the costs of the process.

That is, if the government had looked harder, it might have pulled out these ASIC numbers in relation to corporate businesses that have become subject to external administration, as presented by Professor Harris:

• 75% had annual turnover of under $200k
• 78% had remaining assets or funds of $50k or less, and a majority $10k or less
• 92% were estimated to provide nil dividends to creditors;
• In a significant proportion, the practitioner was unpaid or underpaid.

Based upon these and other figures, Professor Harris has concluded that any idea that the proposed new regime will be able to deal with the expected large number of SME corporate insolvencies is “nonsensical”.  [His presentation is highly recommended].

There has to be something of value left in a business or potentially there to:

• restructure and allow the business to continue;
• pay creditors more than they might receive in a liquidation;
• pay the practitioner.

With nearly 80% having remaining assets or funds of $50k or less, and a majority $10k or less, this proposed SME regime is not properly directed, or at a minimum, it is not directed at helping very many businesses.

Liquidation, or deregistration?

Taking this further, half or most of these SMEs would end up in liquidation. But then the problem remains that many or most of them will have not enough funds to even pay the liquidator.  Unlike in bankruptcy, there is no government liquidator to assist.

Current figures are that there are 5 times as many default deregistrations of companies by ASIC as there are external administrations, that is, companies simply abandoned by their directors, perhaps after shifting remaining assets to a new company.  See Insolvent assetless MSMEs – all but forgotten?

These are the companies Professor Harris and I have described as “too poor to go broke”.[4]

Data

To set up a new business based on inadequate market, financial and other data is not wise, and probably accounts for many business failures.  To propose a new insolvency regime based on inadequate data would be worse, even though its only impact might be that it is not used.

The government’s casual approach to the need for data goes back decades but in 2010 there was a Senate committee recommendation that a joint AFSA-ASIC unit be established responsible for “gathering, collating and analysing data on a range of corporate and personal insolvency matters”. That data was to be made publicly available, online, and for no charge.

This was rejected.

It followed recommendations from the 1988 Harmer Report, a 1992 TPC inquiry, the 2003 “Stocktake” inquiry, and more, that Australia did not nearly have enough insolvency data to allow an understanding of how the system was operating and what changes might be needed. During that time, the need for data to assist in the detection of phoenix activity, for one, was emphasised.

Why?

Apart from lassitude, there have been scandalous suggestions at times that the government does not want to reveal information and data adverse to the operation of the insolvency regime in Australia.

But there must be some good reasons why a well-qualified person like Mr Frydenberg[5] (the Treasurer) was ready to confidently announce these reforms based on such limited substantiation?

To be continued.

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[1] Draft Corporations Amendment (Corporate Insolvency Reforms) Bill 2020 (Cth)

[2] ASBFEO’s Small Business Counts report https://www.asbfeo.gov.au/resources/small-business-counts, and current ABS statistics.

[3] Presentation on SME insolvency reform for the Sydney office of Hunt & Hunt on 21 October 2020, Professor Jason Harris.

[4] Managing the insolvency curve – a new government role is needed? 31 March 2020

[5] Law (hons), Economics (hons), M Phil, MPA