The terms of reference of the current PJC inquiry into corporate insolvency refer at times to small business but given that small businesses comprise over 95% of all businesses in Australia, they are central to nearly all the various questions raised in the terms of reference. Terms of Reference – Parliament of Australia (aph.gov.au)
Small business
An initial difficulty is that “small business” is variously classified in the law – by industry type or financial turnover[1] or revenue or employee number – but not in terms that the law of insolvency recognises, that is, whether the business operates through a sole trader or a company. For better or worse, insolvency only looks at small business in terms of those legal structures, through which debts are incurred and assets held.[2]
Hence to talk of the law of small business insolvency is a bit of a misnomer.
Statistics are limited. The ABS reports, under the heading of “type of legal organisation”, show only that 1.05m companies and 1.03m sole traders/partners comprise the bulk of businesses in Australia and that in 2021-22 sole traders had the largest net growth of any type of legal organisation.[3]
The insolvency of sole traders is dealt with under the Bankruptcy Act, bankruptcy imposing a 3+ year period of restrictions, one being on managing a company. Other options are limited. These are hardly sympathetic to business failure, for example one resulting from COVID-19 restrictions. The insolvency of companies is dealt with under the Corporations Act, with various options, allowing the directors to clean up their business or move on quickly to their next venture. The fact that the sole trader may have failed through unavoidable misfortune and the director may have been inept is not relevant. Insolvency’s blind inequity is obvious.
But even in relation to the insolvency of companies, there will be a significant proportion where the owner [shareholder] has given personal guarantees, or otherwise incurred liabilities in their own name in support of the business. Tax liabilities or indemnities may also have been imposed on the owner personally. Some such liabilities may be owed by the owner to the company itself. Small corporate businesses will not always be neatly packaged within their corporate structure.
Hence, while corporate insolvency can deal with significant corporate liabilities, and that is what the PJC terms of reference focus on, there may be personal liabilities of the owner as well. Corporate insolvency does not resolve those personal liabilities, whether it be liquidation, Part 5.3A; or the new Part 5.3B. “Small business restructuring” is a Treasury-styled misnomer in many cases.
Practical difficulties
The practical difficulty for a small business owner is that if there is some current financial slide in its operations, there is no one-stop-shop in insolvency law to try to remedy that. Insolvency law requires a two or more step process, a trustee as to personal liabilities, a liquidator as to corporate, and even then there is the division between the director’s interests and the company’s interests.
This can be compounded by business owners not having an accurate idea of how their business is set up, courtesy of their local accountant. There may be blurred lines between corporate and personal assets and liabilities. They should be criticised for this but it seems to be a reality. The business owner (of what?) will need to know where the liabilities come from and decide whether their personal insolvency or their company’s insolvency is on the line, or both.
An insolvency practitioner (IP) registered as both trustee and liquidator will only be able to take a bankruptcy or a liquidation and refer the owner on to another firm. This is because of the strict independence rules in insolvency which sees the individual director and the company as separate legal entities. There may have been unfair dealings or transfers of property or contested liabilities between the company and the director.
There can be exceptions for IPs to take both appointments in some cases, ordered by the court.[4] New Zealand law goes further. It has both a government liquidator and a government trustee, the Official Assignee, and in certain cases the OA can be appointed to both a bankruptcy of the director and liquidator of the director’s company: s 241 Companies Act 1993.
Co-ordination/consolidation of personal and corporate liabilities of a business has been recommended for consideration internationally. Other options include disallowing the enforcement of personal guarantees but that would have wider implications.[5]
A holistic view?
Perhaps corporate insolvency law should start to look at all this from the debtor’s perspective and not from the perspective of trustees and liquidators.
The PJC inquiry itself could take a broad and more holistic view of how insolvency law should address “small business insolvency”. The terms of reference do call for inquiry into the law’s effectiveness in protecting and maximising value for general economic benefit. The separation between corporate and personal insolvency has been raised as a productivity issue with the Productivity Commission, and with the government, both by the ASBFEO.[6]
Given the separation between personal and corporate insolvency, it would be difficult for the PJC to go too far. The issue is also difficult legally and conceptually. The need to maintain proper standards of business compliance and conduct is important, that any such reform may disrupt. But a small step would be to consider procedural co-ordination or consolidation of such proceedings, as UNCITRAL suggests. The use of the one court – the Federal Circuit and Family Court – for handling small business insolvency matters would assist. Moving personal insolvency policy to Treasury from Attorney-General’s would also help.
Data
As with all other insolvency inquiries, data will be limited, not only on insolvency itself, but on its constituent debtors. We all need to know more about how small business operates – are personal guarantees common? How often is the family home “on the line”? How often do corporate liabilities lead to personal insolvency? How common are personal tax liabilities? Is the ABS division of 50-50 between corporate and personal accurate?
Surveys of small business would be one way of finding this information. The information being/to be collected by the ABR will help. Apart from these more formal mechanisms, the recent figures about those still to obtain a director identity number suggest many in small business do not know of have forgotten that they operate, or purport to operate, through a company. It seems we can assume that small corporate businesses are not always, or even often, neatly packaged within their corporate structure.
Submissions
The PJC inquiry calls for submissions by 30 November 2022. Terms of Reference – Parliament of Australia (aph.gov.au)
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[1] The ASBFEO Act 2015 s 5 refers to under 100 employees or revenue under $5m. Section 6D of the Privacy Act 1988 refers to annual turnover of under $3m. The ITAA 1997 at s 328.10 refers to aggregated turnover of under $10m.
[2] Bankruptcy Act s 7; Corporations Act s 459A
[3] In 2021-22 sole traders increased by 90,239 businesses, or 12.7% to 798,209 in total. [see Counts of Australian Businesses, including Entries and Exits, July 2018 – June 2022 | Australian Bureau of Statistics (abs.gov.au)].
[4] Application by Solomons [2013] FCA 1273
[5] UNCITRAL, World Bank
[6] See ASBFEO submissions tab.
