While insolvency law uses many and varied terms to describe its various processes for dealing with an insolvent business, no fewer than six in the UK, we are told,
“something is preventing struggling businesses from using it”?!
Perhaps because of the very fact that insolvency law does use so many and varied terms to describe its various processes for dealing with an insolvent business.
The language of insolvency: why getting it wrong can harm struggling firms (theconversation.com) by John Tribe and Emilie Ghio in the Conversation argues that inaccurate reporting of insolvency processes and outcomes is increasing the stigma around insolvency and potentially deterring businesses from seeking help.
“Legal terms and concepts need to be accurate. The law of insolvency is no different”.
Stephen Barnes[1] also responds well to this issue here (9) The language of business collapse. | LinkedIn, and more broadly in his book, Triage, The Art of Business Turnaround, 2024.
While I acknowledge the clarity that these comments seek to achieve, my difficulty is that insolvency law itself hardly sets a good example, both in its terminology and in its rigid application its principles.
Just as we would say to a business seeking to meet its customers’ needs, “look at your services/products from the customers’ viewpoint and convenience, not your own”, so too should we look at addressing a business’s financial distress from its perspective, not from the convenience and learning, and oblique terminology, of insolvency law.
How business sees itself
The main clientele of insolvency law is “small business” which is variously classified in the law – by industry type or financial turnover [2] or revenue or employee number [3] – but not in terms that the law of insolvency insists upon, that is, whether the business operates through a sole trader or a company.
Nonetheless the ABS reports that there are 1.05m companies and 1.03m sole traders/partners in Australia. [4] But even if an insolvency involves a company, there is often an intertwining of company and personal debt of the owners, and third parties, through personal guarantees, tax liabilities and the owners’ use of their personal funds to support the business.
“The corporate vs non-corporate distinction in assets and liabilities is often blurred for small firms, either because lenders require personal guarantees or security – e.g. a second mortgage on the owner’s home – or because prior to incorporating and obtaining limited liability protection, entrepreneurs typically use personal finances”: OECD.
The Small Business Ombudsman reports that 50% of small business loans are secured over the family home.
But when it comes to their financial distress, insolvency law only looks at small business in terms of those legal structures, through which debts are incurred and assets held.[5] The prime example is the Part 5.3B small [corporate] business restructure which specifically excludes directors’ guaranteed liabilities.
As the Small Business Ombudsman said in his submission to the PJC,
“the current insolvency system assumes a neat distinction between a business and an individual, whose distressed financial circumstances do not intersect with one another. Small and family businesses are rarely so neatly arranged. A small business is less likely to be an incorporated entity and more likely to be a blended ‘structure’ of independent contractors, self-employed persons, or a partnership operating through a trust. Even for incorporated entities, Directors guarantees, personal collateral used to secure finance, and statutory sanctions that create a personal Director obligation or liability, add to the blending. The utility of the insolvency system would benefit from a better recognition of this blending of business and personal interests”: Submission 31, 2 December 2022.
Stephen Barnes makes the point that not only separate legislation for personal and corporate structures makes it confusing and more expensive for business owners to navigate their options but the attention from lawmakers, industry associations and the media is given primarily to
“incorporated company distress and not on the types of businesses that there are far more of, and also that are far more likely to end up in distress”.
To Barnes’ list of those responsible I would add academia, in its separation into personal and corporate insolvency in its research, articles and texts.
In all the current focus on construction industry insolvencies as revealed in ASIC data, Barnes gives a figure of only 37.3% of construction businesses operating through a company, with the percentage entering a formal insolvency in fact declining.
As to the focus of government, while Part 5.3B was introduced into the Corporations Act with what some say was undue haste in January 2021, small business personal insolvency reforms suggested in February 2021 have gone nowhere.[7]
I have similarly referred to a corporate insolvency ‘blind spot’, extending to an antagonism, to anything to do with bankruptcy law. I have described this whole process as
“the continued compartmentalisation of personal and corporate insolvency in law reform, conferences, court decisions, and academia. In particular, the corporate focus of the SME insolvency law reforms is at odds with the reality of SMEs operating through a mix of corporate and personal liabilities and assets, with guarantee, tax and other liabilities imposed on proprietors. The disparity of treatment of directors of insolvent companies compared with bankruptcy’s treatment of sole traders is a further issue”.[8]
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 further division between the directors’ interests and the company’s interests. Then there are independence issues. Hence the market for pre-insolvency advisers.
The point is that small corporate businesses will not always be neatly packaged within their corporate structure to suit IPs. Seeking to address the financial problems of an insolvent company is addressing only half of the problem if the financial problems of the directors (who are often owner-managers) are ignored.
Insolvency law might well validly respond to this by saying that this is the law we have to deal with. But at the same time there have been no real moves to change or modify it to deal with insolvent businesses, at least in Australia.
As a matter of law reform, I acknowledge it would be difficult to simplify legally and conceptually, given the entrenched standing of the separate corporate entity, but ideas to combine proceedings for MSMEs that address the problems of the business and the family owners are available.[9] An initial step would be to consider procedural co-ordination or consolidation of personal and corporate assets and liabilities of a business, which has been recommended by UNCITRAL and the World Bank, including disallowing the enforcement of personal guarantees.
The International Insolvency Institute – Asian Business Law Institute’s Guide on the Treatment of Insolvent Micro and Small Enterprises in Asia, at p 17, similarly says that
“as sole proprietors and shareholders/managers often act as guarantors for the debts of MSEs, there should be greater coordination between the systems of corporate and personal insolvency. Otherwise, honest but unfortunate sole proprietors as well as the shareholders of MSEs who guarantee the debts of the MSEs will not find the corporate insolvency framework appealing”.
In Australia, the separation between corporate and personal insolvency has been raised as a negative productivity issue with the government.[10]
Language
But getting back on to the Conversation article, yes, it is good to get the language right, for the relevant context. But as to the authors’ suggested language, it gets complex. When discussing “insolvency”, they list “no fewer than six procedures which can be used by struggling companies”. They want us to see the anodyne term “administration” in positive terms of “rescuing” a company, that is, unless it’s a nationally important company, in which case it’s a “special administration”, or, unless, it seems, it is voluntary. Companies, not businesses, also have the standalone moratorium unless the company is not insolvent, in which case a scheme of arrangement is the go “to alter the company’s financial obligations”; but if the company, has encountered, or may encounter, financial difficulties that are likely to affect its ability to carry on business, the obliquely termed “restructuring plan” is the suggested option.
The authors then say that the UK has seen a record number of business failures, but then go on to report only corporate insolvencies in 2023.
They ponder that
“while the law is here to help, something is preventing struggling businesses from using it”.
Perhaps mixing up the language and concepts of company and business is one factor.
Stigma
As to the negative stigma of experiencing financial difficulties, the English word “bankruptcy” itself does a good enough job in maintaining that stigma, reinforced in Australia by bankruptcy law imposing a quasi-penal sentence of 3 years minimum. Elements of the English class system may have assisted in preserving its negative moral tone. Our reading of English history is that the adoption of the term “insolvency” rather than “bankruptcy” [11] stemmed primarily from 18th C legislation specifically targeted at insolvent non-traders.
“When gentlemen were increasingly part of this large group, it was simply unthinkable for the up-stairs likes of Lord Grantham to be mentioned in the same sentence as a word, previously used for lowly tradesman”.
Both are listed in the Australian Constitution, alongside being ‘attainted of treason’, as a disqualification from being a member of parliament.[12]
All this subject to the reality of a long-time moral opprobrium in relation to unpaid debt which while much ameliorated has an important role in supporting a level of confidence in business dealings,[13] and in maintaining access to credit.
With genuine respect to the Conversation authors, rather than putting businesses and media through a vocabulary mill, insolvency itself might more usefully tidy up its own dictionary and apply terms that connote some sense of the purpose they purport to serve.
But I also think ‘small business’ needs itself to become more tangible and definable, and come at least half-way in revealing and abiding by a transparent operating structure. At present, we rely too much on speculation as to what sort of entity we are dealing with.
INSOL Academics
While some in Australia call for a ‘root and branch’ review of insolvency law, when push comes to shove the status quo and existing language suits many. The excellent 2023 PJC Report has questioned many aspects of the current regime. While I don’t speak here for Jason Harris, he and I are shortly to present some challenging ideas in a rethinking of the structure of Australian insolvency law at the INSOL Academics Colloquium in San Diego on 22 May 2024. We draw on much that comes from the PJC Report, as supported or otherwise from any Australian government response to it.
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[1] Triage, The Art of Business Turnaround, 2024, p 204.
[2] 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.
[3] And internationally, see for example Guide on the Treatment of Insolvent Micro and Small Enterprises in Asia 2022, p 13.
[4] 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)].
[5] Bankruptcy Act s 7; Corporations Act s 459A
[6] Triage, The Art of Business Turnaround, 2024, p 204.
[7] The bankruptcy system and the impacts of coronavirus | Attorney-General’s Department (ag.gov.au)
[8] Insolvency Law Bulletin 2024
[9] See Riz Mokal et al, Micro, Small and Medium Enterprise Insolvency: A Modular Approach (Oxford University Press, 2018); Aurelio Gurrea-Martinez, ‘Implementing an insolvency framework for micro and small firms’ (2021) 30 International Insolvency Review S46.
[10] See Submissions | ASBFEO.
[11] The Historical Development of Insolvency Law, Francis Forbes Society for Australian Legal History, the Hon TF Bathurst, Chief Justice of NSW, 3 September 2014. Insolvency Law and Policy, Duns, OUP, 2002 at 21-22.
[12] Constitution s 44.
[13] See Paul Omar, Insolvency Law and Morality, Ch 2, in Re-examining insolvency law and theory – perspectives for the 21st century, eds Ghio, Wood and Gant, Edward Elgar Publishing, 2023. Also David Milman, The liberalisation of bankruptcy law, Ch 3.
