My recent report explained that the insolvency of micro and small to medium enterprises (MSMEs) is to be the subject of consideration by Working Group V (insolvency) of UNCITRAL.
MSMEs insolvencies for this purpose include small companies and individuals in business, that is, from our Australian perspective, both corporate and personal insolvency.
Many of the issues WGV are considering relate to current reform issues in Australia, in particular the streamlining of small insolvencies, regulating phoenix misconduct and the pending reduction of the term of bankruptcy to one year.
The UNCITRAL Secretariat to WGV has provided a very useful paper dated 13 March 2017 explaining the relevant issues, including a number of country comparisons. Australia itself does not attend WGV and no Australian comparison is given.
The UNCITRAL paper on MSMEs
By way of brief review, these points come from the UNCITRAL paper.
Recent work by the World Bank6, the IMF7 and others suggest that a properly implemented insolvency regime may help mitigate many of the challenges facing MSMEs, including access to credit, job preservation, facilitating entrepreneurship and reducing the personal risk of individuals who create enterprises.
MSMEs experiencing financial distress often face the challenges of access to insolvency procedures, creditor passivity, availability of information, difficulty accessing new finance and the insufficiency of assets to cover the costs of the proceedings, the “no-asset cases” or “insolvent insolvencies”. The majority of MSMEs facing insolvency are likely to liquidate, with only a small fraction being able to take advantage of a restructuring regime.
MSMEs can lack the skills to identify and react to financial distress, often resulting in delay in initiating an insolvency process. They often have inefficient or non-existent record keeping systems, making it hard to judge whether an MSME is approaching insolvency.
For unincorporated MSMEs, the treatment of individual defaulters can be severe. The lack of a “fresh start” for ‘honest’ insolvent owners can reduce the incentives to seek protection and restructuring.
Creditor passivity can exist when the debtor is towards the “micro” end of the spectrum, and the return creditors can expect is insufficient to justify their costs of participating.
Many insolvency systems do not make it easy for MSMEs to access post commencement financing.
There is an overlap between business insolvency and personal insolvency regimes, and a clear distinction between them does not always exist, making it unclear whether a business or a personal insolvency regime is the one most suited to a particular MSME’s financial difficulties.
Directors of MSMEs frequently provide not just equity but also debt funding, there will often be poor or non-existent records, no clearly established ownership of key commercial assets, the entrepreneur and their family members’ work for the MSME may not be documented or remunerated, the entrepreneur may use their own finances without documenting that expenditure and where funds are borrowed the creditor may consider the natural person to be the relevant debtor, rather than the MSME. The personal assets of the entrepreneur may be of greater value than that of the MSME, which encourages lenders to seek recourse personally from the entrepreneur, including the family home.
The insufficiency of assets to fund insolvency proceedings results in many MSMEs never being formally liquidated. In fact some countries have opted not to commence insolvency proceedings if the debtor’s assets are insufficient to cover the costs.
MSME insolvency is approached differently around the world. In some jurisdictions, certain requirements of the general insolvency law are eliminated for MSME insolvency, or modify them. Other countries, like Japan and the Republic of Korea, have adopted comprehensive laws that are specifically designed for MSMEs and thus significantly different to the regimes applicable to larger enterprises.
Other examples include fewer formalities for commencing the insolvency process, reduced rights of creditors, and pre-packaged procedures, for example the German Insolvenzordnung. The new Insolvency and Bankruptcy Code in India has a fast track corporate insolvency process for qualified debtors, within 90 days. The US has streamlined provisions for SMEs in Chapter 11 of the Bankruptcy Code. And the focus of recent reforms in the particular circumstances of the 17 OHADA states is upon simplified and cheaper procedures through règlement préventif and redressement judiciaire proceedings, with liquidation des biens as a final option.
The European Union is also in the midst of pursuing a new approach to business failure and insolvency, which although not targeting MSMEs specifically, does focus on a fresh start and a reduction in the length of the processes.
A “modular” approach to the design of insolvency regimes has been proposed for MSMEs, whether incorporated or unincorporated entities or sole traders or entrepreneurs. See “The Modular Approach to Micro, Small and Medium Enterprise Insolvency”, 26 January 2017, The Bowen Island Group.
The basic assumption is that the parties are best placed to select the appropriate tools. In order to be able to use any such specialized procedures, the debtor has to be a business income earner, may be an individual or a legal entity and must have less than A$3.4 m in total secured and unsecured debts. The debtor entrepreneur can access any of the full range of insolvency law mechanisms. At the same time, creditors and other stakeholders have the right to adequate notification of each step in the process, coupled with the power to override the debtor entrepreneur’s choices.
The process is assisted by presumptions that inaction is interpreted as consent and the failure to exercise procedural rights precludes a stakeholder from later objecting.
Modules for the debtor include mediation and a moratorium, available only upon request, to forestall creditor enforcement and ipso facto clauses and set-off rights. Modules for creditors include mediation, to address disputes concerning, for example, admissibility or quantum of claims, plan formulation or treatment of guarantees; a debtor action moratorium, which affects the debtor’s rights to remain in possession and allows creditors to veto disposal of assets or the incurring of liabilities; rights of creditors to seek to appoint an insolvency professional to replace the debtor; and “doomed to failure” processes which allow debtor-initiated rescue to be terminated and to be converted to liquidation.
The UNCITRAL paper says that solutions to all these issues could be developed in light of the key principles and guidance already provided by the Legislative Guide.
As part of its discussions in New York in May 2017 and following, Working Group V will be considering how the various elements could be combined in an insolvency regime for MSMEs and, in particular, the form that its final work product might take, as a model law or as a legislative guide.
As well, Australia might like to consider its own domestic laws for small business in light of approaches taken in other comparable jurisdictions.
Michael Murray WGV UNCCA