The World Bank has just released a report on small business insolvencies – Report on the Treatment of MSME Insolvency, 4 May 2017, (micro, small, and medium enterprises). Much of the Report is relevant to issues being confronted in Australia in this sector.
As the Report says, MSMEs are a significant part of the global economy among and also the largest commercial users of insolvency systems internationally. However, there are very few specialized legal regimes for MSME insolvency; most jurisdictions treat MSME insolvencies the same as for other corporate entities, or conversely, natural persons, despite MSMEs’ unique attributes.
- Considers the specific challenges of insolvent MSMEs (including the difficulties of defining MSMEs and distinguishing them from large corporate entities);
- Reviews and analyzes how legislation in different jurisdictions deals with the challenges of MSME insolvency; and
- Considers if existing international standards are sufficient to address MSME insolvency.
Some of the key challenges for MSME insolvency are:
- Complex insolvency systems that deter MSMEs from resorting to formal procedures to deal with their financial distress.
- Creditor behaviour – where creditors have few incentives to deal with MSME debtors through legal processes, those that are unsecured generally have limited participation in the process and those that are secured typically focus on enforcement of security at the first sign of financial distress and thus efficiencies may be lost;
- Lack of information about MSME debtors – MSME debtors may lack good records and reliable financial information making it harder to assess their viability and eroding creditor trust;
- Post-insolvency financing – many insolvency systems do not permit or incentivize financing after formal insolvency proceedings are filed even though such financing will be vital to MSME survival. MSMEs are specifically vulnerable to this risk;
- Insufficient assets to fund a formal insolvency procedure – MSMEs often lack the resources to cover the costs and fees for a formal insolvency procedure;
- Personal debts – MSMEs are often financed with a mixture of corporate and personal debt taken on by the entrepreneur (including personal guarantees); the failure of the MSME may thus have severe consequences for the entrepreneur and their family including social stigma; and
- Natural persons – MSMEs might be sole traders and subject to the same insolvency regime as natural persons, which might not have the necessary commercial controls in place to protect the financially distressed business of the MSME.
This Report comes to the following main conclusions in relation to MSME insolvency:
- Any definition of MSME insolvency should not be overly prescriptive because of the varying definitions of “MSME” around the world;
- As a starting point, consideration should be given to addressing the particular issues that arise in the cases of MSME insolvency through specific MSME provisions in the existing insolvency frameworks. The Report does not endorse, at this stage, establishing separate regimes for MSME insolvency, but further investigation of this issue is needed;
- Since the majority of MSMEs facing insolvency are more likely to liquidate and not go into reorganization/restructuring (by virtue of their size), frameworks should not only focus on reorganization/restructuring, but also on expeditious liquidation mechanisms;
- Due to the lack of sophistication of many MSMEs, jurisdictions should consider providing out-of-court assistance to MSMEs such as mediation, debt counselling, financial education, or the appointment of a trustee (though it is noted that funding such assistance must be considered);
- Further exploration is needed between the intersection of personal insolvency frameworks and MSME insolvency; and
- Further exploration is also needed to determine if it is advisable to revise some of the World Bank ICR Principles to provide specific guidance for dealing with MSMEs.
This Report follows the UNCITRAL paper on the same topic, debated this week at UNCITRAL’s Working Group V session in New York, at which my QUT colleague Anne Matthew is attending.
More comments soon.