The Australian Small Business and Family Enterprise Ombudsman has established an inquiry into “the insolvency system” to report by February 2020, focusing on practitioners, lawyers, financiers and others. It is interesting that this government inquiry is not looking at the responsibility of government itself in maintaining the insolvency system.
This commentary is based upon my account of the lack of legislative inattention to MSME insolvencies, in the context of a current international examination by UNCITRAL Working Group V of the particular problems that MSME insolvencies present.
Putting aside til the end of this commentary what is happening internationally, in which Australia is not involved, here are some points that might put the Ombudsman inquiry into context.
According to the Ombudsman’s terms of reference, the inquiry will examine the existing insolvency system through the experience of small businesses, in particular, where they may be able to contribute to the process [of insolvency]; the ‘degree of transparency of the governance, processes and costs’ of [insolvency] practitioners as well as lawyers, valuers, investigating accountants, administrators, receivers and liquidators; how the insolvency of a small or family business may lead to bankruptcy for the owners; and how the established framework impacts the practices and fees of insolvency practitioners.
What do we know about MSME insolvencies?
To start with, reliable information about MSME insolvency in Australia is not much available; a past recommendation that there be a government agency established to gather, collate and analyse data for free public access on a range of corporate and personal insolvency matters was rejected. What information on MSME insolvency exists continues to be separately maintained by each regulator, ASIC and AFSA.
MSME insolvency law?
As to what law is available, in personal insolvency, revised debt agreement laws commenced in June 2019 but the income and assets restrictions do not assist most business debtors. The parallel bill for a reduction in the period of bankruptcy to one year has not proceeded. One focus for that reduction was on promoting a more entrepreneurial outlook and reducing the stigma of insolvency. The numbers of ‘business bankruptcies’ stand at 18% but there are no figures on the extent to which companies are involved; nor within ASIC’s statistics. But as to that, recent research from the University of Melbourne indicates a higher proportion of business bankruptcies than had been assumed.
Australia has the government Official Trustee in Bankruptcy to handle assetless MSMEs along with consumer bankruptcies. The private profession – registered trustees – handle about 15% of all bankruptcies. Creditor returns average under 2%.
In corporate insolvency, there are no specific insolvency laws on MSMEs. A 2015 Productivity Commission Report recommended a streamlined liquidation process for low debt and asset companies, which the government did not pursue because it said it had already reformed insolvency law. The Commission had proposed a simplified ‘small liquidation’ process for companies with liabilities to unrelated parties of less than $250 000. Directors would be required to lodge a verified petition with ASIC. The primary role of the liquidator would be to reasonably ascertain the funds available, with requirements for meetings, reporting and investigations being reduced accordingly.
The government has also raised the idea of a government liquidator to conduct a streamlined external administration of MSMEs with the option to appoint a private registered liquidator if circumstances warranted it. Nothing has proceeded. ASIC reports that 97% of external administrations produce creditor returns of under 11c.
Although no practitioner need take an appointment unless fees are guaranteed, nevertheless, the private corporate insolvency profession is estimated to contribute many millions in unrecovered remuneration. This is despite the ‘official liquidator’ status and obligations having been removed in 2017. Figures may be similar for bankruptcy trustees.
MSME companies tend to be handled by the smaller and cheaper end of the insolvency market, with financial input from directors, less so from creditors; or they are processed through unlawful phoenix and other such processes through pre-insolvency advisers.
As to the remaining insolvent companies, a concern has been expressed about the large number of companies that ‘disappear off the register’ – in the tens of thousands – by way of default deregistration – a “likely ‘black hole’ of director misconduct and unpaid liabilities”.
Joint personal/corporate insolvencies
We also know that MSME businesses present joint personal/corporate insolvency issues. The “reality is that MSMEs cannot get financing for their business unless they can guarantee the debt with their personal assets. Such guarantees effectively blur the distinction between personal and business debt”: Sarra. Therefore the international focus is on dealing with a business in both its corporate and personal insolvency aspects. The Ombudsman refers to this in her terms of reference. The legal separation between the individual and the company remains firm in Australia even in the context of many businesses operating through one director companies. The separation in policy and approach between AGD and Treasury reinforces this.
As to creditor returns generally, we know that of over $308 million brought in by registered bankruptcy trustees in 2017-2018, only $52m reached unsecured creditors, with secured creditors being paid over $84m (28%), and trustee remuneration ($81m, 27%), government charges, legal and other costs exceeding $150 million. Trustees’ court challenges to voidable transactions produced only $13m, and the costs of those recoveries probably accounted for much of that amount.
There are no comparable figures for corporate insolvency. Its more limited figures show that the return to creditors is minimal or nil from most companies in external administration. In 2017-18, 92% of statutory reports lodged with ASIC stated that no dividend would be paid to creditors, and in 4.8% of reports the dividend was reported as being between zero and 11 cents in the dollar.
The terms of reference revisited
Going back to the Ombudsman’s terms of reference, small corporate businesses will often be unable to access insolvency assistance if no or only limited funds are available – corporate insolvency is privatised. Nor can insolvency practitioners do much with those businesses where there are only limited funds remaining, with the practitioner often called in too late to be able to assist.
As to transparency of the process, the government has given little attention to producing relevant insolvency statistics over the years, including for example how the corporate insolvency of a business may lead to bankruptcy of the owners. The figures mentioned in his article are basically as much as we have got.
The insolvency profession itself has shown little interest in producing its own figures, for example on its rates of return, costs and assets realised.
The Ombudsman therefore won’t have much data to go on in its inquiry. The inquiry and its reference group will no doubt rely on the anecdotal submissions upon which our insolvency law reform is generally based.
The international inquiry is being conducted by Working Group V of UNCITRAL, into MSME insolvency, which is next meeting in December 2019; for more information, contact me.
UNCITRAL gives this useful overview of MSMEs, that they are:
“relatively undiversified as regards creditor, supply and client base; as a result, they often face the cash flow problems and higher default risks that follow from the loss of a significant business partner or from late payments by their clients. They also face scarcity of working capital, higher interest rates and larger collateral requirements, which make raising finance, especially in situations of financial distress, difficult, if not impossible.
Access to credit is often made subject to the granting of personal guarantees by the owners or their relatives and friends whose personal assets could be of equal or greater value than that of the small debtor. Owners thus frequently provide not just equity, but also debt funding.
Any physical assets of small debtors, which may be the main or the only assets of the value to creditors, may already be encumbered to secured creditors with “hold-outs” by such creditors being common in the context of negotiating a solution to financial difficulties of the MSME. And unencumbered assets are usually of little or no value. Because the costs of participating in the insolvency proceedings may outweigh the return, those creditors stay disengaged, thus jeopardising reorganization leaving liquidation as the only option.
MSMEs often have poor or non-existent records; there may be no clearly established ownership of key commercial assets; work for the debtor may not be documented or remunerated and the use by the owner of their own funds may not be documented; owners may use their own finances to fund or support the business without necessarily documenting that expenditure.
MSMs are often characterized by a centralized governance with the management unwilling to initiate insolvency protection because of the risk of losing control. They are also prone to adopt more high-risk strategies in attempts to save the business. These factors may contribute to the financial crisis and lead to the debtor addressing financial difficulties too late”.
 Among other recommendations in The regulation, registration and remuneration of insolvency practitioners in Australia: the case for a new framework, 14 September 2010.
 AFSA, March 2019
 The Productivity Commission raised it without developing it: see Business Set-up, Transfer and Closure, 7 December 2015.
 Combatting Illegal Phoenixing, September 2017, Treasury.
 ASIC Report 596
 ARITA claims that “the population of less than 700 liquidators has to write-off some $100 million in unrecoverable fees each year”: ARITA submission to ASIC, 26 April 2019.
 A “likely ‘black hole’ of director misconduct and unpaid liabilities”: The Protection of Employee Entitlements in Insolvency – an Australian Perspective, Professor Helen Anderson, Melbourne University Press, 2014, at p 186. She reports that the statistics kept by ASIC on this are variable in quality and generally not helpful.