Extension of the COVID-19 insolvency protections – what’s the real problem?

The Australian government has extended the monetary threshold of A$20,000 for the commencement by creditors of bankruptcy and liquidation proceedings and the 6 month periods for compliance, to 31 December 2020.  It has also extended the special COVID-19 ‘safe harbour’ protection for the same period.

This has prompted an outcry of objections to the extensions. Why?

The creditor and related interests objecting to these extensions overstate their own willingness to use insolvency for the public spirited aims they mention – to clean out zombie companies and prevent insolvent trading and accumulation of unpayable debt.

Creditor objections are perhaps more based on the time and monetary restrictions imposed on their use of the collective insolvency processes – bankruptcy notices and winding up demands and court applications – for private debt recovery; and less based on any public-spirited right on their part to put an insolvent debtor into insolvency, so that the public and equal sharing features of insolvency can be activated.

Why are there so many winding up orders?

Given the limited returns to creditors in insolvency, the question might be why there are so many winding up orders, well over 20% of all liquidations – with the petitioning creditor finding itself sharing negligible assets with many others, and then receiving endless communications from the liquidator, and perhaps a preference demand.

One reason might be the pre-virus debt threshold of only $2000, a figure set in 1993, the sentiments of a judge at that time

‘that any claim under $2 000 in this Court is prima facie beneath the dignity of the court’

notwithstanding.  The COVID-19 $20,000 may represent a more suitable threshold.

At the best of times, only 7% of liquidations produce any dividends to creditors and in many the liquidator is unpaid.  The fact that creditors are understandably not willing to fund liquidations in what is a privatised insolvency process, in accord with the government’s 2016 opt-out game plan, is fair enough.  It is one reason for zombies continuing, and another for the large number of companies that simply slide into deregistration by default. The extensions of the insolvency protections will not make much difference here.  In these the worst of times there will be even more companies ‘too poor to go broke’.

The restrictions on creditors using insolvency for debt recovery are real.

The new restrictions on debt recovery

We know that there are about 10,000 bankruptcy notices issued each year, but only 1,500 sequestration orders, with slightly higher proportions figures for court ordered liquidations and winding up demands.  We don’t know but can assume that much debt was recovered pre-virus by the processes leading up to the steps of the court.  That recovery option is now much limited.

Some would say that should be made permanent. In bankruptcy, there have been moves to impose a $50,000 debt threshold on creditors’ petitions, with a requirement for creditors to exercise private enforcement rights beforehand.

Insolvent trading?

As to the opposition to the further extension of the insolvent trading (s 588G) protection, much can be said about 588G, but on the other hand very little.  Creditors had no such protection until 1993, and government and industry have since then made no real effort to gather data to allow us to know its effectiveness. Tax and other personal liabilities of directors loom larger.  One academic analysis, comparing Australia with the UK, commented that it is

“remarkable’ that s 588G ‘appears to have been no more effective over its near 50 year history than section 214 [the UK equivalent] has been in its 27 years’”.

An Australian study found only 39 worthwhile court judgments on insolvent trading from 2004 to 2017.

The creditors

As to the creditors, who are invariably also debtors, there is a need for adjustment as does happen when morally hazardous overly protective law is removed.  Business operations had settled into unhealthy arrangements that might now need to be revisited. As to one, removing the ability for businesses to rely on the ATO to finance their operations would have a greater impact than COVID-19, however much the current crisis is acknowledged to be causing significant distress.

Insolvency law has a pervasive and beneficial influence on commercial dealings but it can only ever go so far. There may be good other reasons to object to the extensions of the insolvency protections, but the reasons being offered by certain groups don’t quite ring true.

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