Michael.1
Insolvency and related law and policy, and more

Michael Murray is an Australian author and commentator on corporate and personal insolvency law and related issues, in Australia and internationally. He has a strong law and policy background, is independent of any connections, and his views are his own. He gives no legal advice. 

World Bank insolvency principles – how does Australia compare?

The World Bank has released its updated Principles for Effective Insolvency and Creditor/Debtor Regimes (the Principles), emphasising the needs of micro, small and medium enterprises (MSMEs) in the context of COVID-19. These are said to be a “distillation of international best practice on design aspects of [insolvency] systems”, based on accepted core features of insolvency law. 

It is useful to assess how the design of Australia’s current insolvency regime, and any proposed reforms,[1] measure up.   

Not well.

Like many jurisdictions, Australia’s MSMEs account for over 95% of all businesses, contribute around one third OGDP and are the major employer.  While there is some looseness in the economic definition,[2] sole traders and partnerships comprise over 60% of MSMEs, with the remainder corporate entities and corporate trustees.

Small business insolvency laws in Australia

From a design perspective, insolvency laws in Australia don’t recognise their customer as such – the MSMEs.  Rather they are legally structured, with MSMEs dealt with by the Corporations Act 2001 Ch 5, and related laws for co-operatives and associations, and by the Bankruptcy Act 1966 for mixed corporate and sole trader/partnership businesses. Each offers alternatives to liquidation and bankruptcy.  Liquidators regulated by ASIC administer some corporate MSME insolvencies, trustees regulated by AFSA regulate some personal MSME insolvencies, along with the Official Trustee.

Of the 40% corporates, Part 5.3B is said to have a MSME focus although with its $1m monetary threshold (well below the ATO’s $10m), its inattention to personal guarantees (prevalent among the sector) and other problems, it is being little used, with only 5 company businesses reported as having accessed it since 1 January 2021.  Failed assetless businesses have no access to an official receiver and they, and phoenixed business, are said to be readily deregistered.

Part 5.3B does not address personal guarantees given by directors which remain enforceable.  However, apart from that, and other liabilities that may arise, Australian corporate insolvency law generally provides an immediate release to the company’s directors and members.  Even a director’s non-compliance with their duty to assist the liquidator imposes no automatic bar on their immediate re-entry into business through another corporate structure.

Where personal guarantees are enforced, or other corporate related labilities exist, the Bankruptcy Act can deal with those individuals, along with those whose sole-trader business fails and personal insolvency follows. In contrast to company insolvency, a bankrupt director remains subject to personal and business restrictions for three years and they cannot take any role in company management. Around 40% of bankruptcies are business related.[3]

Based on these outcomes, it will be apparent that Australia does not meet many of the aims of the World Bank Principles.[4] This is explained in more detail in this schedule.

Relevant issue World Bank Principles Australia?
Eligibility Simplified insolvency proceedings should apply to both corporate (juridical) and natural persons classified as MSEs, defined by local criteria such as number of employees, turnover etc, assets etc.

 

Notwithstanding this, MSEs principles should apply “whether as an individual natural person operating as an entrepreneur or a legal entity running an enterprise”.

 

 

Not really. MSME proceedings are defined in legal terms, are the subject of separate legislation and separate regulation and ministerial control.

 

While some attempt was made to harmonise the personal and corporate process laws, this was only in respect of process, and even these are again becoming increasingly separated, both in process and substance.

 

 

 

All debts “All personal and business debts of a natural person should be included in simplified insolvency proceedings”.

 

No. Corporate business debts are dealt with under the Corporations Act with the appointment of a liquidator. Personal business debts are handled separately through the Bankruptcy Act and the appointment of a separate trustee.
Personal guarantees A “simplified insolvency system should address, including through procedural consolidation or coordination of linked proceedings, the treatment of personal guarantees provided for business needs of the MSE debtor”.

 

No. While the enforcement of guarantees during a reorganisation can be stayed, this does not continue and such debts can then be pursued and enforced.
Courts Courts should be established according to the size and complexity of MSEs cases, and the legal system and resources available in each jurisdiction. No. While Australia has a capable and independent judiciary, there is no focus on MSME insolvency and there are different court systems for personal and corporate insolvency.  Court proceedings are avoided in light of the costs involved.
Regulators Regulators must set standards that reflect the requirements of the legislation and public expectations of fairness, impartiality, transparency, and accountability; and have appropriate powers and resources to enable them to discharge their functions, duties, and responsibilities effectively. Not really. While Australia has quite capable and independent regulators – ASIC and AFSA – there is no focus on MSME insolvency.  Each operates separately, and is funded separately, with different regulatory rules for the same issues in each of personal and corporate insolvency.  The ATO is the real regulator.
Costs “The law should contemplate mechanisms for covering the costs of implementing simplified insolvency proceedings where assets and sources of revenue of the debtor are insufficient to meet those costs”.

 

Yes, this is largely met in bankruptcy through the government Official Trustee.

 

But there is no equivalent in corporate insolvency, which relies solely upon a private insolvency profession.

The government has stated that where the funds of the debtor are inadequate to pay an IP, default deregistration through the company’s/directors’ non-compliance with the law is a likely option for many debtors.[5]

 

Discharge The legal system should grant a discharge to all natural person entrepreneurs with limited formalities who act in good faith[6] which should be presumed. Yes, a director of a one shareholder company debtor can rely on the debts having been incurred by the company as a separate entity.

Yes, debts of an individual debtor are discharged.

 

 

Challenges Creditors and others should be able to challenge the debtor on bad faith or fraud. Yes, a liquidator can investigate and report on any director misconduct, and liability may be imposed.

 

Yes, a trustee can investigate and report on any misconduct, and penalties can be imposed.

 

Directors need show no proof of identity, making detection difficult.[7]

Personal insolvents must show proof of identity.

Period until discharge

“The period before discharge is granted should be short to encourage a fresh start, continued entrepreneurial activities and reduce stigma. Upon discharge, claims that could not be satisfied in the insolvency proceedings should be rendered extinguished and personal disqualifications minimized or cancelled”.

 

Yes, a company director has obligations to assist etc but with no automatic disqualification or penalty for failure to do so. No period of time is imposed.

 

No, a period of 3 years is imposed in bankruptcy, with and disqualifications generally, including from being a director and many business activities. A bankrupt has obligations to assist and suffers an extension of the bankruptcy beyond 3 years for failure to do so.

 

Debts discharged “Both personal and business debts that were, or could have been, addressed in the insolvency proceedings should be dischargeable”.

 

Yes, but under separate processes. Corporate business debts are only discharged through Ch 5 and the appointment of a liquidator; personal business debts are only discharged through the Bankruptcy Act and the appointment of a separate trustee.

 

Comment

The Principles are consistent with earlier guidance of the World Bank. Whether Australia endorsed them through its World Bank membership is not known, though Australian input may have come through the International Association of Insolvency Regulators (IAIR) of which both ASIC and AFSA are members.  The Principles are also partly based on UNCITRAL’s comparable guidance, whose Working Group V is meeting again on 4-7 May 2021, though Australia does not take part in these proceedings.[8]

The disparate representation in government of the interests of MSMEs, and their insolvency in particular, is one problem. The Attorney-General deals with personal insolvency, the Treasurer with corporate insolvency and then there is the Minister for Employment, Workforce, Skills, Small and Family Business. Agencies such as ASBFEO and COSBOA | Small Business Advocacy | Australia assist.

Australia has not had a review of insolvency for over 30 years, more so of its structure, and the Principles illustrate the separation between what is said to be current best practice and the disparate approach taken in Australia.  Australia’s insolvency rating of 20 by the World Bank might be too high.  This is not to say that the World Bank’s views on insolvency have not received some informed and critical attention in the past, [9] and aren’t necessarily the best option for Australia, for example with its complicated federal structure and its pro-creditor legal culture.

The Principles also call for insolvency to be examined from the customers’ viewpoint, not that solely of the law.

But in light of the impetus of COVID-19, and in the absence of any relevant insolvency debate here the Principles must be acknowledged as representing an informed and experienced view which should prompt Australia to at least give some better attention to the insolvency issues of small business.

Draft

Some might take issue with this, say one of the relevant government Ministers; in which case I’ll call this a draft and await any comments or corrections.

===========================

[1] In corporate insolvency, see the Consequential amendments to small business insolvency reforms Treasury Laws Amendment (Corporate Insolvency Reforms Consequentials) Bill 2021 No. , 2021.  The Bankruptcy Act is also being reviewed.

 

[2] ASBFEO’s Small Business Counts report uses two primary definitions: one employing less than 20 people (ABS); or with a turnover under $10 million (ATO).

[3]  See Business and non-business statistics | Australian Financial Security Authority (afsa.gov.au)

[4] This schedule does not include the several principles with which Australia does generally comply. For example, the Principles say that a debtor in possession is the preferred approach with removal of the debtor being “exceptional and based on limited grounds well-defined by the law”. Part 5.3B generally provides for this in its current 5 matters.

 

[5] Explanatory Memorandum to the Insolvency Law Reform Bill 2015 at [9.137].

[6] The World Bank deals with consumer debtors separately. See Perspectives on Australian bankruptcy law through the prism of the World Bank report on the treatment of the insolvency of natural persons (2014) 14(3) QUT Law Review pp. 3-28, Mason and O’Mahony.

[7] This is changing, this year, but with a long lead time.

[8] But see www.uncca.org

[9] See Small business insolvency in World Bank Spotlight, Shaw Gidley newsletter, Paul Gidley, 28 March 2019; and 2018 World Bank report on MSME insolvency, implications for Australian law reform (2018) 30(4) ARITA Journal pp 18-21, Mark Wellard.  These obviously pre-date COVID-19.

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2 Responses

  1. Excellent read Michael. Perhaps the nibbling at the edges of corporate insolvency that we are seeing now will lead to wholesale change that recognises the need for a single insolvency regime. Perhaps a separate regime for MSMEs.

    1. Thanks Jill.
      I acknowledge it needs some readjustment of the way we traditionally look at this, which is from the lawyer/accounting perspective, rather than the customer/client, that that in itself might present difficulties.
      ‘Nibbling at the edges’ explains it well but any serious reform would need to take a bigger bite.

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