Do our insolvency laws suit small business failures?

In shopping for a suit recently, I noticed that the Big Store displayed its suits according to brand, which apparently suited the Store, or its supplier, but not the customer, or this customer.  Hence, I went elsewhere.

Insolvency service providers are like the Big Store in that they look at a customer – a business in distress- in terms of how it suits[1] them, not how business itself operates.  Their marketing follows suit. That is how the law is itself divided, between individual and corporate insolvency. Insolvency law looks at the underlying legal entities or entities in distress, that is, whether the business is a sole trader or a company or a partnership or a trust – rather than the business itself.  Internationally, this division is being reconsidered.  Perhaps we should.

 Insolvency ‘services’

So when a business, operated as such, starts to falter, the owners will find, beneath the marketing, that insolvency practitioners offer services only in qualified and limited terms.

One firm might only offer corporate services, because the practitioner is only licensed as a liquidator, not a trustee – the roles are separated in Australia. Other firms with practitioners licensed as both can’t fully assist. Insolvency law’s strict rules of independence generally require one insolvency practitioner appointed as liquidator for the company, regulated by ASIC, from one firm, and a separate practitioner from another firm as trustee of the bankruptcy, regulated by AFSA – all at added cost and time and often confusion felt by the business owner and creditors.  Courts are ready to dispense with these limiting and restrictive rules but they have to be asked.

The result will often be that a business will be classified as a corporate customer and be advised about corporate options, but not be told, or be referred elsewhere about the director’s personal liabilities. A sole trader, with an income, would get certain separate advice.

 Other options?

The better option would be for the business to initially go to an accountant who knows the relevant legal differences, and about failing businesses, and including about the trust and tax arrangements that accountant might have set up, including for the business owner’s family.  At least they can advise on the whole business.

Or a lawyer, who likewise can advise on the business and personal and tax arrangements.

Or, as the Small Business Ombudsman says, “if you don’t have a lawyer or accountant, call us for free and confidential advice”: Small Business Debt Helpline – CALL 1800 413 828 (sbdh.org.au)

Or, beyond these, a pre-insolvency adviser – lawyer or accountant or otherwise – who fills the vacuum created by insolvency practitioners being constricted in their work and in their marketing and who can advise the business, and all its various facets, on its various options.  They can make what is an unnecessarily complicated area seem much simpler.  Some are also the subject of warning about the legality of much of their advice by the regulators.

 Government

Government itself encourages this division. It operates like the Big Store – small business insolvency reform for individuals lies with the Attorney-General, as does employee insolvency protection; SME reform for companies and trusts with Treasury, which also houses the ATO and ASIC, and the Small Business Ombudsman. As to the courts, two federal courts deal with bankruptcy, and federal and supreme courts deal with corporate.

The government’s talk of “small business insolvency reform” is therefore a little deceptive; it is only about small businesses that operate through companies. The government knows that more small businesses in fact operate through individuals, or if they are incorporated, there are often personal liabilities of the individuals owning the business through guarantees or tax debts.  They are not assisted by the government’s limited reforms. Ideas sought by the government in January 2021 for other reforms related to the impact of COVID-19 have not been pursued.

So, while an insolvent company might be restructured through ‘new Part 5.3B’, or ended, by a ‘streamlined liquidation’, the insolvent owner’s personal insolvency liabilities are specifically not protected and must be dealt with under the severe bankruptcy law regime, which can also negate any corporate restructure.

Business law

While insolvency law has this strict legal focus, other significant areas of law, and government, apply to the economic reality, the business itself, without regard to its legal form.

The Small Business Ombudsman has as his “small business” constituency any “enterprise, activity, project, undertaking or arrangement” with fewer than 100 employees or revenue under $5 million.[2]  Its annual statistics report – Small Business Counts – makes no mention of legal structures in its useful body of statistics, mainly because the ATO and ABS statistics on which it relies do not either.  And government COVID-19 support moneys and concessions are paid to a definition of small business in the Income Tax Assessment Act 1997, based on aggregated turnover of under $10m. Privacy obligations are imposed on businesses with turnover of under $3m. Small business employers under the Fair Work Act are defined as those with fewer than 15 employees.

Business owners should necessarily understand that when establishing a business, the legal form is important, even if their real focus at the time is on the nature of the business, its products and its customers.  But perhaps the law and the legal form should change, and professional limitations.

International

Australia has been involved in the drafting and issue of international guidance[3] on MSMEs impacted by insolvency. That guidance explains that separated regimes like those in Australia may not be the best option:

“In the context of MSEs, it may not always be possible to separate their debts into clear categories. Individual entrepreneurs, owners of limited liability MSEs and their family members may all be involved in the business and use consumer credit to finance the business either as start-up capital or for operations. Business insolvency may lead to personal or consumer insolvency once a business fails, even if the business is a separate legal entity. For that reason, separate proceedings with different access conditions and procedural steps applicable to various debts involved in MSE insolvency may not be an optimal solution”.

The guidance recommends that

“all debts of an MSE debtor should be covered in a single simplified insolvency proceeding; where that is not possible under applicable domestic law, it recommends that at least procedural consolidation or coordination of linked insolvency proceedings should be ensured”.

These MSME insolvency issues are being further discussed this month, with a small team of senior lawyers attending from Australia.[4]

All this would require a rethinking across law and business and beyond.  COVID-19 and other potential economic impacts do not discriminate between businesses that are companies or sole traders.  At the same time, COVID-19 also offers some impetus and opportunity for rethinking.

Government arrangements

In a recent review of international insolvency practitioner regulation,[5] Australia’s separation of insolvency law and policy between two or more regulators, two or three ministers, and as many government departments led to a downgrading of its standing.  While decades of legal separation in Australia cannot be undone that easily by law reform, a suggestion made is that insolvency at least be consolidated within one agency.  Government culture can be stronger than the law.

That needs to be done with some thought.

In relation to small business, the recent transfer of the Small Business Ombudsman to Treasury, the centre for tax and corporate insolvency, and inactivity on trusts, leaves the majority of the Ombudsman’s small business constituents left to the Attorney-General, whose present focus is on terrorism, cyber-crime and religious discrimination.

What might have seemed an unwise transfer for the Ombudsman might be remedied by a transfer of personal insolvency law and employee protection to the Ombudsman’s department, away from the A-G.  Change in insolvency business law might then more readily be considered.  This might suit everyone.

Michael Murray*

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[1] Excuse the etc

[2] Australian Small Business and Family Enterprise Ombudsman Act 2015.

[3] United Nations International Trade Law Association. Working Group V: Insolvency Law | United Nations Commission On International Trade Law

[4] Through www.uncca.org, 3-17 December 2021, Vienna and on-line.

[5] Confidential

 

Chair, Expert Advisory Group, Working Group V, UNCCA.

 

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