Small business sole trader insolvencies

A recent newspaper report on the trend of insolvencies in small business was interesting for the reason that it acknowledged that many or most businesses are run by individual people and not by inanimate companies, and that even if there is a company involved, corporate veil protection of the owners has its limits: Insolvencies up as directors’ guarantees hit, C Herde, p 28, Weekend Australian 2-3 March 2024. 

Our “small business” corporate insolvency process does not deal with the personal liabilities of the persons running the company and its business, in fact they are specifically excluded.  

The newspaper report referred to “personal guarantees catch[ing] up with the directors of previously wound-up businesses” and to AFSA statistics showing an increase in business related personal insolvencies into January 2024. 

AFSA has reported that “personal insolvencies” across Australia fell ⇓ significantly in the December 2023 quarter (2608) compared with the September 2023 quarter (3108) but were higher ⇑ than the 2022 December quarter (2321).   AFSA advises that of those 2608, just over 25% (713) were business-related.

But bankruptcies and Part X agreements are the main thing to track, rather than “personal insolvencies” which include debt agreements constituting nearly 40% of all personal insolvencies. With their low monetary thresholds, they are not typically entered into by business debtors. 

More useful and telling figures are that, in the December 2023 quarter, over 40% of bankruptcies and around 54% of Part X agreements were business or company related.  These proportions are largely consistent with previous years: High level of business bankruptcies in construction and retail – Murrays Legal

Good data is not available to show the type of connection between a business failure and a personal insolvency, including the connection between a corporate failure and personal insolvency, and vice versa. 

Recommendations 4 and 5 of the 2023 PJC Report on Corporate Insolvency were that ASIC “collect high quality, granular data in relation to insolvency and provide this data in a timely way to relevant government agencies and regulators”, and that the proposed comprehensive review of insolvency “consult data holders, researchers, industry participants, and public sector organisations to progress the access to and analysis of insolvency data”.

No doubt that data gathering is happening as I write, in particular by industry participants who need it to explain and perhaps counter what came out of the PJC Report about the state of the insolvency system.

The Small Business Ombudsman (ASBFEO) does gather useful data.  It has recently written [1] about insolvency processes in the context of Australia’s 2.5 million small businesses, noting that the majority are individuals and the remainder companies.

In respect of companies, the ASBFEO article refers to the complexity arising from “the unique entwining of personal and business finances”, with nearly half of outstanding small business finance being secured by residential property, blurring the line between corporate and personal insolvency. 

Regardless, “current laws embed a legal distinction and separate approach to business insolvency and personal bankruptcy” rather than an integrated process. 

For example, while Part 5.3B allows a small corporate business to compromise its debts, and to pick and choose whom it pays [anecdotally], it does not resolve personal company related debts; nor does Part 5.3A.  

Hence the insolvency statistics are not that helpful.

AFSA analysis

AFSA reports that most bankruptcies continue to be commenced by way of a voluntary debtor’s petition (90%); most are administered by the government Official Trustee (85%); and most (80%) are handled by a high concentration of 9 firms including the Official Trustee, out of 144.

AFSA has presented some figures on the nature of business bankruptcies. For example:

“Business-related personal insolvencies contribute over two-thirds of total system debt ($9.6 billion). The average debt for a business-related personal insolvency is $905,708 — over 6.6 times greater than the average debt for a non-business-related personal insolvency ($136,926)”.

Average dividend returns to creditors in 2022-2023 were 2.19c/$.

With business failures generally constituting upwards of 40% of all bankruptcies, the consequence of that is severe, with bankruptcy imposing a minimum 3-year restriction on certain business and other activities.  Nevertheless, AFSA says that for those in small business who appear in the corporate or personal insolvency systems and are

“personally liable, bankruptcy through the personal insolvency system may be the most suitable option”.

AFSA goes on to say that:

“Due to the high average amount of liabilities for business-related personal insolvencies, and correlations with the corporate insolvency system, AFSA continues to explore ways to work with co-regulators to provide consistent and streamlined advice for people who may enter the insolvency system through different channels”.

Reform and politics

The need for better legal connection between personal and corporate insolvency was also raised in the 2023 PJC Report on Corporate Insolvency which found that

“the division in insolvency law does not correspond with the operating reality for many Australian businesses, and can greatly increase the costs and complexity they encounter in insolvency”: [5.71]. 

The political reason our Part 5.3B corporate insolvency process does not deal with the personal liabilities of the directors is that any insolvency law change must maintain the division of insolvency responsibility between Treasury and Attorney-General’s Department, irrespective of the needs of business. 

Personal insolvency law reform consultations were had over 3 years ago as to the then economic impact of the coronavirus, including as to the impact that it had “on unincorporated businesses such as sole traders and partnerships”.[2]   The consultation raised reform issues going back to 2015. It was hardly root and branch thinking.

But while AFSA says it continues to work with ASIC and others to provide “consistent and streamlined” for small business, no doubt assisted by the ASBFEO, no relevant small business law reforms have appeared. 

The government’s response to the 2023 PJC Report on Corporate Insolvency is also awaited. 

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[1] Recent trends in small business, Bruce Bilson and River Paul, ASBFEO, (2023) 22(9&10) INSLB 136.

[2] The bankruptcy system and the impacts of coronavirus (ag.gov.au)