“Ultimately, it seems that the two disciplines move as parallel universes, without any coordination …”.
Only “by linking the attempt to restructure the company in crisis to a strict review it is possible to compose the principles underlying the insolvency and competition law into a more coherent system”.
businesses that do not comply with their obligations are getting an unfair competitive advantage over other businesses that do
The ATO has recently said that it is committed to “ensuring businesses that do not comply with their obligations are not getting an unfair competitive advantage over other businesses who do pay on time”, so as to support “other creditors and businesses who themselves can often be left out of pocket …”.[1] It would do this by enforcing the tax laws, including to the point of insolvency of the taxpayer.
Beyond tax and insolvency law, the ATO regulates the black economy, in pursuing dishonest and criminal activities outside the tax system, and those who try to misuse or abuse it.
Persons avoiding their tax obligations and participating in the black economy
“have an unfair advantage, allowing them to undercut people doing the right thing. This undermines community confidence and puts pressure on the margins of honest businesses, directly affecting their profitability and livelihood…. It’s all about protecting honest businesses from competitors who are trying to get ahead by avoiding their tax obligations”.[2]
These competition perspectives are important. A business not paying or delaying its tax has a significant competitive advantage over those businesses that do pay, even though, for example, their relative efficiency might be poor. The ATO is therefore saying it has a role in ensuring a competitive business environment by pursuing non-compliant taxpayers, and unlawfulness beyond. This is apart from but related to its role in [trying to] ensure payment and recovery of taxes.
Typically in small business the unpaid tax will arise from not remitting withholding taxes from employee wages. The seriousness of that form of misconduct has been emphasised by the courts over the years, leading to the director penalty notice (DPN) and other reforms in 1993.[3]
The ATO might well have served a DPN on the directors, imposing personal liability. The directors might also have responded to the marketing by insolvency practitioners of the insolvency law products that serve to allow a company to ‘restructure’ and survive.
The survived company, assuming it does so, has offloaded maybe several hundred thousand in tax debt which other businesses, through efficiency and productivity, have been able to pay.
The clash
In contrast to Australia, there is useful debate in the UK and the EU that has identified the potential for the law of insolvency and of competition to
“clash, insolvency allowing an insolvent and possibly less efficient company to be restored to the market to compete unfairly, inconsistent with Darwinian processes of the promotion of an efficient market”.[4]
At the same time, the two legal fields both have the common purpose of expelling insolvent (and supposedly inefficient) companies from the market, allowing a better resources’ allocation and the entry of new companies.
Insolvency law’s particular focus on facilitating the restructure of a business so as to cleanse the business of its debt and resume trading is said to be a valid policy to encourage entrepreneurial activity without undue fear of failure, and to preserve as much of the value of the business as possible through its restructured form.
On its face that is fine, and generally accepted, but it does depend on the integrity of the insolvency process.
“A balance has to be struck between the conflicting interests of saving a struggling though viable company and the competitive advantages corporate rescue can bestow on such a company”.
Even on the basis of a valid process, it does give the restructured business an advantage over others. If the reason for the businesses’ failure was its economic inefficiency, which its restructure serves to cleanse and remedy, other businesses in the same market might feel aggrieved.
Mergers etc
[It should be noted that this discussion is separate from insolvency and competition issues in mergers and acquisitions which have become an increasingly common means of restructuring financially distressed companies. One relevant issue is the failing firm ‘defence’, which is a set of tests used to determine whether an otherwise anti-competitive merger should be approved due to the imminent failure of a firm in the absence of the merger.[5]
The tests broadly cover whether the failure of the firm is imminent in the absence of the merger, whether there is an alternative entity which can merge with or acquire the failing firm resulting in a less anti-competitive transaction, and whether the assets of the firm would exit the market in the absence of the merger.
These and related issues raise the potential need for assurances as to competition law compliance when an insolvency practitioner is selling a distressed company’s assets or business].[6]
Tax debts
In particular, the undue shedding of tax debts through insolvency has been seen as offering a particular and perhaps unfair competitive advantage, perhaps inconsistent with the ATO’s message of unfair competitive advantage.[7]
That undue release of tax debts may prompt a business environment in which corporate rescue is used as a ‘business tool’ that seeks to circumvent the Darwinian process of competition, to the extent that
“the trust in the insolvency system may be lost and the system may fall into disrepute and misuse”.
General non-compliance
It’s not only or at all an issue with insolvency and tax law. The ATO describes the black economy as including dishonest and criminal activities that happen outside the tax system, and those who try to misuse or abuse it, encompassing under-reporting of income and non-payment of superannuation through to serious criminal activities such as money laundering, illicit tobacco and the illegal drug trade.
If businesses are trading without paying taxes, or are in breach of employment laws, or consumer laws, their unlawful trading gives them an advantage over legally compliant businesses. Industry regulation by ASIC, ATO, ACCC and others should serve to address that.
That regulator enforcement necessarily involves self-help. Creditors, and the ATO, and consumers need to protect themselves from inefficient and non-compliant businesses. In that respect, if there were open and free access to ASIC registers, to Director IDs, to beneficial ownership details, to trusts, and more, the whole compliance environment would change. There isn’t.
UK/EU
While there is little debate here, the context of the UK/EU debate seems to be insolvency law’s increasing focus on business reorganisation and a rescue culture, and away from liquidation and expulsion from the market; rather paying attention to company reorganization, with a clear preference for the continuity of its activity, whenever this can preserve production and workplaces.[8]
This contrasts with the dynamics of competition, the natural selection and expulsion of inefficient companies without regard to their potential for being ‘saved’, which raises the potential for conflict.
The short-term perspective of insolvency vs the medium long-term perspective of competition law
“This conflict can only worsen if we consider the different horizon in which the tools of both disciplines are placed: the short-term perspective of the solutions in the insolvency procedures, and the medium long-term effects relevant for competition law”.
The short-term benefits deriving from the rescue of a large firm in crisis can cause, in the medium-to-long-term, a loss of well being for the community, since a weakening of competition may determine a lower capacity for innovation.
“If competition policy is based on its own strict criteria of the merits and efficiency of the firm, not supported by subsidies and so on, so too should insolvency law be decided according to technical and entrepreneurial assessments on the reality of the reorganization prospects, that is, on business merit”.
“Possible dysfunctions in the legal system can be addressed by an approach to business crisis management that is more sensitive to the consequences not only for the debtors and creditors, but generally for the business itself and its several intersections, in short, a macro-economic approach”.
There is a need for a shift in the understanding of insolvency law for its modernisation to adequately address the efficiency in the market and foster economic recovery and development:
“such modernization needs proper coordination between insolvency and competition law”.
These issues are well addressed in an article by Matthijs Van Schadewijk, among other academic commentary (in the footnotes). He writes in the context of UK pre-pack administrations, but his article is relevant more broadly.
As he says, competition law and insolvency law have been said to be
“clashing doctrines. On the one hand, competition policy is often criticised for interfering with the restructuring process of distressed companies. On the other hand, a certain degree of distortion of competition is inherent to insolvency law, especially corporate rescue. Insolvent companies going through a rescue procedure inevitably improve their market position and consequently gain a certain competitive advantage over solvent competitors who cannot take the same route”.
A balance has to be struck between the conflicting interests of saving a struggling though viable company and the competitive advantages corporate rescue can bestow on such a company.
He concludes that the development of the rescue culture has undoubtedly shifted the scales between the doctrines of competition and insolvency law and in light of the “European-wide ‘restructuring euphoria’, the competition implications of corporate rescue are more relevant than ever.
Part 5.3B etc
That article is written in the pre-pack context, being seen as often having unfair outcomes. As a matter of principle, these discussions might also prompt an analysis of all restructuring and insolvency processes. For example, Part 5.3B Corporations Act has been criticised in that the restructuring practitioner is not required to report on the commercial value of the proposal, or to advise creditors whether it would be in their best interests to approve or reject the plan. The goal is not necessarily to rescue the company in distress, but simply to present a plan to the creditors.
The restructuring practitioner does not report on whether the company will be rescued by the restructuring plan but merely whether there are reasonable grounds to believe that the company can comply with its terms. That hardly gives much comfort to competition principles.
It seems that the ATO is a creditor, maybe the only creditor, in Part 5.3B. Much then depends on the ATO to maintain the integrity of the process. But the ATO is necessarily bound by the legislation. Its guidance to practitioners lists the information it requires in order to be able to assess a plan but it makes no assessment whether a viable company, one more efficient, is being returned to the marketplace.
In competition terms, an inefficient business with large tax debts may offload that debt and resume trading among its competitors. Even Part 5.3A, sprouted always as a success, might only succeed because it offers more than a liquidation. Whether the business has successfully resumed and continued its place in the market into the future, having improved its operational efficiency through a restructure, seems too difficult an assessment to make.
It seems difficult enough for the industry to produce information on the operation of the insolvency regime itself, despite the quantitative nature of the source data; let alone to assess the economic and other outcomes of insolvency.
ATO
A further question is as to the role of the ATO generally. It is a government entity with model litigant obligations. As earlier explained, the ATO says it has a role in enforcing competition policy. In many insolvencies, and now in particular in Part 5.3B, the ATO is a major creditor and in effect directs the outcome of the insolvency. ATO’s attention to these matters is outlined in its guidance. While there are important threshold requirements, there is no call for assurance about the future viability of the company, let alone its competitive efficiency. Only if the plan involves contributions from future profits are financial forecasts and supporting assumptions required.
From a competition perspective, the ATO therefore has a central role in permitting, or otherwise, an insolvent and perhaps inefficient business back into the marketplace. Competitor businesses might feel aggrieved that a business whose low level of efficiency was such that it decided to not pay tax in order to ‘compete’, is thereby permitted back into the market to again ‘compete’. In the context of insolvency, both insolvency law and the ATO’s response to it is important from the competition policy perspective.
An end point in the ATO’s pursuit is to take insolvency proceedings or respond to the debtor’s insolvency. In comparison with ASIC, ATO’s insolvency powers are significant, and its presence in insolvencies so pervasive, it might properly be called the real insolvency regulator.[9]
Reform
The 2023 PJC Report recommended that ATO consider developing model creditor guidelines. As a Commonwealth agency, the ATO has a broad responsibility to apply or at least have regard to Commonwealth laws and policies. It may often be the only creditor in an insolvency with the public interest at heart, all other creditors and their lawyers only focusing on their own commercial or perverse interests. In a model creditor role, apart from its concern to administer the tax laws, the ATO could also be assigned a role to have regard to the broader consequences of unpaid tax on the market.
Beyond this, the interaction between insolvency and competition law should receive attention in any comprehensive review of Australian insolvency law.
Work in progress – comments welcome.
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[1] Commissioner’s address at the Australian Chamber of Commerce and Industry event | Australian Taxation Office (ato.gov.au)
[2] 5 ways the ATO is tackling the black economy | Business Victoria
[3] In the context of the old group tax, see Cullen v Corporate Affairs Commission (1989) 7 ACLC 121, 127 ” … group tax is part of the employees’ wages which have been withheld to be paid to the tax office on behalf of the employees. They are, for all intents and purposes, trust moneys which do not belong to the company. If the company’s directors use these moneys for trading purposes, it shows a complete lack of appreciation of this situation and a serious lack of commercial reality.” Cited in Didovich v ASIC [1998] NSWSC 534. This predated the Insolvency (Tax Priorities) Legislation Amendment Act 1993 (Commonwealth), and director penalties etc.
[4] See for example Pushing the Boundaries between Competition and Insolvency Law: Prepacking in the UK by Matthijs Van Schadewijk, (2017) 5 NIBLeJ 2.
[5] Merger control for IRPs: Do acquisitions of distressed firms warrant competition scrutiny? M. P. Ram Mohan Vishakha Raj W. P. No. 2020-05-02 May 2020 https://www.ibbi.gov.in/
[6] ACCC Merger Guidelines November 2017 at [3.22]. See also NZ Commerce Commission, Mergers and Acquisitions Guidelines, May 2022. See this excellent coverage The chill of competition constraints on the sale of distressed businesses in Australia | Knowledge | Global law firm | Norton Rose Fulbright
[7] Commissioner’s address at the Australian Chamber of Commerce and Industry event | Australian Taxation Office (ato.gov.au)
[8] Insolvency, Competition, Economic Growth (and Recovery), Vittorio Minervini.
[9] The ATO as an Insolvency Regulator (2007) 19(3) Australian Insolvency Journal 24, M Murray.
