Insolvency law failing small business

Our insolvency law framework is complex, slow and expensive and regularly produces no returns to creditors. It is a system that is no longer fit for purpose, which has been made clearer by the COVID-19 crisis. Much of Australia’s insolvency law rules are grounded in the 19^th Century and the time has come to move insolvency law into the 21^st Century. 

That’s one of the key findings made by the Australian Small Business and Family Enterprise Ombudsman’s recent report on the effect of insolvency law on small business. The Report calls for a fundamental rethinking of insolvency law, to help small business deal with financial distress.

It has long been evident that given the cost and complexity of our corporate insolvency laws, the inherent lack of money in business failure, and the changing nature of business assets, there is barely enough to pay the costs of what is a privatised insolvency system in dealing with business failure, let alone repay creditors.  Many companies are simply too poor to go broke and are abandoned rather than put through an insolvency process.

One of the problems is that our insolvency laws adopt a ‘one-size-fits-all’ approach that makes little distinction between winding up a national transport company and dealing with a failed corner store business. This work must be paid for and while the former may well justify the attention of what is an experienced, and highly regulated, private profession, the latter, representing the bulk of insolvencies, will generally have limited or no assets to even fund the work required, let alone pay a dividend to creditors.

Such a market failure needs government intervention. In our view, a government liquidator is needed to handle the large number of unfunded insolvencies. It should also take a role in ensuring regulatory compliance, reporting and enforcement in insolvency, comparable with the roles that that have existed for over a century in the UK and New Zealand. This would free up private insolvency and restructuring professionals to apply their core skills of identifying businesses that can and should be saved and in generating returns for creditors through asset sales and recovery proceedings. Asset-less companies with no prospect of return should be administered by government, acting in the public interest. The focus should shift to efficiently dealing with the problem of hopelessly insolvent businesses with little or no assets in an administrative way rather than offering them the only option of a fee for service liquidation process run by a chronically under-resourced private profession.

In addressing these issues, the Report suggests several helpful reforms to reduce costs through streamlined processes and electronic reporting and recommends greater early intervention and assistance for small business owners to help them save their businesses before it’s too late. These ideas call for better access to information, in particular with free access to ASIC’s company records, and a whole of government approach.

The Report also recommends severely restricting the rights of secured creditors such as banks and preventing creditors from enforcing personal guarantees given by business owners to support corporate loans. These measures would radically reshape commercial finance and would likely further restrict the flow of credit to small business and would need to be approached with caution.

The Report fails to address the significant relationship between personal and corporate insolvency, with many small business owners having both personal and corporate debts. Their business models do not fit in with Australia’s separation of corporate and personal insolvency laws. A combined insolvency system, with its own insolvency regulator, is needed.

Although the Ombudsman’s inquiry was commenced in 2019, before the current crisis, it has arrived at a time of greatly heightened need for insolvency law to be refocused for small to medium businesses. Australia is not alone in this, with international attention being given by the World Bank and other agencies to the plight of SME businesses, as being central to restoring many world economies impacted by COVID-19.    

The COVID-19 pandemic will bring substantially increased numbers of personal and corporate insolvencies. The Ombudsman’s report highlights the inadequacy of the current legal framework to deal with this increase. Now is the time to create an insolvency system for a modern economy, rather than continuing with a broken system that fails the community.

Jason Harris is Professor or Corporate Law at Sydney Law School. He teaches and researches in the areas of Corporate Law, Insolvency Law, Commercial Law and Contracts.

Michael Murray FAAL of Murrays Legal is Director of the Australian Academy of Law, and Fellow at UNCCA.

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