It’s a common expectation during an economic downturn – insolvency practitioners and lawyers will see a significant uptick in work as a consequence of the failing businesses around the world that require their assistance.
But is that true, and is that going to happen in the short term?
As you might expect, financial distress isn’t always as easy as 1 minus 2 = insolvency.
The Main Catalysts for Insolvency
Companies being insolvent and companies being put into external administration are quite obviously different things. Sometimes one follows the other, but not always.
Any survey of external administrations you care to look at will find more than a few companies which have been operating at a loss, or even demonstrably insolvent, for months before the directors:
- Realise the issue; and
- Take action in response to it.
Sometimes directors genuinely (but mistakenly) believe that it’s merely a matter of temporary illiquidity and that an increase in cash flow is just around the corner.
Other times directors bumble on despite all the warning signs to the contrary.
But whatever the case, appointments for liquidators still depend on those two main factors: there being a company in severe financial distress, and somebody doing something about it.
Enter… The Statutory Demand
The humble statutory demand is a powerful tool that has been instrumental in company liquidations for years.
Whether it’s because a company voluntarily appoints external administrators or the Court appoints liquidators based on presumed insolvency, the statutory demand is a standard part of the equation.
But now things have changed dramatically in that arena.
Firstly, the statutory demand threshold has increased from $2,000 to $20,000. That in itself has been a topic of debate for years, but it does push a lot of standard collection practices aside for the time being.
But more importantly, the time to respond to a statutory demand has increased from 21 days to 6 months.
This is a dramatic and unprecedented shift.
Realistically, this simply means that people owed significant amounts of money won’t bother chasing it via the statutory demand process.
The result: a conventional (and possibly the most common) catalyst for insolvency appointments has been reduced to rubble.
But surely directors will still have an incentive to appoint external administrators if their companies are in financial distress, right?
Insolvent Trading Is Now Permitted
The stick that prevents directors from incurring enormous debt through insolvent companies is traditionally the risk that, in doing so, they would be personally vulnerable to a claim of insolvent trading.
That risk, and fear, often gave directors the nudge they needed to make the hard decision and put their companies into external administration.
Now, however, as part of the COVID-19 relief package, directors have something of a free pass when it comes to incurring debt because there is significantly reduced risk of insolvent trading for six months from 25 March 2020. There are a few conditions on this, but they aren’t hard to reach.
So with one fell swoop, we now have a situation where creditors won’t bother winding companies up, and directors don’t have much incentive to do it.
But won’t the downturn mean that companies will just run out of money at some point, even without these pressure points?
Artificially Inflated Cashflow
Now don’t get us wrong – the government’s stimulus package is probably a good thing overall, and we know many businesses who desperately needed many of the measures that have been introduced. That includes the rent relief package, the cash flow boost payments, and the JobKeeper initiatives.
So we’re not saying those are bad things.
What we are saying though, is that the stimulus is probably going to prop up more than a few otherwise insolvent companies for the next six months.
Those companies might be in financial distress for reasons unrelated to COVID-19, but will probably still be able to cling on thanks to the stimulus package. So, with creditors unable to do anything about collecting their debts, and directors having no real incentive to put the companies into administration or liquidation, these companies will probably still be here when the stimulus ends, and the Corporations Act returns to normal.
So will there be some kind of glut of profitable appointments for liquidators when the stimulus ends?
The Problem of Empty Shells
One of the more significant challenges for insolvency practitioners is not getting appointments to companies in distress. It’s getting profitable appointments to companies in distress.
There isn’t much that can be done beyond the essential compliance if a company has so few assets at the time of appointment that the liquidators are unable to pursue any debts or voidable transactions.
Similarly, with directors having a free pass on insolvent trading over the next little while, practitioners likely won’t find much benefit in pursuing those regular investigations about company insolvency.
While we’re confident that there will be a large number of administrations and liquidations in the last few months of 2020 (assuming the stimulus does not get extended), a lot of those are going to be unprofitable for the practitioners.
What to Do as a Company?
As a company owner or director, don’t take your eyes off your finances during this period.
Yes – by all means avail yourself and your company of whatever boosts or stimulus you might be eligible for.
But make sure you’re keeping a close eye on the other numbers too – how are sales, profits, expenses and other matters going? Can you take steps to mitigate or expand during this period?
You’ve probably spent a bit of time battening down the hatches recently in response to the pandemic, but don’t forget to take some time to look ahead as well. What’s your plan to come out the other end?
What to Do as an Insolvency Practitioner?
Realistically, insolvency practitioners are used to appointments which don’t have a high (or any) profit from time to time.
Many insolvency practitioners are experts when it comes to turnaround opportunities, and our sense at PBL is that there will be a lot of those coming up soon.
Perhaps its businesses that managed to get through these tough times but just couldn’t come out the other end strong enough to survive.
Perhaps its businesses that need a restructure to help them thrive or just need to draw a line under their debt via a deed of company arrangement.
Whatever the case, there will be real opportunities for practitioners who can bring their expertise in a positive way to a market in desperate need of sound financial assistance and strategic advice.
So What’s The End Result?
The main drivers of insolvency appointments – statutory demands and the risk of insolvent trading – have mostly been removed from play for the next little while.
That, combined with the stimulus package, means that many companies will be carrying significant debt for a time, and might be functionally insolvent but take no action about it.
Appointments to liquidators following the stimulus end will probably be in high numbers. Still, the companies might be in such dire financial positions by then that insolvency practitioners can’t salvage much for creditors or, in many cases, even pay their fees.
Both companies and practitioners should be taking proactive steps both now and towards the end of the stimulus to position themselves well for the future.
We’re Here to Help
If you’re a business in distress or thinking that you might be once the stimulus ends, don’t wait to get proper advice.
If you’re an insolvency practitioner who needs a strong legal team by your side as you work with companies in distress, we’re ready to help.
Get in touch today.