Anyone who has been paying attention in the second half of 2022 knows that things are getting dicey out there in the global economy, and that 2023 is going to be a wild ride, particularly for those who have been sailing close to the wind since late 2019.
In this article we look at 5 trends which started to emerge this year in the local insolvency and reconstruction space. We think you will hear a lot more about them in the New Year.
1. ATO debt collection activity
The ATO resumed its debt collection activities in mid-2022, after a significant hiatus during the pandemic. The ATO has its work cut out to collect a mountain of outstanding tax – as at 30 June 2022 it was AUD66.6 billion.
In addition to issuing statutory demands, Director Penalty Notices (DPNs) and garnishee notices, the ATO can now disclose outstanding business tax debt to credit reporting bureaus if the taxpayer is not “effectively engaging” with the ATO – this will immediately affect the taxpayer’s credit rating and ability to access finance.
The good news is that the ATO would still prefer to talk with taxpayers and their advisors who engage early and actively in a realistic restructuring and/or repayment plan to reduce the debt.
If a business is having trouble paying tax, the ATO doesn’t have to be the enemy. In the coming months it will become even more important for business advisors to know how to manage a relationship with the ATO on behalf of cash-constrained clients.
2. Increase in corporate and personal insolvency
We have been hearing a lot from the RBA recently about the need to bring inflation down under 3% – at the end of Q1 FY23, it was tracking at 7.3% (up from 5.1% at the end of Q4 FY22) and continuing to accelerate.
The prevailing economic wisdom is that central banks combat inflation by raising interest rates. Since April 2022, the RBA has raised the target cash rate from 0.10% to 3.10% on 7 December 2022. Financial markets imply that the cash rate is expected to peak around 4.2% in late 2023.
The last time the cash rate was above 3% was November 2012, meaning that many small and medium-sized businesses will never have experienced economic conditions like these in their lifecycle.
For every 1% increase in the cash rate, it has been said that Australian households see around a 5% decrease in disposable income. While there has been some positive wage growth off the back of low unemployment rates, the combined effect of the accelerating consumer price index and rising interest rates means that real wages continue to fall.
The effect of rising interest rates has been mitigated by a large uptake of fixed interest rate loans in the last couple of years, but people will be coming to the end of their fixed terms at an increasing rate next year, particularly after June, and when that happens their monthly mortgage repayments will skyrocket.
The upshot is that Australian households will experience a combination of financial stresses which we haven’t seen in decades, and it seems inevitable that there will be a corresponding spike in personal insolvency.
3. Construction industry collapse
The construction industry in Australia has been hit by supply chain constraints and labour shortages, causing delays and price increases which many companies cannot pass on to their customers. The result has been unprecedented financial stress on the industry, leading to failures like that of Clough Engineering in early December, notwithstanding that the construction industry is as busy as it has ever been.
The problems in the construction industry have been around for some time. Over 6 months ago, the Association of Professional Builders estimated that over 50% of Australian building companies were trading while insolvent, i.e. unable to pay their debts as and when they fell due.
The heat is coming out of the construction market in some parts of the country and there is some evidence that global supply chains are starting to unkink, but it is doubtful that all construction firms are going to bounce back to rude financial health in 2023.
It is almost certain that many companies will have used unpaid tax as working capital over the last couple of years to fund projects that have earned minimal profits, so an increase in external administrations in the building industry can be expected as the ATO returns to normal levels of collection.
4. Law reform
Every year there are legislative reforms and changes in case law in the insolvency field. In 2022 we saw the usual crop of statutory amendments and judgments that were very exciting for insolvency lawyers and of vanishingly small interest to the rest of the population.
As 2022 draws to a close, the Parliamentary Joint Committee on Corporations and Financial Services has begun an enquiry into Australia’s corporate insolvency regime. The terms of reference include a review of temporary reforms introduced at the start of the pandemic, and the effectiveness of earlier changes such as the unlawful phoenixing reforms introduces in 2019.
However, the terms of reference also include the examination of much more fundamental features of Australia’s insolvency regime, such as the remuneration of insolvency practitioners, the effectiveness of ASIC as regulator, and the operation of well-established and deeply unloved recovery processes such as unfair preferences.
Parliamentary enquiries do not necessarily change anything. This enquiry might be more effective than some, because when it hands down its report in May 2023 there will probably be many more financially distressed businesses and individuals in Australia than we have seen for some decades. There will be a corresponding need for an effective and functional insolvency regime, and hopefully the enquiry will facilitate the reforms needed to achieve this.
5. Small business restructuring
One of the recent reforms that the parliamentary enquiry will be examining is the Small Business Restructuring (SBR) reforms introduced in 2021.
SBR is a debtor-in-possession restructuring model available to insolvent companies with less than $1M in debt at the time a restructuring practitioner is appointed, and with employee entitlement paid and tax lodgements up to date at the time the restructuring plan is proposed to creditors.
SBR is an attractive option for eligible companies because the day-to-day operation of the business remains with the directors and, because of the more limited role of the restructuring practitioner, it should be cheaper than a voluntary administration.
Uptake of the model was very slow at first but is on the rise – in the first half of FY23, there were more SBR appointments than in the previous 18 months combined. It is difficult to know whether this is a result of worsening economic conditions or increasing familiarisation with the process among business advisors – probably both factors are at play.
Attempting to predict the future has been a singularly unrewarding pastime in recent years. It seems that even the most conservative forecasts of pundits since 2019 have been trampled by one or more of the Horsemen of the Apocalypse. We can only hope that our modest speculations don’t turn out to have been hopelessly optimistic this time next year.
Disclaimer: This document contains a summary of relevant information or an opinion which is current at the date of publication. This document is not intended to constitute legal advice and does not take into account individual facts and circumstances. The reader must not rely on this document as advice.