Many of the historical rules which came into play when a business was having financial problems have been altered.
Governments all around the world have created and commenced a variety of programs to counter the economic consequences of having to shut down large sections of the national economies.
Below is a table showing how a company today faces different insolvency triggers and consequences to that of a company before corona took hold. The purpose of highlighting the differences is to demonstrate that strategies (turnaround techniques) to counter company financial problems many companies are having are different today in comparison to pre-Corona.
1. Overdue taxes (PAYG/GST/Super/Income Tax)
Pre Corona – Tax office hard line and hard to negotiate. Single most prolific applicant in the courts to have companies wound up. Utilised Director Penalty notices to make directors personally liable for tax debts. Issued garnishee notices to collect taxes from parties associated with the taxpayer. Was generally playing hard ball in tax collections.
During Corona – Tax office being retrained in all stimulus packages. Current policy is to avoid making any winding up applications until further notice. Required to enter as many repayment programs as is possible. Leniency is the priority. The ATO is repaying up to $100k per taxpayer over the next 6 months as part of the stimulus packages to ensure companies are not going to become insolvent due to outstanding PAYG or GST. Garnishee orders and director penalty notices are on hold until further notice. The ATO is open for negotiation on all outstanding tax debts with a view to deferral
2. Bank loan outside terms
Pre Corona – Where a borrower (financial institution) fell behind on compliance with lending covenants the banks would transfer the files to what is colloquially known as ‘Bad Bank’. That is, that section of the bank responsible for recovering debts from borrowers who were out of terms. The most likely outcome was to move the customer on to some other lender and clear the debt from the bank’s portfolio. In very bad cases they may introduce a receiver or simply force a realisation of any security they retained.
During Corona – By contrast the government has extracted from the banks the agreement not to act on defaulting borrowers for at least six months. It has also asked them to defer interest and repayments for six months and not to enforce any securities they may retain. The banks have agreed to this request.
3. Property lease in default
Pre Corona – Landlord retained strict rights over tenants. Would use power of eviction when it suited. Would rarely provide discounts or compromises unless the property was difficult to release. Tenants had few rights and Landlords little interest in preserving their business.
During Corona – Landlord market in potential disarray. Many tenants are now not paying rents and have ceased operations. Federal Government requiring Landlords to provide relief to tenants where a tenant has suffered losses in 2020. The landlord is required to wear reduce rent for up to 6 months in proportion to tenants’ commercial losses. Must extend lease and add rent lost to deferred period. NSW government offered subsidies to Landlords who lose up to 50% of their rent through land tax relief. Landlords cannot evict tenants.
4. Employee entitlements not up to date
Pre Corona – If entitlements were not paid or wages not being met at contracted/award rates employees had judicial review through fair work ombudsman. Usually a sympathetic arbitrator. Employee entitlements unpaid could create criteria to commence winding up application for smaller employers. Should a company lay-off staff there were no government relief packages Fair Entitlements Guarantee (FEG) Scheme in place as a safety net for outstanding employee entitlements for liquidated companies’ employees. Entitlements such a superannuation when not paid attaches personal liability to directors. Tax office is quite diligent in pushing for payment of outstanding super, audits, etc.
During Corona – Significant government relief packages. FEG Entitlements scheme continues unchanged for Liquidated companies owing entitlements. The Federal Government introduced Job Keeper and Job Seekers stimulus packages. Jobkeeper pays up to $1500 per employee per fortnight for businesses affected by the shut-down for up to 6 months. Significant incentive to retain staff if possible. Employers are currently cutting many staff from payrolls. Superannuation rules still apply however the tax office is required to provide timing relief to non-payers.
5. Suppliers not being paid in terms
Pre Corona – All providers of goods and services entitled to issue statutory demands for non-payment and the demand crystallised in 21 days. If uncontested the Statutory Demand used as basis for commencing winding up applications for any debt over $2000. It was an effective mechanism to get companies to pay debts if they had capacity to do so. Suppliers also take securities over goods supplied and can act on those securities when conditions are met.
During Corona – Federal government changes to statutory demand threshold and timetable has pushed the minimum amount to $20,000 and the time period 6 months to respond to a statutory demand. This effectively removes any incentive for any creditor (supplier/Service provider/employee/lender/ATO etc) from starting wind up applications thus taking away a major trigger for companies to fall into liquidation. One unexpected outcome of such a policy is to tighten credit availability as it heightens the risk of providing credit. That is, a company asked to provide credit to a customer won’t if they view it as a credit risk. This will shrink working capital for many businesses. It also creates a platform for unscrupulous operators to gain as much credit as possible and avoid ever paying particularly with the relaxation of insolvent trading provisions.
6. Insolvent trading provisions
Pre Corona – The Corporations Act contains an ‘Insolvent Trading ‘provision which is to act as a behavioural creator to prevent companies incurring credit/debit when the company is insolvent or likely to be insolvent. I.e. if a company incurs debt under that condition the directors can be held personally responsible for the quantum of the debt.
During Corona – Federal Government freezes the provision for 6 months from March 2020. Now no ‘punishment’ should companies incur credit in an insolvent situation. As noted above an unexpected consequence is that with the watering down of winding up mechanisms the field is now ripe for abuse. It is also creating a dynamic where credit is not given without other safeguards (security/personal guarantees) put in place. If other safeguards can’t be installed, then credit will simply not be provided. ASIC provides a complete outline of the changes.
7. Safe Harbour
Pre Corona – Corporations Act contains a safe harbour provision which acts as a countermeasure to the insolvent trading provisions. One of the unacceptable outcomes of the insolvent trading provision is that some directors place their companies into Liquidation/Voluntary Administration too quickly as they do not want to be held responsible for insolvent trading. It is thought in some instances if the company could have continued and introduced some turnaround programs the company would not have needed dot go into VA/Liquidation in the first place. The Safe harbour provision provides a ‘protection’ to those directors who elect a safe harbour option and continue to trade. That is a liquidator cannot subsequently pursue the director for insolvent trading even though the company was then placed into liquidation and the safe harbour strategy failed.
During Corona – The Federal government removed the insolvent trading provision and therefore the primary incentive to invoke ‘safe harbour’ has been removed. The unexpected consequence of this is that company directors have even less incentive to avoid insolvent trading as the turnaround programs that accompanied a safe harbour program are designed to restructure credit arrangements and business models. It was a clear mandate with rules to apply, such as engaging a qualified turnaround expert. The change removes that requirement and any unqualified person can now hold themselves out to be a turnaround advisor. Other problems are that the other criteria such as employee entitlements being paid up to date and all tax returns filed are no longer relevant during this 6-month period as is required under safe harbour. Some other insolvency related issues outlined by ASIC can be found here.
8. Availability of alternative credit and finance
Pre Corona – Prior to Corona availability of financing credit facilities ran along historical lines without government support except in special interest group cases (e.g. Indigenous enterprises etc). A business had to demonstrate sound financial metrics and provide adequate security to match the risk of the borrower and purpose. Lenders require borrowers to stay within terms and had default mechanisms and recovery terms adequate to protect the lender.
During Corona – The federal government provides liquidity and working capital to the SME market via a guarantee facility to banks for borrowers who borrow up to $250,000 over a 3-year period. The lend will be unsecured and the government will guarantee it up to 50%. The banks are being asked/forced to offer the loan. They are of course ensuring certain credit credentials of the borrower continue to be in place. A significant borrowing sector is that for commercial and investment properties. As noted above the government has forced landlords to wear some of the pain of their tenants. This is unprecedented and a far more relaxed environment for tenants than landlords and their lenders.
9. State taxes outstanding (Stamp Duty/Payroll Tax)
Pre Corona – A variety of taxes (Payroll tax/stamp duty/land tax) are exercised by state governments through their funding for the public services they provide. They have very strict collection regimes and enforce them consistently.
During Corona – State governments now relaxing collection regimes and reducing all taxes for a short period such as payroll tax, stamp duty and land tax.
The above is not intended to be complete, but does show the enormous changes that have occurred. What will happen in the future is anybody’s guess, but in the meantime accounting firms may wish to think about how they can assist their clients to survive and thrive.