Insolvency – why breaking up is hard to do

Last year marked the highest number of corporate collapses recorded in Australia

At a time of record business failures, learning what to watch for is highly recommended.

LAST YEAR marked the highest number of corporate collapses recorded in Australia. In 2012 there were 10,757 companies put in the hands of an insolvency practitioner. That’s about 7 per cent higher than the previous peak, during the 2008 global financial crisis.

A further 22,163 people went bankrupt during 2012, while another 9343 elected to avoid bankruptcy via a formal repayment arrangement known as a Debt Agreement or Personal Insolvency Agreement.

Only 5 per cent of the bankrupt estates will pay a dividend to creditors. The dividend will typically be about A7 cents in the dollar.

Some 5 per cent of corporate failures will pay a dividend to creditors of about A10 cents in the dollar, while another 2.5 per cent of companies will pay a dividend in the range of A11 to A50 cents.

It follows that 93 per cent of companies and 95 per cent of the bankruptcies will not pay a dividend to their creditors – and, of course, shareholders will not be paid anything until creditors are paid in full.

After managing about 1000 corporate failures in 15 years as a liquidator and trustee in bankruptcy, it is timely to outline some of the constants and warning signs of insolvency.

A typical insolvency: The warning signs

Most directors fail to consult with a liquidator to get asset protection advice when they set up their new business.

It may sound self-serving, but it’s true; directors need asset protection advice when they set up and liquidators are the most cost-effective source.

Poor structure

There’s nothing more common in the world of SME insolvency than to find sole traders losing their house when a corporate shell may have prevented the loss.

Start-up SMEs should trade via a company with a single director that has an appropriate security interest (a fixed and floating charge) to protect their investment.

Directors should own only 1 per cent of their matrimonial home.

Poor accounts

Poor accounts are a constant in the world of insolvency and are typically the first warning sign of insolvency.

Directors need to know the detail of their profit and expense centres, monthly earnings before interest and tax (EBIT) and gross margins together with product and industry cycles.

If detailed accounts aren’t your strength, find a great management accountant who understands these essential business tools.

Staff consultation and retention

Staff retention, in the three key business skills of sales, product or service delivery and accounts that comply with a sound business plan, is the goal.

Regular management meetings with the key staff are an inexpensive tool often ignored by insolvent companies.

Lack of working capital

Exceeding the overdraft limit, returned cheques, and requests for increased security from your bank is not normal business practice; it’s a sign of insolvency.

Mortgage the house

Most directors respond to working capital limitations by injecting their own money into the business.

Selling the last available asset before fixing the underlying trading problems is a frustratingly sad yet common mistake made by directors of insolvent companies.

This is the time you should consult a liquidator.

ATO debt accrues

The next step in the typical path of a failed business is to use the Australian Taxation Office (ATO) as a bank.

Delaying the payment of tax and superannuation is another constant in the world of insolvency.

Most directors are not aware of the ATO’s enhanced director penalty regime, which came into effect in June last year.

Directors are now automatically liable for PAYG debts that are unreported for more than three months and remain unpaid.

In the old days, directors could wait until they received a Director Penalty Notice and then put the company into liquidation to avoid personal liability.

That loophole is now closed. Furthermore, directors are also personally liable for superannuation guarantee charge obligations that are unreported for more than three months and remain unpaid.

Now more than ever, a good accountant who reports on time is vital for an SME.

Creditor litigation

The next step in a typical corporate failure is an increase in creditor demand letters, stopped credit and legal actions that impede production.

It’s at this point that most directors will sit down with a liquidator to discuss informal moratoriums on payment of creditors’ claims, as well as formal restructure options.

But really there’s not a lot we can do if you have sold your house, alienated your suppliers, lost your key staff and have a large personal tax debt with no available funds.

Directors should seek specialist advice from a liquidator on asset protection strategies and can assist with restructuring and turnaround alternatives.

Shabnam Amirbeaggi CPA is an official liquidator and bankruptcy trustee, and managing partner of Crouch Amirbeaggi Insolvency Accountants. The only female managing partner of an insolvency practice in Australia, she was listed in our April issue as one of INTHEBLACK’s 40 Young Business Leaders for 2013.

Key to success

A good business needs distinct elements.

  • A good product or service
  • A successful sales team
  • An accountant who does more than just compliance
  • Directors also must be vigilant in recognising their strengths and seek professional help for their inherent weaknesses.

This article is from the July 2013 issue of INTHEBLACK magazine.