Bankruptcy exclusion period: will dropping it to one year really improve economic growth?

If the stigma around bankruptcy diminishes, rogue bankrupts could become less concerned about the consequences and creditors could suffer greater losses.

Australia's bankruptcy exclusion period is being reduced from three years to one year. Will this really reduce barriers and improve economic growth?

In late 2014, a communication from then Federal Treasurer Joe Hockey to the Productivity Commission requested an inquiry to identify barriers to business entries and exits in Australia. The end goal of the inquiry was “reducing these barriers where appropriate, in order to drive efficiency and economic growth in the Australian economy”.

Recognising the role that organisational entry and exit frameworks play in fostering innovation, competition, productivity and economic growth, Federal Treasury was looking for ways to make the system more efficient.

“Cultural appetite for risk is … an important determinant of the level of business entry and exit in an economy,” Hockey noted. 

“Business insolvency also results in losses to equity and debt holders, and to employees. Different approaches to managing insolvency can affect the efficient provision of finance and labour.”

One of the results of that 2014 request is a Bill before federal parliament that reduces the bankruptcy exclusion period from three years to one.

“Bankruptcy results in an ‘exclusion period’ during which the bankrupt individual cannot act as a company director, and is restricted in terms of access to finance, employment opportunities and overseas travel,” the resulting Productivity Commission inquiry report stated. 

“The Commission considers that this exclusion period should be reduced from three years to one year, but the trustee and courts should retain the power to extend the period to up to eight years.”

The intention is to reduce the stigma attached to bankruptcy and encourage entrepreneurs to start new businesses, while still preserving regulatory oversight to prevent abuse of the bankruptcy process.

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Shortening the bankruptcy period: what's the problem?

Although recognising potential benefits, many experts, organisations and governing bodies are concerned about the legislation. 

“There are practical concerns from an administration point of view,” says SMB Advisory partner Kristen Beadle CPA. 

“It’s a nice idea in theory, but practically and from a policy point of view, it’s going to make it difficult for a bankruptcy trustee to administer estates.” 

In a 12-month period, a bankruptcy trustee may not receive adequate information to fully investigate complex affairs, Beadle says. The only redress trustees will have, is to object to the discharge of the bankruptcy: effectively extending the period. This is the built-in fail-safe mentioned in the Productivity Commission’s report.

The Productivity Commission report found that in jurisdictions with one-year bankruptcy, such as the UK, there were some beneficial outcomes for the economy and entrepreneurs.” Narelle Ferrier, ARITA

The problem, she says, is that the process involved in objecting to a discharge is onerous and overly technical, so much so that many objections are no longer accepted. Regardless, objections to discharge will likely increase and, if accepted, increase the period of bankruptcy.

Then, according to Beadle, there is a possible decrease in consumer confidence around why bankruptcy laws exist. If the stigma around being a bankrupt diminishes, rogue bankrupts could become less concerned about the consequences and creditors could suffer greater losses in a market that does not inspire the same degree of confidence.

Is there an upside to shortening the bankruptcy period?

Narelle Ferrier, technical and standards director at the Australian Restructuring Insolvency & Turnaround Association (ARITA), agrees there are some concerns around the new bankruptcy exclusion period, although ARITA has no strong view one way or the other. 

“We consulted our membership and they actually had mixed views,” she reveals.

Part of the argument behind the 12-month bankruptcy was that it would encourage innovation. While Ferrier accepts that a regulatory framework that does not punish failure as heavily may encourage entrepreneurs to take the right type of risks, she also points out that most bankruptcies in Australia are consumer-driven by issues such as unemployment and irresponsible credit card usage.

“Having said that, the Productivity Commission report found that in jurisdictions with one-year bankruptcy, such as the UK, there were some beneficial outcomes for the economy and for entrepreneurs,” Ferrier concedes.

There is potential, some believe, for the shorter bankruptcy period to result in less red tape. However, there is an equally strong argument that it could create even more bureaucracy, particularly for trustees.

Part of the recipe for success, Ferrier maintains, is for other sectors of the regulatory and business world to change their bankruptcy-related policies and practices. If investors continue to provide credit to serial bankrupts, for example, those investors need to improve their due diligence processes. Further, regulatory mechanisms such as those around phoenixing must also be continually strengthened to create an environment in which rogue bankruptcy becomes less feasible.

If and when this happens, Australia will experience greater innovation, without bankruptcy being perceived as a trivial matter or, indeed, a badge of honour, she adds. 

“In the US at a corporate level, the general attitude is that you’re not playing with the big boys unless you’ve been into Chapter 11 at least once,” Ferrier says. 

“It would be a big shift in cultural perspective for us to get there, and hopefully this change won’t push us in that direction.”

Read next: Australia’s bankruptcy laws are about to change. Here’s what that means.

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