The COVID-19 pandemic and the associated lock downs have led to a global economic slowdown, and Australia has been no exception. GDP fell by 0.3% in the March quarter, and on 3 June 2020 Treasurer Josh Frydenberg announced that Australia was officially in its first recession in 29 years.
While the Australian Government was quick to provide a range of economic support measures – having already spent $289bn or 14.6% of GDP in an attempt to keep the economy afloat – Treasury expects Australia's GDP will decline by 0.5% in 2019-20 and a further 2.5% in 2020-21.
Although some sectors of the economy will still experience growth, a number of industries will experience a continued decline in revenue throughout 2020-21 with the sharpest declines to hit international airlines, housing construction sector and pubs, bars and nightclubs.
So the question is "will there be a flood of formal insolvency appointments once the Government support measures are wound back in late September 2020?"
Conventional wisdom would say "yes" – after all, traditionally a recession leads to rising formal insolvency appointments – but so far this has not occurred. It would be reasonable to assume that Government measures to support the economy are the cause, but some figures from the Australian Securities and Investments Commission (ASIC) show a more complex picture.
Not only have formal insolvency appointments been decreasing over the last few years, they have actually decreased in 2020 compared to the same period in previous years, based on the number of companies entering external administration. A recent survey conducted by the Australian Restructuring, Insolvency and Turnaround Association (ARITA) supports that finding; according to it, 78% of insolvency firms have seen a decrease in their appointments compared to the same period last year.
In fact, according to ASIC, there has been a fall in the number of registered liquidators, and ARITA says close to 55% of insolvency firms are actually accessing Government assistance with 14% of firms reporting that they had implemented "a few" redundancies as a result of the downturn in work with another 10% expecting to.
So what is going on? And what does it mean for the long-term future of the insolvency sector and the regime under which it operates?
Government support measures keeping companies afloat
Without temporary COVID-19-related amendments, many otherwise profitable and viable businesses could have faced financial distress.
The first temporary amendment is the introduction of a new safe harbour in section 588GAAA. This new safe harbour "temporary relief due to coronavirus" provides directors with protection from personal liability for any debts incurred by a business while insolvent. This relief will only apply to debts incurred in the ordinary course of the company's business during the six-month period and directors must continue to comply with their other legal obligations for example, director's duties to act in good faith and in the best interests of the company. Notably, no prescribed statutory thresholds are required to be satisfied for directors seeking the protection from personal liability for debts incurred by a business while insolvent under section 588GAAA in comparison with that protection under the existing safe harbour in section 588GA, for example, having to ensure that all employee entitlements are paid and up to date including superannuation. The onus of establishing the protection of the new "temporary safe harbour" rests on the person seeking to rely upon the protection. The company will remain liable for all debts incurred.
An insolvent company who has continued to trade under the temporary protection in section 588GAAA could attempt to transition to the existing safe harbour protection in section 588GA of the Corporations Act. This could lead to two very different scenarios. Some companies may be able to utilise the temporary protection period to effectively implement the statutory safe harbour protection measures under section 588GA, to successfully restructure their businesses. Oddly, statistics indicate that there has been a decline in the levels of safe harbour advisory work. Other companies may simply do nothing, continue to trade while insolvent in breach of their general director's duties, with a potentially devastating impact on unsecured creditors and ultimately, employees.
Another temporary amendment that has led some businesses to continue trading is the changes to the statutory demand thresholds. The statutory minimum for the issuing of a statutory demand has increased from $2,000 to $20,000 and the period for compliance with a statutory demand, has been extended from 21 days, to six months. We predict that the Government will move to scale this temporary amendment back after 24 September 2020.
The JobKeeper program has also assisted companies with managing any short-term cash flow issues by providing support for payment of employee wages. While the program was due to end on 27 September, it will now continue (albeit in a reduced form) until March 2021.
Credit and capital
The big four Australian banks have agreed to extend repayment deferrals by up to four more months, providing them with time to assess the financial condition of borrowers who have been affected by the pandemic and borrowers with time to consider any restructure and make appropriate arrangements. It also removes the risk of a "fiscal cliff" effect in the second half of 2020, which would otherwise see borrowers unable to resume repayments once the support is removed.
It is said that the extended deferral time will provide affected borrowers with time to improve their financial circumstances. However, the bank extensions are to be granted in a case by case basis where the banks will work with the borrower companies to ensure that they are able to resume payments by exploring options for example, converting to interest only and extension of loan terms. Importantly, although interest rates are low, interest is still being capitalised, leaving the amount of the debt owed at the end of the deferral period greater than what it otherwise would have been.
Is the safe harbour encouraging restructures instead of formal appointments?
The Explanatory Memorandum to the safe harbour stated that the reform was to encourage directors "to keep control of their company, engage early with possible insolvency and take reasonable steps to facilitate the company's recovery instead of simply placing the company prematurely into voluntary administration or liquidation".
Despite directors' best efforts, some companies will not be able to recover and will still proceed to voluntary administration or liquidation. Provided that the director was developing or pursuing a course of action reasonably more likely to lead to a better outcome for the company, then they will still have the benefit of safe harbour in these circumstances. If the safe harbour is being used and distressed companies are able to successfully restructure, then it follows that there should be a fall in the number of formal insolvency appointments.
While there has not yet been any empirical studies considering the safe harbour, a number of small reviews have occurred.
When one considers that the vast majority of companies that enter insolvency are small companies, this could be a significant issue. This is further heightened as the sectors of the economy which are most likely to be impacted by the economic effects of COVID-19, are predominately comprised of small and medium entities.
Further, in ARITA's mid-June survey it was found that the use of the safe harbour has actually declined since the pandemic began, with 31% of respondents saying that their safe harbour work was at lower levels and only 6% reporting any increase in safe harbour work.
Accordingly, while a recession may seem like the perfect time to test the effectiveness of the safe harbour it may be too early to extract any new trends, and the introduction of the emergency legislation in section 588GAAA may only complicate matters of permanent reform at this stage.