Chapter 2A snapshot of corporate insolvency in Australia
Overview of Australia’s corporate insolvency regime
2.1Australia’s corporate insolvency framework is concerned with the financial affairs of corporations that enter financial difficulty and insolvency—a term describing a person’s or company’s inability to pay all their debts as and when they fall due.
2.2As the Department of the Treasury (Treasury) told the committee:
‘[i]nsolvency laws establish…fair, orderly, transparent and predictable processes’ for dealing with the assets and liabilities of companies who enter insolvency, ‘while promoting good corporate conduct and investor confidence’.
2.3The framework seeks to provide viable companies an opportunity to restructure and continue trading. Where this is not possible, it provides mechanisms for the closure of unviable businesses and reallocating resources towards other, productive uses, thus serving a broader function in the Australian economy.
2.4Keay’s Insolvency explains that this framework manages the impact of insolvency on all relevant parties, including unpaid creditors, business owners, employees, families, shareholders, and the government. The authors state:
An absence of any insolvency regime could mean that creditors pursue their own remedies individually, invariably inefficiently, often with the stronger prevailing over the weaker, and with unlawful conduct involved. The debtor would be subject to harassment and undue pressure, at the same time their own involvement in disposing of assets would go undetected. The reallocation of the business assets to better economic use would be hampered by the potential for their break up or loss of value or utility in the process.
2.5In addition to the context of a corporation, natural persons may also become insolvent and enter bankruptcy. Insolvency may arise in the context of a corporate entity or a natural person, the latter of which is more commonly referred to as ‘bankruptcy’. This report focuses on the former, although the latter is considered throughout this report where relevant.
The Australian insolvency framework
2.6Insolvency is indirectly defined in the definition of ‘solvent’ in section 95A of the Corporations Act 2001 (Corporations Act), which states:
(1)A person is solvent if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable.
(2)A person who is not solvent is insolvent.
2.7Common law consideration of solvency has articulated that ‘solvency is a question of fact to be determined by reference to the company’s financial position taken as a whole, viewed in light of commercial realities’.
2.8Australia’s corporate insolvency framework is set out in Chapter 5 of the Corporations Act (including the Insolvency Practice Schedule (Corporations) in Schedule 2), the Corporations Regulations 2001, and the Insolvency Practice Rules (Corporations 2016). It is administered and regulated by the Australian Securities and Investments Commission (ASIC), while Treasury provides policy advice to government in respect of corporate insolvency policy and legislation.
2.9Australia’s personal bankruptcy regime is established under the Bankruptcy Act 1966 (Bankruptcy Act) and is administered and overseen by the Australian Financial Security Authority (AFSA). The Attorney-General’s Department is the relevant policy department in relation to bankruptcy.
Historical context
Development of Australian corporations and insolvency law
2.10The Australian insolvency framework, like Australian corporations law more generally, derives from English law and has been thought to have emerged initially from the enactment of the first bankruptcy statute in 1542.
2.11Prior to Federation, the first such Australian laws were enacted by colonial governments to regulate business associations, corporations and insolvency. This legislation reflected English law to varying degrees. While the frameworks differed across the colonies, calls for uniformity across jurisdictions emerged in the 1890s.
2.12Upon Federation, the Australian Constitution (the Constitution) empowered the Commonwealth to make laws with respect to ‘foreign corporations, and trading or financial corporations formed within the limits of the Commonwealth’ as well as ‘bankruptcy and insolvency’. The extent, scope and application of this power, which has become known as the ‘corporations power’, has been the subject of consideration on numerous occasions by the High Court of Australia.
2.13While the Commonwealth first legislated to regulate bankruptcy law in 1924, (with further significant reform in 1966), State governments continued to hold primary responsibility for the governance of corporations in the post-Federation era. Agreements and other measures to facilitate uniformity across jurisdictions were introduced across States and Territories in the 1960s and evolved through the 1970s.
2.14In 1989, the Hawke government passed the Corporations Act 1989, which was the first national piece of corporations law to be enacted after Federation to regulate companies and securities, including the incorporation and administration of companies. However, a decision of the High Court of Australia in 1990 stated that section51(xx) of the Constitution did not in fact allow the Commonwealth to create laws that impacted the incorporation of companies, but it did have the power to legislate in relation to companies already incorporated. This decision clarified that the Commonwealth did not have the complete power to legislate with respect to corporations and that the provisions pertaining to incorporation within the Corporations Act 1989 were indeed invalid.
2.15Following that decision, a further uniform scheme was pursued, which was subject to further constitutional challenges. The issue of the extent of the Commonwealth’s legislative power with respect to corporations was eventually resolved by the 2001 referral of State powers to the Commonwealth under section51(xxxvii) of the Constitution. This enabled the Commonwealth Parliament to enact the current Corporations Act.
Recent developments in insolvency law
2.16On 20 November 1983, the then-Attorney-General referred to the Australian Law Reform Commission (ALRC) an inquiry into the ‘law and practice relating to the insolvency of both individuals and bodies corporate’. This review concluded in 1988 with the release of the ALRC Report 45 —better known as the ‘Harmer Report’ after the Commissioner-in-charge, Mr Ronald Harmer. The Harmer Report recommendations gave rise to, among other things, the creation of the voluntary administration regime, which was legislated in 1992 and commenced operation in 1993. Since the Harmer Report, corporate insolvency law has been the subject of various reviews and legislative changes. One such review was by this committee between November 2002 and June 2004.
2.17The Australian Restructuring Insolvency and Turnaround Association (ARITA) outlined the key reforms to corporate insolvency law from 1993 to date which can be found in Figure 2.1.
Figure 2.1Major changes in corporate insolvency law
Source: ARITA, Submission 36, p. 27.
2.18Further to the reforms listed above, additional inquiries, consultations and independent reviews have examined various aspects of Australia’s corporate insolvency framework, including:
the Productivity Commission’s final report into Business Set-up, transfer and Closure (2015);
the Australian Small Business and Family Enterprise Ombudsman’s (ASBFEO) Insolvency Inquiry Report (2020);
Treasury consultations:
- proposed reforms to creditors’ schemes of arrangement (2021);
- clarifying the application of corporate trusts in insolvency (2021); and
independent reviews:
- Independent review of the insolvent trading safe harbour (2021).
Corporate insolvency and COVID-19 pandemic emergency responses
2.19In March 2020, the Australian Government introduced temporary measures aimed at supporting businesses through the economic impacts of the COVID-19 pandemic, some of which directly related to corporate insolvency, and:
temporarily increased the threshold at which creditors could issue a statutory demand on a company from $2,000 to $20,000
temporarily extended the time companies had to respond to a statutory demand they received from 21 days to 6 months
temporarily relieved directors of personal liability for insolvent trading with respect to debts incurred in the ordinary course of a company’s business.
2.20These measures commenced on 25 March 2020 and were initially scheduled to end after six months; however, they were subsequently extended until 31December 2020.
2.21Although not directly related to insolvency, the JobKeeper payment nonetheless complimented these measures, assisting employers to continue to pay their employees’ wages. This scheme commenced on 30 March 2020, and was originally due to end on 27 September 2020, but was extended until 28March2021, with some changes.
2.22Concurrently, the Australian Taxation Office (ATO) paused most debt enforcement actions that would ordinarily have led to insolvency appointments. The ATO’s annual report for 2021-22 explained that ‘[d]uring the early stages of COVID-19 [the ATO] deliberately shifted [its] focus away from firmer debt collection action to assist businesses and the community experiencing challenges because of the pandemic’. This assistance included:
deferral of payment and [lodgement] dates,
allowing businesses to vary their payment instalments,
remitting interest and penalties, and
withholding enforcement actions including Director Penalty Notices and wind-ups.
2.23During this period, collectable debt owed to the ATO increased from $26.5billion at 30June 2019 to $44.8billion at 30 June 2022, an increase of $18.3billion or 69 per cent.
2.24The collective effect of these measures resulted in a dramatic decrease in the number of businesses entering administration, dropping by almost half in April2020, and remaining at low levels until April 2022. Included at Figure2.2 is a graph provided by ARITA which charts the number of weekly appointments of external administrators between 1 July 2018 and 1 July 2022 as reported by ASIC. The red line marks the commencement of the pandemic emergency measures.
Figure 2.2 Weekly external administrator appointments July 2018 to July 2022
Source: ARITA, Submission 36, p. 26. Data originally from ASIC.
2.25The ATO’s 2021–22 annual report identified addressing the debt accrued across this period as one of its key priorities in the recovery period. It sought to undertake this task by expanding its enhanced engagement program and making clients aware of potential firmer and stronger actions that could follow from a lack of engagement with the ATO in relation to an outstanding debt.
2.26After an initial awareness campaign launched in March 2022, the ATO issued 7,523 Director Penalty Notices (DPNs) between July and September 2022, which compared to only 125 DPNs issued over the same reporting period in the previous year. By December, the ATO issued an average of 150 DPNs each business day and rising. This compared to the pre-COVID era, in which the ATO issued significantly fewer DPNs, averaging around 52 each business day in the 2019 financial year (13,120 in total).
2.27During the course of this inquiry, the committee was told that the number of insolvencies was expected to rise to pre-pandemic levels, and perhaps beyond. One reason proffered for this was that the support provided by the emergency measures, including the shift in the ATO’s approach during the initial stages of the pandemic, kept a number of companies in operation that may not otherwise have been viable. Thus, the removal of these measures, and the ATO’s return to enforcement action in significant numbers, was expected to result in, and was observed as leading to, a rise in the number of companies entering insolvency.
2.28The projected increase in the number of insolvencies seems to be reflected in recent ASIC statistics. Figures released on 5 June 2023 indicate that in each month of the 2022-23 financial year to date, the number of companies entering external administration has increased relative to the same month of the previous two financial years, and nearing (if not exceeding) pre-pandemic levels. These same statistics show that construction industry continues to be the most highly represented industry in these statistics. The remainder of this chapter contains further discussion on trends in insolvencies demonstrated by ASIC statistics.
2.29Mr Michael Brennan (Offermans) summarised the difficulties that directors of Micro, Small, & Medium Enterprises (MSMEs) face with insolvency, including:
that practical day-to-day issues dominate more than regulations;
unavoidable conflicts of interests between personal and business director duties can lead to:
- interaction of personal and corporate insolvency law;
- governance issues around business and private use of assets; and
- difficulty in handling business non-performance in a timely way; and
inability to diversify human capital.
2.30Mr Brennan expanded on the above issue in terms of the practical aspects of human psychology for real individuals who are both the business owner and the company director, interacting with a legal system that attempts to separate the principal (the owner) from the agent (the company director):
The MSME owner is so inextricably linked to the success or failure of their business, that it is incredibly difficult to divorce their own feelings of failure when the business underperforms. In the context of agency theory, it is in the principal’s best interest that an insolvency appointment occurs to maximise outcomes. Unfortunately, that would present multiple issues for the agent, least of which is the possible loss of employment, exposure of personal assets to attack and the mental health issues associated with the ‘failure’ of their business.
The damage and loss to this human capital in MSME failures is devastating whilst being intangible and the fear of this loss must be addressed in every decision to engage in the insolvency framework.
As a result, nearly all business owners faced with such a loss will delay seeking any advice or taking any steps that may ultimately lead to an admission of personal failure and the cessation of their business.
The current state of corporate insolvency: a statistical snapshot
2.31In order to understand the current state of corporate insolvency in Australia, analysis of data collated by ASIC on insolvency provides a useful backdrop. Ona regular basis, ASIC publishes statistics on insolvency. This section uses the ASIC insolvency statistics to summarise:
corporate insolvency by sector, state, and type of administration;
company size, reports by sector and reports statistics;
level of assets and liabilities;
impact on creditors;
causes of company failure and types of misconduct; and
registered liquidator demographics.
2.32The data available in the ASIC insolvency statistics is discussed in Chapter 6, and contain significantly more detailed data, which is accessible on the ASIC website.
Corporate insolvency by sector, state, and type of administration
2.33On a weekly basis, ASIC releases insolvency statistics to report on the level of company insolvency in Australia the first time a company enters external administration or has a controller appointed. Summarised in Figure 2.3 below, the ASIC Series 1 data on corporate insolvencies indicates that:
Over the last year, insolvencies increased significantly in almost all states and territories and in almost all sectors (see right panel):
- construction, accommodation, food service, retail trade, and manufacturing have the highest numbers; however,
- care should be taken in interpreting the relative numbers by sector, as the level of business aggregation can significantly influence numbers; for example, the Virgin Australian Airlines administration impacted a significant portion of domestic air travel capacity in the country, while it would only count as one insolvency event.
All types of insolvency rose over the last year (top left panel), with the most common to least common types of insolvency being: creditor's voluntary liquidation; voluntary administration; court appointments; controller appointments; and restructuring.
It is difficult to discern any meaningful trend in the type of insolvency due to significant variations over time for each type of insolvency, as shown for New South Wales (NSW) in the bottom left panel of Figure 2.3.
Figure 2.3 Corporate insolvency by sector, state, time, and type of administration
Source: Plotted by the committee secretariat from ASIC insolvency statistics, Series 1, 3 April 2023 Release, https://asic.gov.au/regulatory-resources/find-a-document/statistics/insolvency-statistics/how-to-interpret-asic-s-corporate-insolvency-statistics/ (accessed 12 April 2023).
Company size, reports by sector and reports statistics
2.34This and the following sections use Series 3 data collated by ASIC which is based on external administrators’ and receivers’ reports for Australia, selected industries with the highest number of external administrators’ reports lodged by region for the financial year, as well as time series data. ASIC Series 3 corporate insolvency statistics are summarised in Figures 2.4 to 2.7. Series 3 reports only cover those corporate insolvencies in which potential misconduct is identifiedordividends of less than 50 cents in the dollar are expected (what could be called ‘deep insolvency’, a term used elsewhere in this report). ASIC noted that Series 3 reports capture the majority, if not all, companies.However, in interpreting the data presented in Figures 2.4 to 2.7, it is important to note that insolvent companies that are not suspected of misconductandare expected to return more than 50 cents in the dollar are not included in the dataset.
2.35 Figure 2.4 shows that:
Most companies in Series 3 reports have fewer than five full-time employees (bottom left panel), and the sectors with the most Series 3 reports are accommodation and food, construction, and business and personal services (top right panel).
Over 90percent of Series 3 reports are submitted by liquidators, with most of the remaining reports submitted by voluntary administrators, indicating that liquidation is the most common pathway involving external administrators (middle left panel).
Most types of administrators submit Series 3 reports to ASIC in the first three to five months from the beginning of insolvency (top left panel).
On average, all types of administrators estimate that the time to complete the administration will likely be less than five months (55 per cent), with 10per cent expected to take more than a year (top left panel).
Figure 2.4 Causes of failure, company size, reports by sector and reports statistics
Source: Plotted by the committee secretariat from ASIC insolvency statistics, Series3, January 2023 Release, https://asic.gov.au/regulatory-resources/find-a-document/statistics/insolvency-statistics/insolvency-statistics-series-4-quarterly-registered-liquidator-statistics/ (accessed 12 April 2023).
Level of assets and liabilities
2.36Series 3 reports to ASIC include information on the estimated assets and liabilities of the company in administration. This information indicates that companies with Series 3 reports are often deeply insolvent, with liabilities (top right panel, Figure 2.5) greatly exceeding assets (top left panel). Of note:
The estimated level of assets in insolvent companies is less than $1 in 30percent of Series 3 reports and under $10,000 in a further 20percent of reports (top left panel).
The estimated level of liabilities in insolvent companies is over $100,000 in 60 per cent of cases, with $250,000 to $1 million being the most frequent liability level (top right panel).
2.37 The deeply insolvent nature of most companies with Series 3 reports to ASIC is long-standing, with:
Estimated assets occurring most frequently in the two lowest categories of <$1 or $1 to $10,000 for the past 15 years (bottom left panel).
Estimated liabilities occurring most frequently in the categories of $1 to $250,000 or $250,000 to $1m for the past 15 years (bottom right panel).
Figure 2.5Level of assets and liabilities
Source: Plotted by the committee secretariat from ASIC insolvency statistics, Series3, January 2023 Release, https://asic.gov.au/regulatory-resources/find-a-document/statistics/insolvency-statistics/insolvency-statistics-series-4-quarterly-registered-liquidator-statistics/ (accessed 12 April 2023).
Impact on creditors
2.38Series 3 reports to ASIC include information on the impacts on creditors shown in Figure 2.6, which indicate that:
Unpaid employee entitlements (top panel) typically range between $1,000 and $150,000 and affect the following entitlements in decreasing size order: superannuation, annual leave, wages, pay in lieu of notice, long service leave, and redundancy.
Estimated amounts owing vary by creditor type (middle left panel), with:
the majority of secured creditors having $0 owing;
most unsecured creditors being owed between $1 and $250,000, but with significant numbers nonetheless owed over $1m; and
outstanding taxes and charges most commonly from $1 to $250,000.
(Other sources of data show similar trends. World Bank reports show returns for secured creditors in insolvency at 82.7 cents in the dollar. AFSA data shows average returns for unsecured creditors in bankruptcy at 1.6 cents in the dollar. AFSA notes that the Personal Properties Securities Register may contribute to the difference between returns to secured and unsecured creditors).
The dividend to creditors (bottom right panel) is estimated to be zero cents per dollar for 85 to 92 per cent of Series 3 reports over the past 15 years. ASIC's data collection and reporting method changed part way through 2020, leading to a recalibration of this statistic, which can be seen as the difference between the blue and red curve in the bottom right panel of Figure 2.6.
The most common level of liquidator remuneration was between $1 and $50,000, with voluntary administrators, deed administrators, and receivers typically having lower remuneration.
Figure 2.6Series 3 impact on creditors
Source: Plotted by the committee secretariat from ASIC insolvency statistics, Series3, January 2023 Release, https://asic.gov.au/regulatory-resources/find-a-document/statistics/insolvency-statistics/insolvency-statistics-series-4-quarterly-registered-liquidator-statistics/ (accessed 12 April 2023).
2.39Series 3 reports to ASIC include information on the causes of failure and types of misconduct shown in Figure 2.7 (see below), which indicate that:
The most common causes of company failure (top left panel), as categorised in Series 3 reports, include under capitalisation, cash flow, financial controls and record keeping, trading losses, strategic management, and economic conditions.
In most cases, the variations over time in the causes of company failure relative to each other (top left panel) follow the number of liquidator reports (top right panel). However, the number of reports identifying economic conditions (thick black line top left panel) is a clear exception. The number of Series 3 reports citing economic conditions increased by nearly a factor of six following the Global Financial Crisis.
Of the possible misconduct identified by Series 3 reports (middle right panel), breaches of civil obligations are the most common. The share of Series 3 reports with possible civil misconduct exceeds 100 per cent because multiple breaches are typically identified per company.
Possible criminal misconduct is identified in around 40 per cent of Series 3 reports, with post-appointment misconduct being significantly more common in reports than pre-appointment misconduct.
Over time, the incidence and relative share of different types of misconduct reported have changed significantly:
The number of possible civil breaches identified per report has approximately doubled over a decade.
The share of Series 3 reports identifying possible criminal misconduct has fallen from 70 per cent to below 50 per cent.
The share of Series 3 reports identifying no misconduct has fallen from 40per cent to around 10 per cent.
The bottom right panel shows further detail on the relative frequency of types of misconduct, indicating that the most common types of misconduct are insolvent trading, breaches of director's duties; and failure to keep financial records.
Figure 2.7Causes of company failure and types of misconduct
Source: Plotted by the committee secretariat from ASIC insolvency statistics, Series3, January 2023 Release, https://asic.gov.au/regulatory-resources/find-a-document/statistics/insolvency-statistics/insolvency-statistics-series-4-quarterly-registered-liquidator-statistics/ (accessed 12 April 2023).
Registered liquidator demographics
2.40The ASIC Series 4 data on registered liquidator demographics is summarised in Figure 2.8, which indicates that:
firm sizes range from one to more than 20 liquidators per firm, and there is no predominant firm size (top left panel);
most liquidators are between 40 and 60 years old (middle left panel);
liquidator numbers have declined slightly over the last two decades (bottom left panel);
the majority of liquidators are in NSW, Victoria and Queensland (bottom left panel);
the number of years since a liquidator was registered peaks between five to ten years and falls steadily for longer periods of registration (top right panel);
the share of female liquidators is below 10 per cent (middle right panel); and
over the past 15 years, approximately 30 new liquidators are registered each year, with the same number ceasing their registrations; however, the numbers vary significantly from year to year (bottom right panel).
Figure 2.8Registered liquidator demographics
Source: Plotted by the committee secretariat from ASIC insolvency statistics, https://asic.gov.au/regulatory-resources/find-a-document/statistics/insolvency-statistics/insolvency-statistics-series-4-quarterly-registered-liquidator-statistics/ (accessed 12 April 2023).