In 2024, businesses in Australia will continue to navigate complex economic terrain marked by high-interest rates, ATO scrutiny and enforcement action, volatile markets, slowing consumer spending and the unpredictable effects of global political tensions and international warfare.
Several of these factors contributed to the rising levels of formal insolvency appointments and distressed asset sales seen over the past year, which is likely to continue into 2024.
In this article, we look back at, and think forward to, the trends and legal developments which businesses, insolvency professionals, accountants and investors need to be aware of as 2024 gets underway.
Key trends
Formal insolvencies
The general downturn in aspects of the Australian and global economy led to a heightened focus on financial stability and risk management within Australian businesses. Many businesses have encountered significant adverse fluctuations in aged debtor payments, with some debtors delaying payments, making partial payments or failing to pay altogether. This cashflow impact created a myriad of issues for creditor companies, including as to concerns about their own solvency. Some businesses have suffered restricted access to affordable credit and capital, seen competitors and distressed asset investors seeking to take advantage of the distress, and experienced board-level concern about the risk of personal liability for insolvent trading.
In 2023, Australia saw a surge in formal insolvency appointments, with a 42 per cent increase in voluntary administrations and a 56 per cent increase in receiver and manager appointments compared to the previous year. There were 10,366 corporate insolvencies in FY22/23, being the highest level since 2019 in which 11,224 insolvencies were recorded.
The Australian Securities and Investments Commission (ASIC) reported that companies entering external administration or having a controller appointed for the first time rose significantly from 4,912 in FY21/22 to 7,156 companies in FY22/23.
According to ASIC’s latest corporate insolvency statistics, published in December 2023, the predominant reported causes of business failure were:
New South Wales saw most insolvencies (41 per cent), followed by Victoria (27 per cent) and Queensland (18 per cent).
With the high rate of increase in corporate insolvencies, solvency concerns will occupy the minds of CFOs and board members in 2024, particularly in the light of ongoing global factors. These factors include, amongst others: persisting cash flow difficulties; continued disruption to supply chains; disruptive global influences (including the volatility in the US with the upcoming presidential election); a crunch on mainstream credit; and a downturn in the number of initial public offerings and appetite for risk in the private capital markets.
We expect that formal insolvency appointments will increase in 2024, exceeding the number of appointments in 2023 – especially as the ATO continues to take more aggressive enforcement action.
Heightened ATO enforcement action
In 2023, the ATO undoubtedly intensified its efforts in pursuing debts. This included the issuance of Director Penalty Notices (DPNs) (being ATO issued notices under which company directors can become personally liable for the company’s tax debts), garnishee orders and winding-up petitions. Anecdotally, and from Ironbridge Legal’s own experience, the ATO has been pushing back on payment plans, preferring to take enforcement action – especially where tax lodgements are outstanding and there has been a history of non-communication or persistent payment delinquency.
In the first half of 2023, the ATO initiated 476 winding-up proceedings compared to just 14 in the same period in 2022. The amnesty on penalties for SMEs that failed to lodge income tax returns expired on 31 December 2023. It is also reported that the ATO had issued approximately 31,000 DPNs by the end of 2023 and intends to increase their use in 2024.
Budget estimates indicate that the ATO’s debt book will continue to grow in 2024, reaching $50 billion. This will undoubtedly result in the ATO taking even more aggressive enforcement action, resulting in increased insolvencies, particularly of small businesses.
Enforcement action by secured lenders
If economic conditions deteriorate this year, financially distressed individuals and businesses may continue to experience leniency from the big banks. This is because indebtedness increased as a result of COVID-19, including to Australian banks which received $188 billion in cheap government loans from the RBA to help them support their customers and keep the economy afloat throughout the pandemic. In addition to this, major banks’ share prices have risen approximately 15 per cent in the last 6 months.
Considering these factors, and the continuing effect of the 2019 Royal Commission into Banking which left reputational scars, major banks may continue to take a relatively softer approach to some distressed borrowers in the short-term. This may include waiving covenant breaches, entering into forbearance agreements, using independent advisers to review the financial health of the business and value any underlying security, and allowing an administrator or liquidator of a company to deal with the secured assets of the business without the bank appointing a receiver. Despite this, there are already signs that this approach is being tightened – particularly where individuals and businesses do not engage proactively and constructively with the lender.
Restructuring behaviours
In 2023, Australia experienced a substantial rise in appointments of insolvency practitioners, with a 42% increase in voluntary administrations and a 56% increase in receiver and manager appointments from the previous year.
Ironbridge Legal also saw a rise in alternative capital providers and secondary lenders taking investment opportunities using Australia’s voluntary administration.
We expect that voluntary administrations (being Australia’s primary restructuring tool), along with the subsequent implementation of deeds of company arrangements (also known as “DOCA”), will continue to be popular methods for restructuring and effecting debt-for-equity swaps where appropriate.
Small business restructuring
In response to the COVID-19 induced financial distress the government expected would hit SMEs, Parliament introduced a small business restructuring scheme. According to ASIC’s latest corporate insolvency statistics, published in December 2023, SMEs dominated corporate insolvencies, with 83% owning less than $100,000 of assets, 82% having less than 20 employees and 68% owing less than $1 million in liabilities.
The use of the small business restructuring scheme continues to increase with creditors showing a willingness to embrace work-out proposals under this scheme. This framework provides financially distressed small businesses with a single, streamlined process to work with a restructuring practitioner to restructure their debts while allowing its owners to remain in control of the business. This is a faster and more flexible process for eligible small businesses, helping more of them to survive which can mean better outcomes for creditors, employees and the economy.
The small business restructuring scheme allows businesses to reduce their ATO and other unsecured debts by significant amounts. Anecdotally, some companies have intentionally brought down their liabilities below the $1 million threshold in order to qualify for this rescue procedure, the use of which is expected to rise in 2024.
Stakeholder involvement
There has been a growing trend of debtors actively engaging with stakeholders (creditors and shareholders), representing a shift from reactive insolvency to a more value-preserving, strategic approach. Doing this early and transparently enables businesses to develop restructuring plans that are more likely to garner support from stakeholders and increase the likelihood of success. In addition, Ironbridge Legal has also seen debtors seeking safe harbour advice sooner, to avoid the personal liability associated with insolvent trading.
Impacted industries
Consumer services
The consumer services industry is a cornerstone of the Australian economy, encompassing sectors such as retail, hospitality and tourism. Together, these sectors contribute more than 20 per cent to the nation's GDP and support the livelihoods of over 1.2 million people.
Consumer spending in these sectors surged following the pandemic lockdowns, reaching unprecedented levels. However, this spending boom is gradually tapering off as consumers divert money to pay increased mortgage repayments and implement a household savings policy.
Recent ASIC data revealed that a 12.5 per cent surge in insolvencies in January was predominantly driven by the accommodation and food industry, with 75 business closures in January following the projected busy period over Christmas (a 21 per cent rise as compared to the previous year). The hospitality sector – in particular restaurants and cafes – greatly suffered under the weight of cost-of-living pressures.
This downward spending trajectory, which is expected to continue in 2024, is likely to adversely impact businesses which were kept afloat by post-lockdown demand. In turn, there may be a consequential uptick in personal insolvencies as jobs are lost.
Construction
In 2023, about 28% of formal insolvency appointments were attributed to the construction industry. Several factors contributed to solvency concerns in the sector, including the inability to deliver under fixed price contracts, developer and head contractor insolvencies having a cascading effect on the contractual chain, and staff shortages and rising employment costs.
With the continued global price rise in raw materials, continued disruption to the supply chain and consistently higher interest rates, the construction industry is expected to be remain a major contributor to insolvency appointments in 2024.
Potential legislative changes and new guidance
Corporate insolvency report
In July 2023, the Parliamentary Joint Committee on Corporations and Financial Services issued its report on corporate insolvency. The report highlighted the need for an independent and comprehensive review of the entire insolvency system, encompassing both corporate and personal insolvency. It concluded that Australia’s corporate insolvency system is far too complex, inaccessible and costly.
Given that the Australian corporate insolvency system had not undergone a full review in 30 years, the report was welcomed. While it is not clear yet which of its 28 recommendations may be implemented, the Joint Committee identified several near-term actions and reforms, such as streamlining the simplified liquidation pathway and the small business restructure pathway, improving the insolvency process for trusts, and enacting the proposals outlined in Treasury’s 2022 report into the insolvent trading safe harbour regime (Safe Harbour Review).
Safe Harbour Review
The most important of the recommendations in the Safe Harbour Review were:
On 30 January 2024, Parliament released exposure draft legislation updating, amongst other things, the wording of the safe harbour provisions in the Corporations Act 2001 (Cth). The proposed amendments are intended only to correct technical and drafting defects and remove any anomalies. Accordingly, the recommendations of the Safe Harbour Review are yet to be implemented.
Updated guidance
In September 2023, ASIC released Consultation Paper 372 "Guidance on insolvent trading safe harbour provisions: Update to RG 217". The current version of Regulatory Guide 217, released in August 2020, focuses on fundamental principles aimed at helping directors understand their obligation to prevent insolvent trading, but it does not provide guidance on the operation of the safe harbour provisions of the Corporations Act 2001. The new draft of Regulatory Guide 217 proposes to expand on the sections relating to insolvent trading, such as by including: the actions directors must undertake to fulfil their duty to avoid insolvent trading; the consequences of a breach; the defences available in the event of a civil claim; and the parameters for establishing insolvency.
Submissions for the consultation paper closed in October 2023. ASIC is currently in the review process and is expected to publish the updated RG 217 during the first quarter of 2024.
Conclusion
Corporate insolvency rates are rising in Australia, and we expect that insolvencies recorded in 2024 will exceed the number recorded in 2023.
Businesses will need to consider their solvency positions carefully, remembering that the closer they get to insolvency, the more important it is to consider the duties they owe to creditors.
We expect that the volume of insolvency appointments we saw in 2023, as well as their expected volume in 2024, will lead to increased litigation against directors for breach of duties, insolvent trading and related voidable transaction claims (including against creditors).
With increasing corporate insolvency, we also expect to see an uptick in shareholder litigation, investor claims and personal bankruptcies.
The key message this year for directors, boards and creditors is to rigorously and proactively consider the risks and opportunities this market will present, and to brace for a potentially difficult year ahead.
By Trevor Withane, insolvency and litigation lawyer, Ironbridge Legal
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