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Why swift action to flatten the COVID-19 ‘insolvency curve’ is vital

With the coronavirus continuing to decimate Australia’s economic landscape, lack of immediate action by already distressed SMEs will trigger an inevitable insolvency avalanche.

Insights Sule Arnautovic, Jirsch Sutherland 03 April 2020
— 4 minute read

While the financial support and debt deferral initiatives announced by the federal government will certainly offer invaluable lifelines, already struggling business owners who put off making crucial decisions as a result of this recently announced grace period risk merely postponing the inevitable.

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Lying in wait

Imagine having to pay six months’ rent, utilities and financing costs as a lump sum before you can open your doors again. That’s the situation some businesses will be facing when we eventually move into a recovery environment. Not surprisingly, there aren’t many businesses that will be able to sustain that type of capital hit. With the challenge of re-establishing market position, renewing trading relationships with suppliers and adapting to an altered environment, many businesses will be forced into a financial restructure through an insolvency procedure.

Make no mistake: debt deferral with no exit strategy is fatal. Unless appropriate action is taken now, it’s highly likely that in six months’ time, we’ll see a proliferation of businesses failing completely or experiencing dire financial difficulties. Indeed, during the last GFC, the busiest insolvency period occurred some 12 to 18 months after the initial shock, when banks began to enforce repayment requirements and the taxation bodies started “knocking” on doors for deferred tax.

While the regulatory and ethical obligations of directors have never been greater, neither have the consequences for individuals who get it wrong. Good intentions can still result in directors becoming personally liable for making wrong calls. Deliberately avoiding debt can land directors in even hotter water. The recent government moratorium on insolvent trading is somewhat of a red herring, given the raft of director obligations stipulated in Australia’s corporate legislation.

Knock-on effect

Significantly, the consequences of failing to flatten the looming insolvency curve will not only impact the small-business community. It will also likely see insolvency and restructuring professionals pushed to their limits as the advantages of government stimulus packages expire. It’s a situation that could see insolvency/restructuring practitioners inundated with terminal insolvency cases.

Significantly, the resulting strain on their time and resources could possibly reduce their capacity to help every business that might otherwise be saved or restructured. Further, if viable businesses are being inundated with mass terminal insolvencies of their clients at that time, it may cause some contagion to other businesses which might otherwise be saved/restructured as creditors scramble to deal with the fallout to their own businesses.

That’s why we at Jirsch Sutherland believe that finance professionals have an early, key role to play in averting disaster as the coronavirus disaster rapidly unfolds. Accountants are one such group ideally positioned to lend support as the reality of the COVID-19 world rapidly dawns for their clients. Helping business owners conduct a self-assessment is a vital first step to determining whether they are affected and, if so, to what degree. This process may even help some businesses identify new growth opportunities as a result of the “new normal”.

The line of inquiry need not be overly complex. For example: Has the coronavirus affected your business? If so, how are you coping? Do you fear that the coronavirus will soon create significant challenges? If your business is affected, would you describe the impact as marginal, major, critical or fatal? By simply asking these types of questions, accountants will be far better placed to provide early, tailored guidance.

Setting a course of action

While the current reality for many businesses is dire, it’s important to remember that there are a range of available measures that can help them ride out the crisis and re-commence their activities once it’s over.

Opting to restructure a business early (utilising the framework established under the safe harbour legislation) is one possible course of action, as is initiating a merger or consolidation.

Creating a creditors’ trust (a legal arrangement used to accelerate a company’s exit from external administration) for participating creditors may also be advisable.

Owners may alternatively choose to implement “holding”, “hibernation” or other deeds of company arrangements with a view to extending the period of moratoriums. This will buy crucial time to investigate potential restructuring opportunities.

Immediate liquidation and loss minimisation is also an option. This will possibly allow a business to restart further down the track.

For those business owners/directors who believe they may have prospects on the other side of this crisis, seeking immediate professional advice in order to take advantage of formal insolvency or restructuring options is vital.

The case for exploring options

When it comes to initiating an action or intervention, there are some very good reasons why company directors, accountants and lawyers should not delay insolvency or restructuring appointments. Still not convinced? Consider these realities:

  • The market value of many business assets has been adversely impacted. This essentially translates to a lower restructure cost for various restructure supporters who are trying to offer creditors more than they’d get in a liquidation scenario.
  • Creditors are more likely to understand why businesses have collapsed at this time and to support restructuring efforts to ensure continuity of business post-crisis.
  • If a business had accrued unpaid liabilities before the crisis, it’s unlikely to survive — even with government support.
  • Accessing the Fair Entitlements Guarantee Scheme (FEG) for employee entitlements takes time, so acting now will offer staff a quicker solution.
  • Any delays in action may also exacerbate liabilities resulting from personal guarantees. Businesses should be aware of “sleeping personal guarantees” (such as leases, make-goods, supplier credit applications, finance and credit card debts) that could put personal assets at greater risk later on.
  • Deferment of liabilities will be added to existing liabilities. For example, not paying rent for six months is not a pardon for that period and extra interest could well be capitalised into the outstanding liability amount. That’s why it’s important to always check the full terms and conditions of any finance agreement for any deferment.
  • Acting early also enables businesses to protect or limit their valued suppliers to ongoing debt exposure.

An eye to the future

Ultimately, action taken now dramatically increases the likelihood that stressed businesses will be able to re-emerge (albeit with different operational models or strategies) once the coronavirus crisis abates and the expected upturn commences. Of course, it’s not just financial and business ramifications at stake during this most debilitating of times. The mental health implications for all involved are also enormous. Dealing with a business problem early can offer clarity and play a major role in helping to reduce stress and anxiety.

Sule Arnautovic, partner, Jirsch Sutherland

Why swift action to flatten the COVID-19 ‘insolvency curve’ is vital
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