1-Year Bankruptcy, Why Businesses Fail, Negotiating Payment Plans and Phoenix Law Reform

11th September, 2018

One Year Bankruptcy

The Bankruptcy Amendment (Enterprise Incentives) Bill 2017 came before the Senate in late August 2018 and the legislation is now a step closer to becoming effective law.

Amongst many things contained in the Bill, some highlights are to:

  • provide for an automatic discharge after one year of bankruptcy, and related transitional arrangements;
  • enable the extension of a period of bankruptcy on the basis of an objection by a Trustee; and
  • ensure that a bankrupt or discharged bankrupt will be liable for income contributions for at least three contribution assessment periods.

With respect to income contributions, a bankrupt will still be liable to be assessed for income contributions for 2 years after discharge.

A Trustee has the power to extend the bankruptcy by making objections, but the Trustee will only have 12 months to assess and lodge objections. Such objections can extend the bankruptcy discharge period from 5 or 8 years from the date the Statement of Affairs is filed.

The revised period of bankruptcy is expected to reduce administrative costs for bankruptcy Trustees and the Government in administering and overseeing bankruptcy matters.
If the Bill is passed, the new provisions will commence 6 months after Royal Assent is received.

Once the new laws commence, all bankruptcies (including existing bankruptcies) will be discharged if they are over 1 year unless they are subject to a notice of objection.

When implemented, even large, high profile and difficult bankruptcies will be entitled to a one-year bankruptcy, just like your average consumer bankrupt.

Why do businesses fail?

A common question we are asked is why do businesses fail.

The short answer is that businesses fail because they run out of cash to pay creditors, so the answer comes from a consideration of the factors that create the cash flow problems in the first place.

We consider there are broadly three categories that cause cash flow problems in businesses. They are:

  • management reasons;
  • strategic reasons; and
  • operational reasons.

Management reasons include:

  • excessive use of company funds for personal purposes;
  • poor leadership by the directors who are not capable of motivating or managing staff to perform effectively/profitably;
  • disputes between owners causing irreconcilable differences within the business; and
  • starting a business for the wrong reasons i.e. buying a job or not having the skills to operate a small business in the first place.

With respect to strategic reasons, they include:

  • a lack of planning for, or a lack of focus on, a business goal that is achievable and profitable;
  • not being clear on what the business’ Unique Selling Proposition is;
  • being unable to satisfy customers’ needs when compared to that proposition;
  • failing to differentiate the business from similar businesses;
  • expanding the business before the business has the necessary capital to back it;
  • locating the business in a poor position; and
  • poor marketing strategy leading to an inability to connect with the customer.

Operational reasons include:

  • a lack of profit caused by an inability to extract a fair price for products/services sold or an inability to control expenses as revenues grow;
  • a lack of capital leading to heavy reliance on debt and increasing the sensitivity of the business failure from unprofitable trading;
  • poor financial reporting, meaning the directors of the company and other key stakeholders do not have reliable financial information to make business decisions; or
  • the company fails to comply with its reporting obligations for tax/superannuation and other statutory obligations.

In our experience, the following factors tend to coexist in many businesses that we see in external administration. These businesses:

  • have lacked any strategic planning;
  • have failed to differentiate themselves from their competitors;
  • have poor financial reporting; and
  • have suffered an excessive personal use of company funds.

Negotiating a Payment Plan

One of the first steps in implementing a restructuring strategy is to identify a means of creating short term working capital.

Often re-negotiating payment terms with creditors is the best way of easing the cash flow pressure and giving the business time to implement restructuring strategies.

We set out below some tips for consideration when negotiating payment plans with creditors.

Rule No 1 is to speak to your creditor as soon as possible after problems arise. Be sure to be clear how the problem arose and be specific about how, when and over what period you’ll make payments. Creditors will often work with you as long as your offer is reasonable, you keep up with agreed payments, and you keep in touch with them.

Rule No 2 is to be realistic when you offer to make a part payment on your debt. To do this, a reliable forward budget is required to forecast exactly how much can be afforded (leaving a little buffer for emergencies) and over what time.

Rule No 3 is to put the agreement in writing (either you send the terms to the creditor or ask the creditor to confirm the terms to you). Keeping a clear record of phone calls, emails and agreements is critical to establishing what the deferred payment terms were.

When negotiating terms with creditors, follow the following strategy:

  • Be clear with the message – make sure you can explain what you are going to do to get the business back on track and don’t have differing stories for different creditors.
  • Remain controlled in the discussion and don’t create conflict. Call back if the conversation is not going well.
  • Take written notes of the conversations to remain clear about the terms and commitments made.
  • Keep all mail from your creditors. Open it, read it, and save it in a file. The last thing you want is not opening a red letter because you thought the deal had been done.
  • Negotiate first with the creditors that you owe the biggest debt to. More leverage can be gained renegotiating a $20,000 debt than a $200 debt.
  • If collection agencies call, try to negotiate with the creditor direct, not the debt collector.
  • Try to avoid the account being referred to a debt collection agency, as negative credit reports can stay on a credit record for a long time.

The ATO are experienced debt negotiators and have information on their website regarding their approach to negotiating repayment plans.

For amounts under $100,000, it is possible to use the ATO’s online services or calling 13 72 26 for businesses or 13 28 65 for individuals.

If the debt is more than $100,000, additional considerations are required and contacting the ATO on 13 11 42 during office hours is the appropriate approach.

You can expect that the ATO will require businesses to demonstrate that they are viable. The ATO will look at a range of indicators, including:

  • gross margin;
  • cash flow;
  • asset/liability position (including working capital);
  • liquidity;
  • debtor/creditor position; and
  • availability of funding.

Reforms to combat illegal phoenix activity – Draft Legislation out for comment

Last year we alerted readers to legislation being considered to combat illegal phoenix activities.

After broad consultation, the Government has now issued draft legislation and is seeking market feedback.

The proposed reforms appear to focus on:

  • the introduction of a new phoenix offence to target those who conduct and those who facilitate illegal phoenix transactions;
  • the focus will be on creditor‑defeating transfers of company assets that prevent, hinder or significantly delay creditors’ access to those assets;
  • pre-insolvency advisers and other facilitators of illegal phoenix activities will also be held liable for procuring, inciting, inducing or encouraging a company to make creditor‑defeating transfers of company assets;
  • an extension of the existing liquidator asset clawback avenues to cover illegal phoenix transactions;
  • the prevention of directors from backdating their resignations to avoid personal liability;
  • preventing a sole director from resigning and leaving a company as an empty corporate shell with no director;
  • extending the director penalty provisions to make directors personally liable for their company’s GST and related liabilities;
  • expanding the Australian Taxation Office’s existing power to retain refunds where there are tax lodgements outstanding; and
  • restricting the voting rights of related creditors of the phoenix operator at meetings regarding the appointment or removal and replacement of an external administrator.

Consultation on the proposed reforms is open until 27 September 2018.

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