The language of business collapse

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Every second day there is an article written about another corporate collapse in Australia, or the increase in the number of business failures.  However, the formal insolvency actions are almost always after a prolonged period of business distress, and then usually triggered by an event – such as a statutory demand, default notices, ATO actions such as director penalty notices.

Many of these formal actions could have been prevented if businesses sought help early.  Universally both formal and informal insolvency advisors would suggest getting help early, so why don’t businesses?

John Tribe and Emile Ghio published an article in April 2024 in ‘The Conversation’ – a publication of research-based news – that suggested that sloppy language in the media and by politicians is increasing the stigma around insolvency and potentially deterring businesses from seeking help.  They further argue that insolvency terms are being used incorrectly, or overly negatively.  They explain also that though the number of business failures in the UK is 43% higher than pre-pandemic 2019 levels (much like in Australia), that the business rescue cases have in fact dropped from 10% to 6%.

Tribe and Ghio argue that inaccurate wording, misleading language by politicians and media, play an important role in this decline in business rescues.  That the stigma around financial distress, and the negative way it is talked about may prevent businesses from looking for help, or timely help, that would provide the greatest chance of turning a business around. Additionally in Australia pre-insolvency advice is scorned upon with overt connotations of illegal practices and shark-oil practitioners.

In Australia as there are also different laws and regulations for businesses incorporated as companies, and businesses operated as sole traders.  An example of this is the conversation regarding construction company collapses.  There is little or no conversation around the collapses of construction businesses operated as sole traders – of which there are far more of these businesses, and the small, sole trader business as have a greater propensity to collapse.

So, what is the correct language to use?  Here are my definitions, and greater explanation of each can be found in my book ‘Triage: The art of business turnarounds’.

Bankruptcy – a legal process where a bankruptcy trustee is appointed to manage an insolvent person’s affairs, and to provide a fair distribution of that person’s divisible assets to their creditors. It is process on an individual and not a company, so may be used when a person is a sole trader, and the businesses debts are their debts.

Insolvent – means the business is unable to pay its debts as and when they fall due.  There are two tests for insolvency – the balance sheet test (looking to see if there are more assets than liabilities) and the cashflow test (that looks if a business can pay their debts as and when they must be paid). They are a quantum test and a timing test which both need to be satisfied to prove insolvency.

Liquidation – a process to wind the company up, end its financial affairs and dismantle its corporate structure. This may be utilised to cease trading a solvent business using a ‘Members Voluntary Liquidation’ (requiring a statutory declanation that debts, plus costs and interest can be paid within 12 months). This may include a ‘Creditors Voluntary Liquidation’, where no such declaration has been made and resolutions are passed such that a registered liquidator can maximise realisations for creditors. Another is the Court Liquidation – a creditor may seek for a company’s winding up via the Court (and where a Provisional Liquidator may also be appointed to preserve the assets, books and records.

Phoenix company – a company that ‘rises from the ashes’ of a failed or insolvent company. It is established to carry on the business of the failed or insolvent company using the assets and employing the staff, but not taking on the failed or insolvent business’s liabilities. Usually, the shareholders and directors are the same as the failed or insolvent company. The new company rises from the burden of liabilities of the old company and the creditors are left to recover what they can from the old company.

Phoenixing can be both legal and illegal – I make the distinction by calling pre-pack arrangements legal phoenixing. The characteristics of illegal phoenixing are there is little or no consideration paid by the new company for the old company’s assets, and there is no plan to repay all or some of the outstanding liabilities such as creditors, taxes, superannuation, or employee entitlements.

Pre-pack arrangement (legal phoenixing– a legally binding agreement to rescue an insolvent business before the formal appointment of an insolvency practitioner. It is a sale process where the business assets at commercial value, or the whole business, is sold prior to the appointment of an insolvency practitioner. The may or may not be to the same shareholders of the original company. The insolvency practitioner would review the sale terms and if appropriate ratify the sale agreement.

Receivership – a court-mandated tool that creditors holding a registered security interest over an asset can use to recover funds they are owed. Creditors appoint a Receiver (manager) to take control of the asset, sell the asset or protect the rights of the creditor.

Safe Harbour – a provision under the Corporations Act in Australia that allows some relief against a director’s duty to prevent a company trading while insolvent. This governance process can buy directors additional time to review their options and develop a strategic a plan with various restructuring and turnaround scenarios. As a last resort, the Safe Harbour plan can include a ‘pre-pack arrangement’ (legal phoenixing, discussed above). Effective February 2020, new laws were introduced to protect stakeholders from illegal phoenixing and section 588FDB introduced a ‘creditor defeating disposition’. Not only will the transaction be voided, civil and criminal proceedings can be brought against directors, shadow directors, officers AND advisors to the transaction.

Simplified Liquidation Process – an option for small businesses that reduces the cost, time and paperwork required to liquidate their company.

Small business restructuring –allows small businesses in financial distress to access a streamlined, cost-effective process to restructure their debts while the directors remain in control of the business.

Voluntary Administration – a formal insolvency process where the directors of an insolvent company appoint an Administrator.  The Administrator assumes control of the company and the directors’ powers are suspended. The purpose of the Voluntary Administration is to provide an alternative to immediately placing the company into liquidation, and for an independent person to protect the going concern value of the company. Over a period of about six weeks the Administrator firstly decides whether the day-to-day trading of the company continues, and while assessing the company and business, they also attempt to develop a plan to put to the creditors that will provide them with greater value than immediate liquidation.

Even if the terminology is understood and consistent the challenge then is to de-stigmatise business distress.  Over the last 10 or so years Australians have got a lot better at discussing mental health issues, and it is less of a taboo topic. We are encouraged to discuss our mental health issues and seek help early.

The same thing needs to occur with business distress.  43% of small to medium business fail to turn a profit.  Of those that do, the majority earn less than the minimum wage.  A third of small business owners end up with a mental health condition.  Let’s change the conversations and how we talk about business distress, and struggling businesses please seek help early.  A directory of business turnaround advisors can be found at the Association of Business Restructuring and Turnaround.

Stephen Barnes BCom(Acc&Fin), PostGradFin, FICDA, DipBus(Gov), FGIA, FCA, RTP®

S Barnes
Stephen Barnes
Certified Restructuring & Turnaround Practitioner ~ RTP®, Academic Member
Byronvale Advisors
Victoria, National
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