By Shevon Faux, a Solicitor of Matthews Folbigg Lawyers
Influence of COVID-19 on Insolvency and Future Expectations
When the COVID-19 pandemic hit Australia in March 2020, insolvencies were expected to increase dramatically. To reduce this, mitigation measures were implemented through:
- state and federal government support payments;
- the ATO reducing debt enforcement activity;
- temporary debt moratoria and increased debt recovery thresholds; and
- Certified Credit Executives (CCEs) implementing improvements to their processes and strategies to combat risks.
These factors all contributed to the significant decline in corporate and personal insolvency appointments in Australia from 2019 to 2022.
On the recovery from COVID-19, five common factors currently driving the threat of insolvency are:
- supply chain issues that have caused essential supplies to be delayed, resulting in company’s products and services to also be delayed limiting ability to generate revenue;
- supply chain cost increases and inflation which has reduced profitability, especially in situations where there are ongoing fixed cost contracts or the limited ability to pass on those increased costs;
- the lack of staff to meet demands reducing the ability for businesses to deliver products and services, limiting revenue;
- slow recoveries in international travel, affecting industries hardest hit by COVID such as tourism, hospitality and international education; and
- significant adverse weather events such as bushfires, floods and storms in the last 2 years which continue to take a significant toll on many regions throughout Australia limiting the ability to deliver goods and services in a timely and cost effective manner.
Since 2011, the number of insolvencies has been declining. Contrary to expectations set out in the 2021 Risk Report issued by the Australian Institute of Credit Managers (AICM), corporate insolvencies in 2021 have continued to decrease, dropping a further 9% from the low level set in 2020. This is despite the reduction in government support and temporary enforcement protections coming to a halt. Personal insolvencies also remained low at around 400 per fortnight compared to around 900 prior to 2020. While these figures show a dramatic decrease in insolvencies, it is generally regarded as masking the fact that only 1 in 5 shut downs go through a ‘proper’ insolvency process, with a significant proportion of companies simply being deregistered through ASIC. Many other so-called ‘zombie’ companies have otherwise ceased operations, but have yet to enter a formal insolvency process.
The Effect of Inflation on Businesses
Inflation is affecting the world globally. One of the many reasons for this is the increase in fuel prices due to the war in Ukraine, leading to increased transport costs and price rises. COVID-19 has also contributed to supply chain issues and has increased labour shortages with people taking sick leave and international workers not being able to assist.
While it may appear to Australians that there has been a dramatic increase in inflation, compared to other Organisation for Economic Co-operation and Development (OECD) nations, Australia’s inflationary curve was modest, with the USA and UK recording inflation 5.5% and 8% respectively. To get inflation under control will mean that there needs to be (hopefully) short term pain for borrowers to get long term gain.
In Australia, consumer confidence has been worsening since mid-2021, resulting in a reduction of spending on discretionary items. However, again, Australia has not been impacted as much as the USA, UK and OECD average. Throughout the pandemic, many developed economies were provided with extra cash to keep them financially afloat, however this has also contributed to inflation and resulted in higher prices across the board. It is expected that the businesses with the highest probability of payment default in 2022-2023 are:
- the food and beverage services;
- arts and recreation services; and
- the transport, postal and warehousing services.
Those with the lowest probability of default are:
- health care and social assistance;
- agriculture, forestry and fishing; and
- manufacturing.
Looking Forward
The effects of inflation, increased interest rates, labour shortages, supply delays, the cessation of government stimuli and global uncertainty due to the Ukraine war are not yet fully known. Some credit professionals are optimistic in their performance expectations for the remainder of 2022, while others are expecting insolvency levels to increase and return to normality.
It is reasonable to anticipate that large scale debt recovery efforts will remain muted, due to viability concerns. It is also expected that deregistration and informal business closures, rather than formal insolvencies, will become the new normal. In turn, creditors can anticipate pressure for greater debt leniency in the future as a result of the last few years and the prevailing economic winds.
The ATO has returned to the debt recovery market near the end of March 2022 which is likely to be an indirect cause of the slight increase in insolvencies. The ATO began a publicity campaign requesting reports and threatening the issue of penalty notices and garnishee orders. However, formal direct winding up activity by the ATO is still limited. Once the effect of its indirect actions is known, and as the ATO moves to direct insolvency activity as the major insolvency player in courts, we see a more true depiction of the outcome of the last 2 years.
It is forecast that beyond 2023 insolvencies will return to a ‘normal’ level and will steadily continue to increase, as ‘zombie’ companies (those who have ceased activity but not been wound up) are cleaned up.
If you would like more information or advice in relation to insolvency, restructuring or debt recovery law, contact a Principal of the Matthews Folbigg Insolvency, Restructuring & Debt Recovery Group:
Jeffrey Brown on (02) 9806 7446 or jeffreyb@matthewsfolbigg.com.au
Stephen Mullette on (02) 9806 7459 or stephenm@matthewsfolbigg.com.au
