Errant directors beware, the dam holding insolvencies is bound to burst soon

A universally predicted tsunami of insolvencies hasn’t eventuated, although the industry now expects a flood of insolvencies (if not a tsunami) across the country later this year in the wake of the May 21 federal election.
Although data indicates there are thousands of Australian companies beyond their tipping points for viability, and there has been consensus among insolvency practitioners that appointment enquiries would increase substantially this year, hard numbers for actual financial collapses are still unsighted.
The predicted tsunami didn’t occur because the Australian Taxation Office (ATO), the nation’s most active creditor, curbed debt collection two years ago in earlier stages of the pandemic, and since then has been remarkably restrained in lodging winding-up applications, issuing Director Penalty Notices (DPNs), and making statutory demands.
However, it has now resumed its debt recovery campaign, and resumption of these ATO demands and DPNs will likely be catalysts for many company restructurings and voluntary liquidations.
Errant directors, especially those of tax-indebted zombie companies, sustained essentially by pandemic government financial stimulus now being withdrawn, are accordingly about to face accountability that could include personal liability for their company’s debts.
Challenges ahead for SMEs
Many SMEs struggling to fulfil tax obligations can also expect that other creditors who have deferred debts during the pandemic will begin, if they haven’t already done so, to revert to normal debt collection practices.
Landlords, for example, can be expected to increase their efforts to recover rent deferred during the past two years.
And links in disrupted supply chains aren’t going to be repaired any time soon – especially while China maintains its on-going commitment to zero tolerance of COVID. Global continuity of supplies essential to sustain many businesses aren’t suddenly going to be more readily available. Where they are available, it can only be at increasing cost because of scarcity and inflation. The rising cost of materials has already caused the demise of major building companies.
Exacerbating supply chain problems likely to extend well beyond 2022, will be inflation, forecast at 4.9% over the next two years. This in an economic climate where the Reserve Bank of Australia (RBA) is predicted to raise its cash rate imminently from the consistently maintained record low of 0.1% to normal levels of around 2%.
Incidentally, this it’s estimated, would result in a 10% reduction in household disposable income and a consequent decline in spending on SMEs’ goods and services.
Corporate insolvency appointments are still down at least 35% on historical levels (the same level we saw in 2021) and the comparable figure for personal insolvencies is 50%, but because of factors referred to above, expect total insolvencies to have peaked well above historical levels by the end of this year -- which is shaping up as a unique and extraordinarily difficult one for SMEs.
Does the spectre of S588FGA hang over you?
Two years into the pandemic, virtually all key financial stimulus for businesses and legislative provisions affecting debt collection and insolvency have been removed -- or are about to be. It’s expected therefore insolvency appointments will rise inevitably and that the ATO will figure prominently in these, for it’s by far the nation’s most prominent creditor.
When considering liquidation appointments because of pressure to pay tax debts, companies tend to make payments under an arrangement to appease the ATO, but should such a company subsequently succumb to liquidation, its directors could then be held personally responsible for those payments.
This liability can occur because of provisions of section 588FGA of the Corporations Act 2001, which makes directors liable to indemnify the Commissioner of Taxation when a liquidator recovers an unfair preference payment made by the company to the Commissioner.
That means, should a court make an order requiring the Commissioner/ATO to repay such a payment to a liquidator, the ATO, in representing the Commissioner, can then make a claim against directors for loss or damage resulting from that order -- including costs and interest. (Unfair preference payments usually involve transactions that discriminate in favour of one creditor at the expense of other creditors. The law aims to ensure creditors are treated equally by preventing any unsecured creditors from receiving an advantage over others.)
Low awareness of S588FGA
Macks Advisory is astonished at widespread low awareness of section 588FGA of the Corporations Act 2001, and that many business owners and advisers are oblivious to dangers associated with that lack of awareness.
If your business has a tax debt it has difficulty in discharging immediately yet is functioning well enough to be able to decrease the debt by regular incremental repayments, then it’s logical to expect the ATO to negotiate an arrangement with you, and entirely appropriate for you to discuss with your accountant budgeting, cash flow forecasts and overall viability of the business that would determine the likely success of the negotiation.
But if common sense tells you your business is bound to fail, then prolonged testing of the ATO’s limit of patience as an attempt to buy time, or entering a repayment arrangement under false pretences, could leave you and co-directors worse off financially by having dodged an early liquidation only to be compelled to face an inevitable one later on.
While stalling tax officers may appear as an easy and cheap way to have the ATO in effect help sustain your business with cheap credit, that’s an erroneous and short-sighted view.
By stalling, by delay in confronting reality, you could be potentially involving yourself and codirectors in being held personally liable for company debts, exposure to the provisions of section 588FGA, cold shouldering from banks disinclined to offer loans of any kind to a company with tax debts, and possible exposure to the high interest rates of alternative third-tier lenders.
Company directors should bear in mind that if the ATO approves their repayment plan and they don’t honour it, if meantime the company fails to make tax lodgements on time, consequences won’t look anything like cheap and easy. They’ll be very extensive and not easy to handle.