Looking Back and Thinking Forward: The Insolvency Landscape in 2024 and Beyond

In 2024, businesses in Australia will continue navigate the complex economic terrain marked by high-interest rates, Australian Taxation Office (ATO) scrutiny and enforcement action, volatile markets, slowing consumer spending, and the unpredictable effects of global political tensions and international warfare. Several of these factors have contributed to the rising levels of formal insolvency appointments and distressed asset sales seen over the past year, and these will continue into 2024.

In this article, we look back at, and think forward to, the trends and legal developments which businesses (insolvency professionals, accountants and investors) need to be aware of as 2024 gets underway.

Key trends

Formal insolvencies

The general downturn in aspects of the Australian and global economy has led to a heightened focus on financial stability and risk management within Australian businesses. Many businesses have encountered significant adverse fluctuations in aged debtor payments, with some delaying payments, making partial payments, or failing to pay altogether. This cashflow impact has created a myriad of issues for creditor companies, including as to concerns about their own solvency. Some businesses have suffered restricted access to affordable credit and capital, competitors and distressed asset investors seeking to take advantage of the distress, board-level concerns about the risk of personal liability for insolvent trading.

In 2023, Australia saw a surge in formal insolvency appointments, with a 42% increase in voluntary administrations and a 56% increase in receiver and manager appointments compared to the previous year. There were 10,366 corporate insolvencies in FY22/23, being the highest level since 2019, in which 11,224 insolvencies were recorded.

The Australian Securities and Investments Commission (ASIC) reported that companies entering external administration or having a controller appointed for the first time rose significantly from 4,912 in FY21/22 to 7,156 companies in FY22/23.

According to ASIC’s latest corporate insolvency statistics, published in December 2023, the predominant reported causes of business failure were:

• inadequate cash flow (52%);
• trading losses (49%); and
• pandemic-induced failure (19%).

New South Wales saw the majority of insolvencies (41%), followed by Victoria (27%) and Queensland (18%).

With the high rate of increase in corporate insolvencies, it is clear that solvency concerns will occupy the minds of CFOs and board members in 2024, particularly in the light of ongoing global factors. These factors include, amongst others: persisting cash flow difficulties; continued disruption to supply chains; disruptive global influences (including the volatility in the US with the upcoming presidential election); a crunch on mainstream credit; and a downturn in the number of initial public offerings and appetite for risk in the private capital markets.

We expect that formal insolvency appointments will increase in 2024, exceeding the number of appointments in 2023 – especially as the ATO continues to take enforcement action.

Heightened ATO enforcement action

In 2023, the ATO undoubtedly intensified its efforts in pursuing debts. This included the issuance of Director Penalty Notices (DPNs) (being ATO issued notices under which company directors can become personally liable for the company’s tax debts), garnishee orders and winding-up petitions. Anecdotally, and from Ironbridge Legal’s own experience, the ATO has been pushing back on payment plans, preferring to take enforcement action – especially where tax lodgements are outstanding and there has been a history of non-communication or persistent payment delinquency.

In the first half of 2023, the ATO initiated 476 winding-up proceedings compared to just 14 in the same period in 2022. The amnesty on penalties for SMEs that failed to lodge income tax returns expired on 31 December 2023. It is also reported that the ATO had issued approximately 31,000 DPNs by the end of 2023, and intends to increase their use in 2024.

Budget estimates indicate that the ATO’s debt book will continue to grow in 2024, reaching $50 billion. This will undoubtedly result in the ATO taking even more aggressive enforcement action, resulting in increased insolvencies, particularly of small businesses.

Enforcement action by secured lenders

If economic conditions deteriorate this year, financially distressed individuals and businesses may increase their bargaining power with secured creditors, particularly with the big banks. This is because indebtedness increased as a result of COVID-19, including to Australian banks which received $188 billion in cheap government loans from the RBA to help them support their customers and keep the economy afloat throughout the pandemic. In addition to this, major banks’ share prices have risen approximately 15% in the last 6 months.

Considering these factors, and the continuing effect of the 2019 Royal Commission into Banking which left reputational scars, major banks may continue to take a relatively softer approach to some distressed borrowers in the short-term. This may include: waiving covenant breaches; entering into forbearance agreements; using independent advisers to review the financial health of the business and value any underlying security; and allowing an administrator or liquidator of a company to deal with the secured assets of the business without the bank appointing a receiver. In spite of this, there are already signs that this approach is being tightened, particularly where individuals and businesses do not engage proactively and constructively with the lender.

Restructuring behaviours

In 2023, Australia experienced a substantial rise in appointments of insolvency practitioners, with a 42% increase in voluntary administrations and a 56% increase in receiver and manager appointments from the previous year.

Ironbridge Legal also saw a rise in alternative capital providers and secondary lenders taking investment opportunities using Australia’s voluntary administration.

We expect that voluntary administrations (being Australia’s primary restructuring tool), along with the subsequent implementation of deeds of company arrangements (also known as “DOCA”), will continue to be popular methods for restructuring and effecting debt-for-equity swaps where appropriate.

Small business restructuring

In response to the COVID-induced financial distress the government expected to hit SMEs, Parliament introduced a small business restructuring scheme. According to ASIC’s latest corporate insolvency statistics, published in December 2023, SMEs dominated corporate insolvencies, with 83% owning less than $100,000 of assets, 82% having less than 20 employees, and 68% owing less than $1 million in liabilities.

The use of the small business restructuring scheme continues to increase with creditors showing a willingness to embrace work-out proposals under this scheme. This framework provides financially distressed small businesses with a single, streamlined process to work with a restructuring practitioner to restructure their debts while allowing its owners to remain in control of the business. This is a faster and more flexible process for eligible small businesses; helping more of them to survive can mean better outcomes for creditors, employees and the economy.

The small business restructuring scheme allows businesses to reduce their ATO and other unsecured debts by significant amounts. Anecdotally, some companies have intentionally brought down their liabilities below the $1 million threshold in order to qualify for this rescue procedure, the use of which is expected to rise in 2024.

Stakeholder involvement

There has been a growing trend of debtors actively engaging with stakeholders, representing a shift from reactive insolvency to a more value-preserving, strategic approach. Doing this early and transparently enables businesses to develop restructuring plans that are more likely to garner support from investors and increase the likelihood of success. In addition, Ironbridge Legal has also seen debtors becoming more proactive in seeking financial advice, including engaging safe harbour advisers.

We also expect to see the trend of “creditor-on-creditor violence” continue as it has done in other jurisdictions such as the US and the UK where certain existing or new creditors seek to take advantage of loopholes in financing documents to disadvantaged other creditors. This highlights a greater need for liability management advice.

Impacted industries

Consumer services industry

The consumer services industry is a cornerstone of the Australian economy, encompassing sectors such as retail, hospitality and tourism. Together, these sectors contribute more than 20% to the nation’s GDP and support the livelihoods of over 1.2 million people.

Consumer spending in these sectors surged following the pandemic lockdowns, reaching unprecedented levels. However, this spending boom is gradually tapering off as consumers divert money to pay increased mortgage repayments and implement a household savings policy.

Recent ASIC data revealed that a 12.5% surge in insolvencies in January was predominantly driven by the accommodation and food industry, with 75 business closures in January following the projected busy period over Christmas (a 21% rise as compared to the previous year). The hospitality sector – in particular restaurants and cafes – greatly suffers under the weight of cost-of-living pressures.

This downward spending trajectory, which is expected to continue in 2024, is likely to adversely impact businesses which were kept afloat by post-lockdown demand. In turn, there may be a consequential uptick in personal insolvencies as jobs are lost.

Construction industry

In 2023, about 28% of formal insolvency appointments were attributed to the construction industry.  There were several factors which contributed to solvency concerns in the construction sector, including: the inability to deliver under fixed price contracts; the developer and head contractor insolvencies having a cascading effect on the contractual chain; and staff shortages and rising employment costs. 

With the continued global price rise in raw materials, continued disruption to the supply chain, and consistently high interest rates, the construction industry is expected to be remain a major contributor to insolvency appointments in 2024.

Potential legislative changes and new guidance

In July 2023, the Parliamentary Joint Committee on Corporations and Financial Services issued its report on corporate insolvency (Corporate Insolvency Report). Key findings from the report highlighted the need for an independent and comprehensive review of the entire insolvency system, encompassing both corporate and personal insolvency. It concluded that Australia’s corporate insolvency system is far too complex, inaccessible, and costly. Given that the Australian corporate insolvency system has not undergone review in 30 years, the Corporate Insolvency Report comes as a breath of fresh air. While it is not clear as yet which of its 28 recommendations may be implemented, we hope to see much needed industry-wide reform in the coming years.

The Joint Committee has identified several near term actions and reforms, such as: streamlining the simplified liquidation pathway and the small business restructure pathway; improving the insolvency process for trusts; and enacting the proposals outlined in Treasury’s 2022 report into the insolvent trading safe harbour (Safe Harbour Review).

The most important of the recommendations in the Safe Harbour Review are as follows:

• The law should be amended to include a reference to ‘a person starting to suspect the company is in financial distress’ in addition, and as an alternative to, ‘a person starting to suspect the company may become or be insolvent’.
• Safe harbour protections should be extended to the obligations of directors not to enter into agreements that avoid employee entitlements.
• A plain English “best practice guide” to safe harbour should be developed in consultation with key industry groups.
• A finite list of tax reporting obligations (which the company must comply with to utilise the safe harbour regime) should be included in the relevant legislation.
• Treasury should undertake a full, holistic, in-depth review of Australia’s insolvency laws.
• ASIC’s Regulatory Guide 217 should be updated to provide straightforward guidance on the operation of insolvent trading prohibitions and safe harbour provisions.

In March 2022, the Federal Government initially agreed to nine of the Safe Harbour Review’s 14 recommendations, noting that some would need further consideration. After initially allocating $800,000 for the implementation of the recommendations in the Safe Harbour Review, this funding was reversed as the result of a spending audit pending the Corporate Insolvency Report.

In September 2023, ASIC released Consultation Paper 372 “Guidance on insolvent trading safe harbour provisions: Update to RG 217”. The current version of Regulatory Guide 217, released in August 2020, focuses on fundamental principles aimed at helping directors understand their obligation to prevent insolvent trading, but it does not provide guidance on the operation of the safe harbour provisions of the Corporations Act 2001. The new draft of Regulatory Guide 217 proposes to expand on the sections relating to insolvent trading, such as by including: the actions directors must undertake to fulfil their duty to avoid insolvent trading; the consequences of a breach; the defences available in the event of a civil claim; and the parameters for establishing insolvency.

Submissions for the consultation paper closed in October 2023. ASIC is currently in the review process and is expected to publish the updated RG 217 during the first quarter of 2024.

Conclusion

Corporate insolvency rates are rising in Australia, and we expect that insolvencies recorded in 2024 will exceed the numbers we have seen in 2023.

Businesses and their advisers will need to consider their solvency positions carefully, remembering that the closer they get to insolvency, the more important it is to consider the duties they owe to creditors.

We expect that the volume of insolvency appointments we saw in 2023, as well as their expected volume in 2024, will lead to increased litigation against directors for breach of duties, insolvent trading and related voidable transaction claims.

With increasing financial hardship, we also expect to see an uptick in shareholder litigation, investor claims and personal bankruptcies.

The key message this year for directors, boards and creditors is to proactively consider the risks and opportunities this market will present, and to brace for a difficult year ahead.