New reforms to personal insolvency system provide relief for small businesses

The simplest form of business organisation is the sole trader and Australia has nearly 700,000, as well as around 250,000 partnerships. These businesses carry the greatest financial exposure to their owners if profits and cashflow go into the red and the ultimate consequence of that is bankruptcy.

While corporate insolvency laws have seen both temporary and permanent reforms introduced in 2020 to deal with the pandemic, the only bankruptcy-related relief was a temporary increase between March and December of the debt amount required to make an application to bankrupt a debtor ($5000 to $20,000) and the time period that the debtor had to respond (21 days to six months). The only permanent reform, introduced on 1 January this year, was to fix the debt amount required for a bankruptcy court application to $10,000.

However, more reforms appear to be in the wind, with the Federal Government seemingly anxious about the pandemic causing a spike in personal insolvencies which could discourage small business entrepreneurialism, and consequently the broader economy.

A discussion paper recently released by the Attorney-General’s Department has floated reducing the minimum bankruptcy term from three years to one. This idea has been around for a while and was nearly legislated in 2017/18 as part of former Prime Minister’s Malcolm Turnbull’s enterprise incentivisation drive before he was ousted.

One-year bankruptcy would obviously enable sole traders and partners to get back on their feet again much sooner than otherwise. Restrictions on obtaining credit, holding assets in their personal name, eligibility for professional registrations and memberships, and even being able to manage a company, would all be eased more quickly.

I think it is likely that one-year bankruptcy will come to fruition in 2021, but it is unlikely to be without conditions, the foremost of which could be that income contribution assessments continue for the full three years (that is, individuals are liable to hand over to their bankruptcy estate half that part of their income exceeding statutory thresholds).

The challenges for introducing one-year bankruptcy are having to address the same concerns raised back in 2017/18, namely that shortening bankruptcy encourages abuse by rouge, reckless and repeat bankrupts.

While it might seem a little dubious that too many would actually extend credit of any significance to anyone who has been a bankrupt more than once (at least in quick succession), to a certain extent the Attorney-General’s discussion paper pre-empts that concern with new offence provisions and expansion of current offence provisions to target providers of dodgy (or “untrustworthy”) advice about creditor-defeating transactions.

Of course, bankruptcy is not the only option when a sole trader or partnership small business is faced with a terminal lack of cashflow to meet its debts.

A Personal Insolvency Agreement is a process within the Bankruptcy Act that gives a debtor the opportunity to put forward a proposal to compromise and pay their debts via instalments, via a Controlling Trustee, which is binding on all creditors.

A Debt Agreement is the name given to a simplified similar process, but with lower eligibility income, asset, and debt caps. Both PIA’s and DA’s allow an individual to carry on business activity while they are still bound by an agreement.

The Attorney-General’s Department has flagged making amendments to both agreements to make them more attractive or accessible, particularly for individuals with business-related debts.

So overall, the proposed reforms to the nation’s insolvency system are good news for small business as those which struggled during the pandemic would have the opportunity to get back on their feet – and back to healthy trading – much sooner than they can at the moment. And that is not only good for small-business owners but good for Australia’s economic health.

Brendan Nixon, Partner, SM Solvency Accountants

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