Changes to insolvent trading – are we safeguarding or impacting the problem and delaying the inevitable?


Changes to insolvent trading – are we safeguarding or impacting the problem and delaying the inevitable?

In one of our recent articles, we outlined in a nutshell the extensive Federal and State packages available to assist businesses in these difficult times, including JobKeeper, cash flow boosts and various business grants available.

However, we are finding that whilst this Government assistance is providing temporary support and relief for many businesses, it may not be enough!  Read more in last month’s article …  Government Support packages offer great help, but what other options are also available for businesses?

For businesses experiencing financial distress, the Australian Federal Government has also introduced a six-month suspension of insolvent trading laws.  The objective of these laws is to help businesses who are otherwise profitable and viable to get through to the other side of COVID-19.

Changes to Insolvent trading: 

  • From 25th March, the statutory timeframe for a company to respond to a statutory demand was extended temporarily from 21 days to six months;
  • An increase to the current minimum threshold for creditors issuing a statutory demand on a company from $2,000 to $20,000;
  • Suspension of director’s personal liability for insolvency trading during this time (however be aware of the detail, as this is not a get out of jail free card!);
  • Additional Safe Harbour provision.

It has recently been reported that the government is considering extending the six-month insolvent trading period by a further six months. 

How will businesses and the market be affected?

We can see some areas of concern here.  Riad Tayeh, partner at dVT Group says “hibernation or delaying the challenges directors and businesses will face at the end of this period (and even more so the extended period) may not be helping safeguard the business. but rather allows the issues to build up, possibly resulting in a worse situation at the end of the period”.

Riad says, “there is also the concern that if businesses are permitted to trade insolvent during this time, they will be creating a more difficult situation to deal with after the suspension is lifted and may create a position that is too difficult to reverse.  The result is rather than helping, these measures may actually cause the demise of these small to medium businesses, with a ripple effect to other businesses in that sector.  In addition to this, it could create a death spiral, as the viability of businesses that continue to trade and incur debts with these affected businesses, may also become affected, as will their competitors”. 

Businesses in decline tend to try and trade their “way out” through a price war spiral to try and recover market share at low margins.  This not only distorts the market, but may derail whole sectors of our economy and be fatal to many businesses.

Cash flow pressure

The SME sector is heavily reliant on cash flow. There is little in the way of reserves, and capital is often sourced from external sources such as directors’ properties.

The COVID-19 environment has exposed companies not earning income for say six months with a gradual re-opening over the next six months and potentially fully operational sometime after that.

The government has encouraged the accrual of a high degree of debt by SMEs, which ultimately needs to be repaid.  If an SME had say a net margin of 10% at full trading and it had accrued costs and overheads of say 10% (of pre-COVID-19 trading) over the shutdown period, it could take more than 24 months to get back to a break even position.

If we consider an SME will not be profitable immediately on the day it opens its doors again and that it may not become profitable for several months, then we need to consider how it will be able to trade once it is allowed to again.

The SME will have creditors unpaid from March 2020 onwards.  It is unlikely credit will be extended by suppliers under such circumstances (as the supplier will also have their own issues).  Thus, given the prospect of losses by the SME and a diminished capital position of its shareholders, cash flow loans become a large issue.

If some form of capital can be raised to allow resumption of trade, it is unlikely to be enough to pay the backlog of creditors, let alone buy much needed supplies or pay wages and overheads.  Consider then, the costs of overheads they would have carried for this period of time on top of the potential trading losses they will endure until trading gets back to normal.

While JobKeeper may have helped them to be able to pay their staff whilst not earning an income, they will still have;

  • Accrued rent outstanding (to at least 50%)
  • Accrued employee entitlements (super, annual leave, long service leave and personal leave)
  • Accrued overheads (e.g. insurance, subscriptions, utilities, memberships etc.)

So as the company limps to a potential future profit situation, the six-month moratorium ends and credit claims become an issue.

If we now add a desperate (and probably insolvent) competitor trying to stave off the inevitable by heavily discounting prices to increase revenue (note not profit), the SME trying to do the right thing is caught in a price war, which can only have one outcome.

We have destroyed the orderly market and its credit cycles and only companies that are not carrying huge debt burdens will be able to compete in a post COVID-19 marketplace.

When the cycle restarts, most suppliers will be concerned about getting paid, and if a company has to fund trading and past debts and prepay GST (i.e. before they collect their debtors), then our historical credit cycle may be under pressure (further exacerbated by not being able to chase debtors for six months).

Companies need to plan how to be able to resume trading.  We need a road map to recovery for SMEs.

Can Safe Harbour help?

Safe Harbour was mentioned as an avenue to restructure.  However, we need to understand that the SME market faces different challenges to that of larger corporations.   Safe Harbour has always been a challenging and somewhat costly process for most in this sector in a normal market.  Under these conditions, it may be unworkable.  SMEs often cannot suitably meet the criteria to invoke this process ordinarily, and if they do and fail, they could be exposed to a charge of insolvent trading with diminished defences.  The insolvent trading moratorium may not assist.

So, these conditions point to a remarkedly different set of circumstances that will come into play post restrictions being lifted, and it is unlikely that an extension to insolvent trading rules is going to assist in underpinning confidence in this sector.  In fact, in the SME sector, it may cause the credit cycle to be all but destroyed, as suppliers need confidence that they will be paid.

Hibernating and delaying dealing with these issues in business is not an option and should not replace getting the right help at the right time!

SMEs would benefit more from a well thought out plan to assist in determining how or if they should reopen for business and how it will be funded or whether they can re-open at all!

If you have clients that may be experiencing any of the above difficulty and need help to work through it and come up with a plan, please contact Riad Tayeh on 02 9633 3333, email

dVT Group is a business advisory firm that specialise in business strategy, turnaround, forensic investigations and insolvency (both corporate and personal).