An avalanche of insolvencies is expected across the economy once governments’ COVID-19 fiscal support finishes, but businesses will enter a “traumatic” and broken process that many will never recover from.

The Australian Small Business and Family Enterprise Ombudsman has released its Insolvency Practices Inquiry final report, which has found systemic failures that have harmed small businesses.

Ombudsman Kate Carnell said many companies were on the brink after natural disasters, including the summer bushfires, followed by the COVID-19 pandemic, and this would likely trigger a wave of insolvencies.

“The reality is that Australia is now in the grip of a recession. Trading conditions are the worst we’ve seen since the Great Depression and many small businesses won’t survive,” she said.

“Our inquiry has found that the system as it stands does not work for small businesses.

“Small businesses that have been through the liquidation process have told us their experience was so traumatic they will never fully recover, let alone try to start a new business down the track.

“Instead of getting the support they need to turn it around, small businesses too often find themselves on an express train to winding up with no control over the process.”


Changes to insolvency rules

The government put protections in place early during the pandemic lockdowns to shield companies from COVID-19-induced insolvency.

The temporary measures included lifting the threshold at which creditors can start bankruptcy proceedings, and removing personal liability for directors if their company trades while insolvent.

Treasurer Josh Frydenberg said the more than 80 temporary changes, which the government says it will extend to help companies suffering from a further lockdown in Victoria, had already prevented a series of business failures and suggested there was more that could be done to improve insolvency and bankruptcy laws.

The Australian Institute of Company Directors (ACID) however is urging governments to look past the prospect of “zombie” companies to the real risk posed by new waves of pandemic to functioning businesses.

AICD CEO Angus Armour noted the resurgence of cases in Victoria and NSW and warned of the damage that uncertainty did to the economy.

“The federal government was quick to take critical steps to provide relief but the impacts from this pandemic will continue beyond the original six-month reprieve,” he said.

“The insolvent trading relief is not about supporting businesses with no viable future. Directors must continue to think carefully about their ongoing duty to act in the best interests of the corporation, including the interests of creditors when approaching insolvency, and whether incurring additional liabilities would be a prudent course of action.”

The AICD wants a series of initiatives to be extended to the end of the year, from insolvent trading relief and changes to continuous disclosure laws.

Frydenberg has already said changes enabling companies to hold virtual AGMs would be made permanent.


Legion of zombies

However, the federal government is worried about creating a legion of “zombie” firms that can’t survive without support yet also won’t die, with stays of execution delaying payments to creditors down the line.

CreditorWatch chief Patrick Coghlan expects to see a jump in companies going into administration as government support is lifted.

The company’s data showed 300-400 “missing” companies from administration statistics, meaning there is risk of a sudden surge in numbers once these relief measures cease.

CreditorWatch data shows that government relief packages have helped companies to stay alive during the lockdowns, but it also suggests some are using the money to delay going into administration.

“In June 2020, there was a 20 per cent decrease in SMEs entering into external administration compared to May 2020, and a 50 per cent decrease compared to June 2019,” the company said in its small business risk review for June.

“There has also been a 17 per cent decrease in court actions and 25 per cent decrease in payment defaults compared to last month.

“Although this may appear to indicate a rebounding economy, in reality, businesses are struggling with significant cash flow issues. Payments in June 2020 were overdue by an average of 49 days across all industries – a 342 per cent increase from June 2019.”