September 22, 2020

Zombie Businesses Set to Continue with JobKeeper 2.0

In March 2020, the Government’s early response to the economic consequences of COVID-19 included temporarily suspending Australia’s Insolvency Laws under the Coronavirus Economic Response Package Omnibus Act 2020, with an expiration date of 25 September 2020.

On 7 September 2020, the Federal Government announced the extension of the temporary relief for financially distressed businesses which included the extension of the temporary insolvency and bankruptcy protections until 31 December 2020.

Regulations are expected to be made to:

    • Extend the temporary increase in the threshold from $5,000 to $20,000 on which bankruptcy notices can be issued;
    • Extend the temporary increase in the threshold from $2,000 to $20,000 at which creditors can issue a statutory demand against a company;
    • Extend the response time to respond to statutory demands from twenty-one (21) days to six (6) months; and
    • Extend the temporary relief for directors from any personal liability whilst trading insolvent.

With insolvency numbers at an all-time low, fears that JobKeeper, commercial leasing rules and creditor limitations are opening the way for directors to take advantage of temporary COVID-19 insolvency laws have now become a reality.

Statistics indicate that at least 1,000 businesses are currently engaging in insolvent trading, with protection from the continued insolvent trading amendments. It is well known that half of all businesses have revealed that they are relying on the COVID-19 measures to survive.

What is a Zombie Business?

In June 2020, a survey of insolvency and reconstruction professionals undertaken by the Australian Restructuring Insolvency and Turnaround Association (ARITA) outlined a reported increase in the number of “zombie businesses” as a result of the Government’s protection measures.

“Zombie businesses” are commonly defined as entities that were facing liquidity issues before COVID-19 and are continuing to trade, relying on the Government’s stimulus and protection measures, such as JobKeeper and the temporary relief from insolvency laws, with no genuine prospect of staying afloat in the future.

According to a November 2019 report by KPMG Australia (Distance to Default: a Default Indicator for Australian-listed Companies Volume 6), approximately one in seven ASX listed companies were trading in the “zombie territory”.

Businesses that would have otherwise failed are being kept alive by a combination of the Government’s measures, designed to give temporary support to going concern businesses.

Why Early Action is Important

If you or your client are relying on the JobKeeper scheme, you will need to have a plan in place when JobKeeper ends. Whilst it is tempting to wait and see what happens, you are running the risk of becoming a “zombie business”.

The amendments to the temporary insolvency laws have given directors greater protection from being personally sued if their business incurs further debts whilst being insolvent. However, it is important to remember that these measures do not include protection from your duties as a director, such as:

    • Duty to Act with Due Care and Diligence (Section 180)
    • Duty to Act in Good Faith (Section 180)
    • Duty to act in Good Faith, use of Position and Use of Information (Section 184)
    • Director Penalty Notice claims by the Australian Taxation Office which can cover a mixture of PAYG, SGC and GST.

It is vital to keep an eye on the well-known “red flags” of insolvency. Whilst more than half of Australian businesses are now relying on the Government’s measures, it is important to remember that businesses are still likely to be experiencing insolvency indicators.

Whilst directors have the protection from trading insolvent, they can still have personal exposure in terms of already providing personal guarantees on financial facilities or supply accounts.

You may find that now is the time to consider the options available and potentially restructure the business to ensure it can survive post the withdrawal of the COVID-19 measures.

Develop a Plan

It is important to consider a “Plan B” approach. Now might be the time to consider a plan for the future by asking some critical questions, including:

    • Are your books and records in order?
    • Where do you expect your income to come from and will it be sufficient?
    • Do you have the same customer/client base as before COVID-19?
    • What can you do to increase your income?
    • Are you able to reduce your overheads?

It is important that you have a Plan B strategy in place.

Getting the Right Advice

Given the future economic outlook, it is expected that most businesses are going to feel the pinch before 31 December 2020. Businesses will need to face the reality that they are going to have to continue to deal with the residual debts from COVID-19.

Recently appearing before the House of Representatives Standing Committee on Economics, RBA Governor Philip Lowe advised:

“we’ll have to confront the reality that there are firms in Australia that are no longer viable because of the pandemic and they will need to be wound up…so there will be insolvencies. There will be bankruptcies. There will be some businesses that will not recover. That’s the harsh reality of an economic downturn that’s the worst in 100 years”.

SV Partners regularly deal with businesses that have been or are at risk of becoming insolvent. Getting the right advice early is paramount to achieving the best outcome. Learn more about our services for business and individuals.

Article written by Joshua Robb (Associate Director) – SV Partners Newcastle

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