RISK Identifying Things to watch 2023

Massive interest rate rises on business and home loans, high inflation, a tight labour market pushing higher staff costs, and long-term supply chain issues are some of the key drivers of an expected to be tough financial and economic landscape in 2023. The question then is – how are these pressures going to affect trading conditions in 2023? In this article, we discuss this and some recent developments in the law relevant to trade credit providers.

Insolvency trends

There are three major trends which will be impacting creditors in 2023. The first is that insolvency appointments are rising, the second is the increased use of the Small Business Restructuring Process and the third is the Federal Government’s Insolvency Inquiry.

First, some statistics. According to recent statistics published by ASIC 1:

1. In the first and second quarters of FY2023, corporate insolvency appointments increased by approximately 65% on the same period last year. This brings corporate insolvency appointments much closer to prepandemic levels.

2. In the current financial year, for the period from July 2022 to December 2022, there were a total of 4840 formal insolvency appointments. This compares to 6,483 of all appointments in FY2022.

3. Of all industries, the construction industry is impacted the most.

4. Personal insolvencies remain lower than before the pandemic.

The rise in insolvency appointments can almost certainly be attributed to the double-whammy of worsening financial and economic conditions brought about by the reasons outlined above together with the withdrawal of government support which many businesses relied upon to stay above water during the pandemic.

Adding to the pressure is the ATO re-commencing its debt recovery action. According to the Commissioner of Taxation’s annual report, released recently, the Country’s undisputed tax debt has increased from $26.5 billion on June 30, 2019, to $44.8 billion as of June 30, 2022. 2023 will see the ATO begin to action its large book debt in earnest.

We predict that 2023 will also see not only a rise in insolvency appointments overall, but also an increase in the Small Business Restructuring Process which we are already seeing is growing in popularity.

Small business restructuring

Small Business Restructuring was introduced in January 2021. So far this financial year there have been around 140 Small Business Restructuring Appointments which is more than there have been since its inception in January 2021.

Small Business Restructuring is intended to help small businesses restructure their debts and maximise their chances of trading out of financial difficulties. Directors of insolvent companies are able to appoint a restructuring practitioner who will assess the company’s eligibility for Small Business Restructuring and help develop a restructuring plan to put to creditors, under which the company’s debts will be paid off in part or in full. If a majority of the creditors approve of the restructuring plan then the company can continue to trade under the control of the directors whilst the plan is implemented over a period of not more than 3 years at the end of which the company is released from its admissible debts.

Despite the increase in popularity of Small Business Restructuring as of late, there is a general feeling in the industry that the regime has not been utilised to its full capacity.

The advantages of small business restructuring include:

1. Early intervention by a restructuring practitioner can avoid pitfalls in directors trying to avoid their trading problems.

2. Allows directors to retain control as opposed to the costs and loss of control which accompanies a voluntary administration. This can mean more ownership of the process.

3. The restructuring practitioner’s remuneration is capped meaning there may well be more funds in the pool for creditors.

4. The process is relatively timely.

The disadvantages of small business restructuring include:

1. Strict eligibility requirements mean that many businesses are not eligible. These include that the debt owing by the company cannot exceed $1 million and that all tax and superannuation obligations must have been met.

2. All creditors are bound to a restructuring plan if more than 50% of creditors vote in favour of it.

3. Once a restructuring plan has been voted on, all admissible debts are cleared.

4. Credit teams may need to reconfigure their credit management strategies to include considering compromising on debt at an earlier stage than before.

5. The SBR Process may be used as a tactic to avoid wind ups. Companies with current wind up proceedings on foot are using the SBR process as a reason to seek an adjournment of a wind up hearing. This will no doubt become more common. The Court will adjourn the wind up if it is satisfied that it is in the best interest of creditor’s to continue under the restructuring plan.

The legal landscape of insolvency is changing in other ways as well. An inquiry report into Australia’s corporate insolvency regime amongst other things is due to be tabled to Parliament in May 2023. This is the first major review of our insolvency regime in 30 years since the Harmer Report.

The Inquiry provides a rare opportunity for a review of the whole industry and appears aimed at ensuring Australia’s corporate insolvency regime is fit for purpose. So watch this space for further developments.

Cyber fraud

News of recent high-profile data breaches has spurred individuals and organisations across the country to re-examine their cybersecurity.

Cyber-criminals commonly gain entry into systems by way of phishing, smishing, or a plethora of other types of scams and techniques.

Trade credit providers are not safe from this type of behavior either. Here at Turks, we recently assisted a client who had provided goods and services to persons they believed represented a well-known organisation. In reality they had been tricked by criminals who set up email accounts with a domain name very similar to the well-known organisation. The difference was, for example, as simple as using .org instead of .com.

The fraud did not come to light until after our client sought payment for the outstanding tax invoice.

Trade credit providers are especially at risk of this type of fraud as they often extend credit without ever having met their clients. Accordingly, trade credit providers should revisit their practices and procedures. As a suggestion:

1. Establish a strict system for verifying and setting up new credit accounts.

2. Check everything – including the domain name from which emails are received.

3. Do not skip steps in the process merely because the brand name of the applicant seems familiar, fraudsters are more likely to disguise themselves as familiar brands as had happened to our client above.

4. Double check information. Legitimate and potential clients will not be offended if you do so – you are protecting their brand and your own bottom line.

Clients of trade credit providers are also at risk. They may be tricked into making payment to fraudsters believing them to be the trade credit provider. This puts payment to trade credit providers at risk which will be problematic to all parties concerned especially if the economic environment deteriorates. To minimise this risk, as a suggestion:

1. Encourage clients to adopt a two tier verification of payments system whereby they call you to confirm account payment details before payments are made.

2. Provide clients with examples of what your invoices will look like and make it clear to them that your invoices will not be attached to emails containing links to facilitate payment.

3. Notify clients of the steps you will take if your bank details change. For instance clients should know that you will send a letter, an updated client agreement or terms and conditions – not just an email with a link.

4. Advise your clients against using instant payment methods for a first payment. Clients should be able to transfer $1.00 first and wait for you to confirm its receipt before transferring a large sum of money.

It is also important to note that a client’s obligation to make payment to a trade credit provider is not affected if the client makes a mistaken payment to a fraudster. They still need to pay the trade credit provider. The relief in this kind of case would be against the fraudster in unjust enrichment or fraud. Trade credit providers may continue to press for payment although by reason of considerations of commerciality one may wish to be more lenient in such a case.

Debtors using court to delay payment

Creditors who have issued Court proceedings are often frustrated by well-informed debtors who utilise Court procedure and rules to delay the proceedings and avoid paying the debt when due.

We believe as more Court jurisdictions move to online court processes there will be more opportunities for well advised debtors to delay the proceedings. This is because there is less face to face time with a Court Registrar or Judge to explain delay.

In addition, debtors will sometimes file a Defence which gives little detail as to the reasons for nonpayment and potentially is in breach of the Court rules.

Each case must be assessed on its merits, however when met with such tactics creditors may wish to consider filing for summary judgment or using the Court rules to get the matter listed before a Judge or Registrar (as opposed to the Online Court). A summary judgment allows a claimant to be heard sooner and judgment awarded before proceeding to trial in circumstances where the other party’s case has no prospects of success.

Another technique employed by debtors in larger claims is making ad hoc payments during proceedings. This technique puts pressure on the plaintiff not to aggressively pursue a case as money is arriving and also a plaintiff may have concerns about the payments being an unfair preference. When ad hoc payments are made by a defendant, creditors may wish to negotiate a deal with debtors which evidences a payment arrangement with a guillotine clause enabling instant judgment on any default.

Unfair preferences

When we presented our webinar to AICM members in December last year, two Federal Court decisions about the unfair preference regime were subject to appeal to the High Court of Australia. The High Court has now handed down its decision in both appeals, the result of which has unequivocally altered the unfair preference regime and provided certainty to creditors about the defences which may be used in an unfair preference claim.

The first is the decision of Metal Manufactures Pty Ltd v Morton [2023] HCA 1 (Morton).

The High Court in Morton upheld the Full Court of the Federal Court’s decision in Morton as liquidator of MJ Woodman Electrical Contractors Pty Ltd (in Liq) v Metal Manufacturers Pty Ltd [2021] FCAFC 228 and has abolished the set off defence.

The set off defence enabled creditors to set off the unfair preference claim against any debts still owing by a company in liquidation.

The High Court agreed with the Federal Court in that a set off under s533C of the Corporations Act 2001 (Cth) requires mutuality between the two claims such that the claims must be between the same parties and held by those parties for their own benefit and interest. As the right of action pursued by the liquidators was not for the benefit of the company in liquidation but for the benefit of unsecured creditors there was no mutuality.

The Morton decision means that creditors may no longer reduce their liability under an unfair preference claim by relying on statutory set off as this will unfairly diminish the distributable pool of assets to all creditors.

Running Account

The second decision is that of Bryant v Badenoch Integrated Logging Pty Ltd [2023] HCA 2 (Badenoch). This decision has changed the landscape of the running account defence to the benefit of creditors.

In Badenoch, the High Court again upheld the Full Court of the Federal Court’s decision in Badenoch Integrated Logging Pty Ltd v Bryant, in the matter of Gunns Limited (in Liq) (receivers and managers appointed) [2021] FCAFC 64 and held that the peak indebtedness rule is not the correct method for calculating a deemed unfair preference under a running account.

Instead, the New Zealand methodology has been followed whereby the net position of all transactions during the relevant period will be deemed the unfair preference amount.

The practical implication of this is that instead of the liquidator maximising their recovery by choosing the time when there was the greatest level of indebtedness for the purposes of a running account, the entire six month relation back period must be taken into account by deducting the indebtedness at the end of the period from that at the start of the period. This will result in a more favorable result to the creditor and can reduce the unfair preference to NIL if the final amount owing to the credit is greater than that at the start of the six month period.

The High Court has now put an end to two key uncertainties in Australia’s unfair preference regime, which should result in a reduction in a creditor’s time and costs in litigating an unfair preference claim.

Directors identification numbers

The final matter for discussion in this article is that of director identification numbers which all directors of ASIC and ACNC registered organisations were required to apply for and have by 30 November 2022. This includes directors of corporate trustees of self-managed superannuation funds.

If you have not yet applied, an extension of time may be sought by accessing a form from the Australian Business Registry Service site at www.abrs.gov.au

You must provide your director identification number to the person in your company responsible for keeping records. This may be the company secretary or another director.

In the future, it is possible director identification numbers will be accessible for a fee, like other company information.

For trade credit providers, director identification numbers are another means to cross reference information. Each director only has one identification number regardless of how many positions he or she owns. A director identification number stays with a director for life and does not change.

By now, directors should have applied for and obtained their director identification numbers so it is open for trade credit providers to ask for this number from new clients when they apply for credit or existing clients.

“For trade credit providers, director identification numbers are another means to cross reference information. Each director only has one identification number regardless of how many positions he or she owns.”

Perhaps the best part of director identification numbers is the expected reduction in risks associated with Phoenixing and family businesses. In relation to family businesses it is open for guarantors to argue that security given in relation to family property was given without their knowledge or understanding. Director identification numbers, together with other systems, makes mounting such a defence much harder.

Daniel Turk MICM Partner

T: 02 8257 5727

E: Daniel.Turk@turkslegal.com.au

Louise Nixon MICM Partner

T: 07 3212 6716

E: Louise.Nixon@turkslegal.com.au

Lucy Tindal MICM Senior Associate

T: 02 8257 5714

E: Lucy.Tindal@turkslegal.com.au

FOOTNOTES:

1 Australian and Securities Investment Commission Corporate Insolvency Statistics, Series 2.