From the front line of insolvency

By John Winter, Chief Executive Officer of ARITA

The Australian Restructuring Insolvency and Turnaround Association (ARITA) doesn’t collect and collate data related to insolvency and its effects on credit.

But as Chief Executive Officer John Winter points out, the peak body representing Australia’s restructuring and insolvency profession has something equally valuable.

“ARITA is in the unique position of being in daily discussion with insolvency professionals from across the country,” Mr Winter said.

“We gather anecdotal information about what level and type of inquiries our members are fielding – canary in the coal mine type information.”

“Our members will be talking about a range of support that covers everything from earlystage distress where informal restructuring and turnaround is the solution, through to providing safe-harbour advice to directors who are likely to have to trade while insolvent in a turnaround, right through to taking a formal appointment over a business that’s insolvent,” Mr Winter said.

So what trends are ARITA’s member’s seeing as the Australian economy grapples with combined effects of a devastating bushfire season and the economic freeze bought on by the COVID-19 pandemic?

Unfair Preferences

“It does need to be said that unfair preference claims in this environment are going to be challenging for credit professionals,” Mr Winter said.

“A liquidator’s legal requirement is to pursue unfair preferences. Credit professionals will need to take note that, as mentioned above, you’re almost going to need to presume a debtor is insolvent and that will open you up to unfair preference claims should they fail.

“To avoid preference claims from a liquidator, credit professionals need to be well out in front of any insolvency risk and to be able to shift trading terms to manage any exposure,” he said.

Insolvent Trading

“The suspension of insolvent trading provisions should be a red-flag to all credit professionals,” Mr Winter said. “There is a real risk that businesses will now push the maxim “you can’t get more broke than broke” even further and that some will attempt to rack up bills without concern or, perhaps, will just do so out of sheer desperation.

“Concerns about insolvent trading claims always acted as a moderator to reckless director behaviour in the majority of instances. But now the handbrake is off and the car is rolling down the hill.

“There’s a practical reality that businesses in many sectors are absolutely already hopelessly insolvent and so credit professionals almost need to move to a default assumption that your client won’t be able to pay,” Mr Winter said.

Sectors at Risk

“ARITA members are seeing rising inquiries and distress among tourism, hospitality, retail and resources and construction,” Mr Winter said.

“The distress could well signal greater problems ahead, but inquiries, and their timing, is also a positive.

“We know that many credit professionals are wary of safe harbour out of concern that it may increase their losses,” he said.

“Instead, it means that even though there may be some sanctioned insolvent trading, there’s a greater likelihood of the businesses trading through their distress and going on to repair not just current debts but to also remain a productive customer – and that’s an outcome we should all aspire to.”

Given the level of familiarity its members have with the various stages of distress, ARITA is well aware that insolvency risk is the primary risk of default facing a credit professional in respect of an amount they’re owed.

And as Mr Winter points out, in many cases insolvency will represent a near or total loss scenario, which is why credit professionals have to know a borrower’s business intimately.

Whilst nominating cash flow, reserves and debt maturity as the obvious areas where credit professionals are likely to uncover insolvencyrelated risk, Mr Winter said the value of those orthodox approaches can be enhanced by looking outside the square.

“Indicators of sector or geographic insolvency risk are helpful in making generalisations about risk exposure and manage trading terms ahead of any build-up of debt,” Mr Winter said.

“Following the news is also a great way to see where risk is unfolding,” he said.

“For example, the coverage of various recent retail sector collapses and the commentary from the liquidators charged with managing those appointments gives a powerful insight into the systemic risks in the sector,” he said. This is unprecedented and it threatens the solvency of a significant portion of business community. Counterparty risk is absolutely everywhere. Government stimulus means zero, or worse, if businesses are directed to close or have supply or demand collapse.”

“A credit professional can use those insights to stress test their approach to retail creditors.

“You can delve into the success or otherwise of the online channel of a retailer. You can see reviews online from unhappy customers that may indicate your borrower is experiencing some of the same issues that preceded collapses of other retailers.”

And he has a warning for those in the business of making loans and managing credit. “There’s an increasing number of people and businesses coming in to see liquidators for advice about their circumstances,” he said.

“Secondly, insolvency practitioners are reporting more and more people seeking advice to cover themselves with the safe harbour provisions.

“The enormity of the financial impact of COVD-19 still hasn’t dawned on people,” Mr Winter warned.

This is unprecedented and it threatens the solvency of a significant portion of the business community. Counterparty risk is absolutely everywhere. Government stimulus means zero, or worse, if businesses are directed to close or have supply or demand collapse.”