Date posted: 16/09/2020 8 min read

Zombie Companies Await Insolvency When Stimulus Packages Stop

Zombie companies that are surviving on the back of government stimulus packages await a slew of insolvencies when the subsidies run out.

In Brief

  • Government support during COVID-19 has seen the rate of business insolvencies drop below the usual level.
  • Winding back life-support systems will release a wave of insolvencies that will shudder through the economy.
  • There are a number of ‘zombie’ companies that won’t be viable when things get back to normal.

By Ben Hurley

The impact of COVID-19 will be long-lasting and unpredictable, particularly for hard-hit industries such as tourism, retail and hospitality. No-one can be sure what’s ahead.

The return of COVID-19 lockdowns in Victoria in July and August, for example, is expected to cost Australia’s economy between A$10 billion and A$12 billion. And Australia’s official unemployment rate, forecast to peak at 9.25% in December, is now slated to be closer to 10%. (The ‘real’ unemployment rate, which includes people on zero hours and those not looking for work, is about 13%.)

But despite the unpredictability, there are a range of milestones businesses in Australia know to expect. On 25 September, directors of Australian companies will once again be liable for trading while insolvent after a six-month exemption to help them trade through the worst of the crisis. (There are some reports that the moratorium may be extended, but that’s yet to be confirmed by the Morrison government.)

September will also see a reduction in the JobKeeper subsidy (from A$1500 to A$1200 a fortnight from 28 September) and an end to the employer cash-flow boost, delivered as tax credits to eligible businesses.

And before the year’s end, landlords will no longer be required to provide rent relief or refrain from evicting commercial tenants. Banks will unfreeze mortgage repayments and the Australian Taxation Office will ramp up compliance activities to ensure only eligible employees and employers are receiving stimulus measures.

Insolvencies to have far-reaching impact

Winding back these life-support systems will release a pent-up wave of insolvencies that will shudder through the economy.

Insolvency statistics by the Australian Securities and Investments Commission (ASIC) show that since March, when the Morrison government began releasing stimulus packages to aid the economy, the number of companies entering external administration and controller appointments has been consistently far below the previous year. Provisional figures for May found the number had dropped by more than half compared with May 2019.

With insolvency rates well below average at a time when businesses are struggling, it is clear there are a large number of ‘zombie’ companies that won’t be able to return to viability as business slowly gets back to normal.

“These businesses were probably struggling before COVID-19, they may have encountered more issues related to COVID-19, but because of the support measures in place, and also the fact that nobody is really enforcing debts at the moment, that means businesses that aren’t viable are being carried along,” says Karen McWilliams FCA, business reform leader at Chartered Accountants Australia and New Zealand.

“Businesses that aren’t viable are being carried along.”
Karen McWilliams FCA, CA ANZ business reform leader

John Winter, CEO of the Australian Restructuring Insolvency and Turnaround Association (ARITA), expects a wave of insolvencies at the end of this year as a result of the removal of stimulus and insolvent trading protections. Another wave is likely in the first half of next year, as businesses holding on for a Christmas rush may not get it, and others that normally close down for Christmas realise they don’t have the usual fat they normally rely on to get through that period.

“Businesses can’t be turned on and off like a light switch,” Winter says. “It takes time for customers to come back, it takes time to re-establish how you’re going to trade. A lot of businesses won’t survive that transition.”

“Businesses can’t be turned on and off like a light switch… a lot of businesses won’t survive that transition.”
John Winter, ARITA chief executive

This surge of insolvencies will impact the economy in a wide range of ways. Some of these businesses will burn their creditors, who are often suppliers such as grocers, plumbers and a range of other SMEs they owe money to – including, potentially, their accountants.

“One of the challenges with the insolvency moratorium put in place is that you start seeing people exhibiting reckless behaviour,” he says. “They do that because they feel you can’t get more broke than broke.”

Don’t see closing a business as failure

While it’s tempting for businesses to wait and see if things improve, CAs have an important role to play in helping clients get realistic about their prospects and, if necessary, referring them to an accredited insolvency specialist. Visiting an insolvency practitioner early to discuss options may ultimately help the business survive or at least minimise the consequences of closing it down.

Auckland-based Kare Johnstone, partner at McGrathNicol, encourages business owners and accountants not to look at restructuring a business through the lens of failure.

“If the option at the end of the process is to shut down your business, this isn’t a failure,” she says. “It’s a strength to identify the position of your company and take appropriate steps if you believe your business won’t be able to come out the other side.”

“If the option at the end of the process is to shut down your business, this isn’t a failure.”
Kare Johnstone, McGrathNicol

In Australia, the business could potentially be restructured under ‘safe harbour’ laws, keeping the directors in control of the company alongside a restructuring adviser and offering protection beyond the six months of temporary relief during COVID-19.

In New Zealand, the recently introduced business debt hibernation scheme could provide the business with a six-month moratorium period, if the creditors agree, giving it time to put forward a compromise proposal for creditors to consider and vote on.

A range of other restructuring tools are available, including receivership, scheme of arrangement and voluntary administration – an arrangement sometimes allowing the directors to put together the deed of company arrangement that is considered by the creditors and usually involves the creditors compromising their debts.

Importantly, McWilliams says CAs should advise businesses to stick to accredited specialists and avoid dodgy operators who offer the opportunity to ‘phoenix’ a business and leave debt behind, potentially breaking the law.

An irony for the insolvency sector

It is an irony that the insolvency sector itself is in distress. A survey conducted in May by the Australian Restructuring Insolvency and Turnaround Association (ARITA) found more than half of all insolvency firms either had registered or were planning to register for JobKeeper, and 56% were very concerned or slightly concerned about their viability for the next six months.

Redundancies have been common throughout the sector, which normally booms during downturns but has been starved of work due to the government stimulus packages and insolvency protections.

The number of registered liquidators is down 15% compared with two years ago, says John Winter, chief executive officer of ARITA. This leaves the industry ill prepared for a deluge of insolvencies set to arrive with the winding down of government stimulus.

“The phone has stopped ringing for even that basic workload that is normally there,” Winter says. “Insolvency firms are staring down the barrel of six months of no revenue and, on top of that, insolvency fees take a very long time to get paid due to requiring approval from creditors.”

Insolvency law is one of the most complex fields of commercial law, Winter says, and it takes time to skill people up, particularly as 65% of Australian insolvency firms are small practices without the ability to roll people over from other departments.

The shortage of professionals when the deluge comes could have far-reaching impacts, as distressed businesses that delay seeing an insolvency practitioner risk missing the opportunity to save their business or at least minimise the consequences of closing it down. They could also potentially be breaking the law.

For CAs who see the writing on the wall for a client or employer, referring the business to an insolvency practitioner early may be the best course of action, particularly as it may be hard to get an appointment later in the year and fees could be higher.

Ultimately, it may also benefit the accountant. “If they refer the business early enough, they might get them back as a client because they get a turnaround, not an insolvency,” Winter says.

Andrew Barnden FCA, a Sydney-based director at insolvency firm Rodgers Reidy, says liquidating a business is the worst-case scenario and only recommended if there are no other viable alternatives.

“I always tell chartered accountants: ask the right questions and ask the questions as soon as you become aware of any issues,” he says. “If you haven’t paid tax or super, is that just a one-off mistake or indicative of an underlying problem that needs to be dealt with before it becomes fatal?”

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