Aug 132015
 

What reasons are given for the failure and insolvency of non-corporate businesses, i.e., those owned by individuals as sole traders or in partnership? Is there any alignment between the reasons given for non-corporate business failures and the reasons given for corporate failures? And where a non-corporate (aka personal) business  insolvency has been brought about by the phoenix scheme of a corporate customer or client, is this made known to the regulator for statistical purposes?

This article is an extension of the discussion in my post  “Confusing causes of corporate insolvency”.

Collection of data

Where a person becomes bankrupt or enters into a debt agreement or personal insolvency agreement under the Bankruptcy Act, and that person (debtor) has personally operated a business,  the debtor is required, in a Statement of Affairs, to “Tick one cause only … that best describes the main cause of your financial difficulties”. [Statement of Affairs – Bankruptcy Form 3, Part A, Personal Details – Confidential, Section 18B.]

The bankruptcy regulator, Australian Financial Security Authority (AFSA), analyses the data and publishes certain statistics.

Guide to business and non-business personal insolvency activity statistics

For those using its statistics AFSA provides a guide which states relevantly:

Every debtor who becomes bankrupt or proposes a debt agreement or personal insolvency agreement is required to lodge a completed statement of affairs form with AFSA. The business and non-business personal insolvency statistics are generally sourced from this form …. A business related personal insolvency occurs where an individual’s bankruptcy, debt agreement or personal insolvency agreement is directly related to his or her proprietary interest in a business. The statement of affairs form does not provide guidance, including this definition of business. The business and non-business personal insolvency statistics may be affected by differences in debtors’ interpretations of what constitutes a business and whether a proprietary interest in a business was the primary cause of insolvency…. The business and non-business personal insolvency statistics solely relate to personal insolvencies and not corporate insolvencies. Debtors are not asked for further information on their proprietary interest in a business such as the size of the business.

Permitted categories of causes

The categories of causes created by AFSA for business debtors are:

  • Economic conditions affecting industry, including competition & price cutting, credit restrictions, fall in prices, increases in costs
  •  Excessive drawings, including failure to provide for taxation
  •  Excessive interest payments on loan monies and capital losses on repayments
  •  Failure to keep proper books of account and costing records
  •  Gambling or speculation
  •  Inability to collect debts due to disputes, faulty work or bad debts
  •  Lack of business ability including underquoting or failure to assess potential of business
  •  Lack of sufficient initial working capital
  •  Personal reasons, including ill health of self or dependents, domestic discord & other personal reasons
  •  Seasonal conditions including floods & droughts
  •  If other reason not listed, please specify.

Numbers for categories of AFSA causes in 2013/14

The following table has been extracted from an AFSA spreadsheet.

Table 1

Main reason for entering a business related personal insolvency

No. of
Business
Debtors 2013/14

A. Economic conditions affecting industry, including competition & price cutting, credit restrictions, fall in prices, increases in costs 2,378
B. Excessive drawings, including failure to provide for taxation 395
C. Excessive interest payments on loan monies and capital losses on repayments 227
D. Failure to keep proper books of account and costing records 158
E. Gambling or speculation 35
F. Inability to collect debts due to disputes, faulty work or bad debts 125
G. Lack of business ability including underquoting or failure to assess potential of business 245
H. Lack of sufficient initial working capital 398
I. Personal reasons, including ill health of self or dependents, domestic discord & other personal reasons 446
J. Seasonal conditions including floods & droughts 103
K. Other business reason (please specify) 1,347
Total 5,857

Source: Australian Government – Australian Financial Security Authority (AFSA) > Resources > Statistics > Social characteristics> >Causes > Datasets > BusinessCausesTimeSeries.xlsx

Top nominated causes

Table 1 shows that in percentage terms, the top 5 causes, from highest to lowest, are:

Table 2

Main reason for entering a business related personal insolvency

Percentage
of Debtors
2013/14

Economic conditions affecting industry, including competition & price cutting, credit restrictions, fall in prices, increases in costs 40.6%
Other business reason (please specify) 23.0%
Personal reasons, including ill health of self or dependents, domestic discord & other personal reasons 7.6%
Lack of sufficient initial working capital 6.8%
Excessive drawings, including failure to provide for taxation 6.7%

As noted in my recent blog on the causes of failure for companies, the “other business reasons (please specify)” cause ranks highly, suggesting that the number of permitted categories of causes may need to be increased. As also noted in that blog,  the “please specify” descriptions that are requested and given are not publicly disclosed by the regulator, which means we don’t know what is being included under this catch-all heading.

Differences between data for personal business insolvency and corporate insolvency

1.Descriptions of categories

During the last couple of years there has been much talk in the insolvency profession and in offices of relevant government authorities in support of the concept of “harmonising” or aligning the rules governing administration of bankruptcy and corporate insolvency. However, this desire does not appear to have had any influence over describing the possible causes of business failure.

The following table illustrates the differences in categories that exist. The causes are listed in the order in which they appear in the statutory forms: no attempt has been made to match descriptions.

Table 3

Bankruptcy Regime

Corporation Regime

Economic conditions affecting industry, including competition & price cutting, credit restrictions, fall in prices, increases in costs Under capitalisation
Excessive drawings, including failure to provide for taxation Poor financial control, including lack of records
Excessive interest payments on loan monies and capital losses on repayments Poor management of accounts receivable
Failure to keep proper books of account and costing records Poor strategic management of business
Gambling or speculation Inadequate cash flow or high cash use
Inability to collect debts due to disputes, faulty work or bad debts Poor economic conditions
Lack of business ability including underquoting or failure to assess potential of business Natural disaster
Lack of sufficient initial working capital Fraud
Personal reasons, including ill health of self or dependents, domestic discord & other personal reasons Deed of Company Arrangement failed
Seasonal conditions including floods & droughts Dispute among directors
If other reason not listed, please specify Trading losses
Industry restructuring
Other, please specify

[There is a minor difference in terminology which is nevertheless worth noting:  bankrupts/debtors are asked to choose a category that best describes “the main cause of your financial difficulties”, whereas in corporate insolvency the request is for categories that describe “the causes of failure”.]

2. Source of data

In the bankruptcy regime (personal insolvencies) the source of the data – in other words, the person who chooses the cause of a business failure – is the bankrupt or debtor. In corporate insolvency that task is performed by the external administrator, after he or she has examined the company’s affairs.

3. Number of causes

In personal insolvencies the bankrupt or debtor is asked to choose one cause only (the main cause). But in corporate insolvency the external administrator can nominate as many causes as he or she likes, and they do not have to be rated for importance.

4.  Fraud and corporate phoenix activity

Strangely, as can be seen in Table 3, there is no ability in the bankruptcy/personal insolvency regime for “fraud” to be chosen as the main cause of business insolvency.

Superficially this  may seem to make sense, because a bankrupt/debtor might baulk at the idea of choosing “fraud” for fear of being considered the perpetrator.

But if “fraud” means dishonesty by employees or outsiders – like the misappropriation of funds, or the abuse of position by employees, or wrongful or criminal deception by outsiders – then fraud could well be the cause of a personal business insolvency.

Also, if the debtor/bankrupt has operated a business as a subcontractor in the construction industry in New South Wales, where fraudulent phoenix company activity is regarded as being common, he or she may be a phoenix victim, having been forced into bankruptcy or a personal insolvency arrangement as a result of not receiving retention monies or other payments. Indeed, this is a main reason why the Senate Economics References Committee is currently inquiring into “Insolvency in the Australian construction industry”.

My post  “Confusing causes of corporate insolvency” discusses this issue more fully and provides links to source material, such as the research paper “Defining and Profiling Phoenix Activity”.

 

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