Bankruptcy & Insolvency Law

A nation of failures?

By Stephen Mullette, Matthews Folbigg Lawyers

If any one fail to meet a claim for debt, and sell himself, his wife, his son and daughter for money or give them away to forced labour: they shall work for 3 years in the house of the man who bought them, or the proprietor, and in the fourth year, they shall be set free.
   — Code of Hammurabi, King of Babylon, c 1750 BC

There is something about 3 years and bankruptcy. But not if the Commonwealth Government has its way. This is because, apparently, Australian entrepreneurs are being hampered in their endeavours to fail repeatedly (and ultimately succeed). In April 2016, the federal government released a proposals paper, Improving Bankruptcy and Insolvency Laws (the Proposals Paper) under the banner of the National Innovation and Science Agenda (the Agenda) recommending that there be a reduction in the current default bankruptcy period from 3 years, to 1 year.

Importantly, the Agenda and the Proposals Paper, are premised on the fact that:

“More often than not, entrepreneurs will fail several times before they achieve success. … Our current insolvency laws put too much focus on penalising and stigmatising the failures.”

The three measures actually proposed by the government, to “improve the bankruptcy and insolvency laws”, are:

  • reduction in the bankruptcy period; as well as
  • a “safe harbour” protection for directors from personal liability for insolvent trading if they appoint a restructuring adviser; and
  • removing “ipso facto” clauses, allowing termination of contracts upon an insolvency event.

The underlying premise of the change to the bankruptcy period is that the current period “may discourage innovation and business start-ups” whereas reducing the default period to 1 year “will encourage entrepreneurial endeavour and reduce associated stigma.”

One significant difficulty with the logic behind the amendment is that it applies to all bankruptcies. If the only reason to reduce the period is to encourage entrepreneurship, then why is the proposed bankruptcy period being reduced for all bankrupts? According to the Australian Financial Security Authority (AFSA), who collect statistics on the causes of bankruptcy, in 2013/14, 19% of debtors entered a personal insolvency because of business related reasons.

This means that 81% of debtors in 2013/14 entered personal insolvency because of non-business related reasons. The majority of these (18,473 out of 24,438 or 76%) were caused by:

  • unemployment or loss of income;
  • excessive use of credit; and
  • domestic discord or relationship breakdowns.

In these circumstances, it seems strange to let 81% of bankrupts out of bankruptcy for reasons solely seeking to address what, at most, would be related to the other 19%.

And it is not actually 19% of bankrupts who are failed entrepreneurs.

That is, simply because a business has failed leading to bankruptcy does not mean an entrepreneur’s dream has been stifled, or that Australia’s onerous insolvency regime is to blame.

Further, it is difficult to see how the government’s proposal will achieve what it seeks. That is, how will reducing the bankruptcy period from 3 years to 1 year “encourage entrepreneurial endeavour and reduce associated stigma”?

As to the former, while it is true that the restrictions (such as obtaining credit) which apply during bankruptcy may make it harder to obtain money for longer (if the period is not reduced), it is not clear that the absence of credit is obviously stifling the entrepreneurial activity which the government wishes to foster.

As to the latter, it seems more reasonable to conclude that the stigma associated with bankruptcy comes from the fact of having been made bankrupt, rather than the duration of it. Bankruptcy is a matter of public record and lasts indefinitely. There is a public record on the National Personal Insolvency Index (NPII) which can be searched at any time by any one.

The Proposals Paper acknowledges that the challenge for the government is to strike a balance between encouraging entrepreneurship and protecting creditors. For the moment, the government is focused on entrepreneurship. However, history tells us that the focus will shift in due course.

Hammurabi, King of Babylon, would no doubt be disappointed with the Proposals Paper.

Note: This is an extract from Insolvency Law Bulletin Vol 17 No 5