What are private practice accountants recommending that their potentially insolvent clients do?

Estimated reading time: 0 minutes Small Business Restructuring, Voluntary administration, Company liquidation, Other

Table of contents:

Summary

For many, if not most, company directors and owners in Australia, private practice accountants are the first port-of-call for insolvency advice. This is problematic as:

  • they often have a poor understanding of potential insolvency/ restructuring solutions because it is a specialist area; and,
  • they may not be motivated to undertake insolvency/ restructuring solutions as it is not part of their regular business model. 

We examine the evidence in support of these conclusions in this article.

What are accountants recommending that their potentially insolvent clients do?

Often when businesses are in financial difficulty, they go to their private practice accountant for advice. This may be the only regularly consulted professional advisor for a typical Australian business director, so this is not surprising. But this does mean that the views of accountants have a significant impact on the steps that struggling or insolvent businesses go on to take. In recent doctoral research, Professor Jason Harris surveyed accountants to determine their views and recommendations with respect to corporate insolvency. We consider some of the statistics that he gathered below.

Specifically, we consider: 

  • Why most accountants recommend insolvency practitioners
  • What the other options for pre-insolvency advice are
  • The knowledge gap which means that accountants often don’t know enough about formal insolvency appointments to provide complete advice

The majority of accountants recommend insolvency practitioners for further advice

There are a range of individuals that could, in principle, be sought out for ‘pre-insolvency advice’. In light of this, accountants could recommend:

  • Other public practice accountants. If the accountant themself is too busy, or feels they lack the expertise, they can recommend another accountant who they find to be more familiar with insolvency issues. 
  • Chief financial officers or finance managers on contract. An accountant may know professionals of this sort who can be contracted for urgent turnaround services. 
  • Lawyers with a speciality in insolvency matters 
  • Turnaround advisers. This could include ‘phoenix operators’, who specialise in dodgy asset transfers defeating creditor interests. 
  • Insolvency practitioners. These are registered liquidators who are qualified to undertake liquidations, voluntary administrations and company restructuring, and work as receivers and managers. 

However, in his recent survey, Professor Harris found that the overwhelming majority of accountants in Australia (over 76 percent) recommended insolvency practitioners to their clients in pre-insolvency scenarios (see p 137). Professor Harris didn’t go further, however, and explain why this was the case.  

Below we consider in detail whether accountants should be so strongly recommending insolvency practitioners.

Insolvency practitioners have duties to creditors, but not directors

Once formally appointed to an insolvency, an insolvency practitioner has an obligation to act in the interests of creditors. This is established both in common law, and through various specific duties of insolvency practitioners in the Corporations Act 2001(Cth) (for example, Section 435A which states the purpose of voluntary administration is to maximize the chances of the company continuing or to provide a better return for creditors than would result from immediate liquidation). 

While these obligations don’t apply prior to appointment, whether prior to or following appointment, the insolvency practitioner is under no obligation to act in the interests of directors. 

Often directors sit down with insolvency practitioners to discuss their company and receive a strong recommendation to utilise voluntary administration or small business restructuring to attempt to turn the business around. These may not always be the best options from the Director’s perspective. As we discuss in further detail below, there may be legal means to avoid a formal insolvency appointment, such as a rescue finance deal negotiated under the safe harbour framework in section 588GA of the Corporations Act 2001 (Cth). But insolvency practitioners usually have little interest (of knowledge) in recommending those sorts of option.

Insolvency practitioners are limited in the advice they can give

According to the ethical obligations of insolvency practitioners, they aren’t allowed to give pre-insolvency advice that goes beyond ‘options’ (see APES 330). This can leave directors without proper guidance. Read more about this in our guide to the duties of insolvency practitioners. 

The type of proper advice that directors of potentially insolvent companies should receive is:

  • Is the company actually insolvent and does that mean I need to take action now?
  • Could I use the safe harbour to restructure my company?
  • What is the chance that a voluntary administration will deliver a restructure and how much would I need to contribute to a deed fund?
  • Is the company so insolvent and its foundation so unviable that I should just liquidate it?
  • Can I undertake any transactions before or after external administration if I want to save my business through a prepack or would this be illegal?
  • Are there any transactions that I really need to look at now before I appoint an external administrator? This could involve reinstating transactions to avoid legal problems down the track. 
  • What are the goals I have for the business and what do I need to do to obtain my objectives?

Insolvency practitioners are unlikely to recommend non-external administration options 

Formal insolvency appointments are the bread and butter of the insolvency practitioner. Because this is what they know the best and the service that they predominantly sell, they will tend to recommend formal insolvency appointments. This may mean that informal options are neglected (for example, negotiating a debt reduction with creditors or organising rescue finance through the ‘safe harbour’ in the Corporations Act 2001 (Cth)). 

Are accountants sufficiently knowledgeable and motivated about insolvency/ restructuring to give advice?

This is not meant to be a criticism of the intelligence of private practice accountants. They, for example, need to get a handle on personal and corporate taxation law in Australia and a variety of other compliance issues that businesses face. It would be unrealistic to expect, however, that they have a handle on all areas of business.

According to Harris’ research, only 23 percent of those surveyed were ‘very familiar’ with voluntary administration (p 137). This does not instil confidence that accountants are generally in a good position to advise on all insolvency options.. 

Furthermore — 60 percent think that voluntary administration is good for small and medium-sized enterprises (p 137). While some medium-sized businesses can benefit from voluntary administration, smaller businesses usually benefit more from either small business restructuring under Part 5.3B of the Corporations Act or a ‘safe harbour’ restructuring process. This is backed up by the findings of the e Australian Small Business and Family Enterprises Ombudsman in its 2020 Insolvency Practices Inquiry. 

Are accountants sufficiently knowledgeable and motivated about insolvency/ restructuring to give advice?

This is not meant to be a criticism of the intelligence of private practice accountants. They, for example, need to get a handle on personal and corporate taxation law in Australia and a variety of other compliance issues that businesses face. It would be unrealistic to expect, however, that they have a handle on all areas of business.

According to Harris’ research, only 23 percent of those surveyed were ‘very familiar’ with voluntary administration (p 137). This does not instil confidence that accountants are generally in a good position to advise on all insolvency options.

Furthermore — 60 percent think that voluntary administration is good for small and medium-sized enterprises (p 137). While some medium-sized businesses can benefit from voluntary administration, smaller businesses usually benefit more from either small business restructuring under Part 5.3B of the Corporations Act or a ‘safe harbour’ restructuring process. This is backed up by the findings of the e Australian Small Business and Family Enterprises Ombudsman in its 2020 Insolvency Practices Inquiry. 

Accountants are not the ideal first stop for pre-insolvency advice

It is clear that accountants have significant blind spots when it comes to pre-insolvency advice: They don’t generally appear to have sufficient understanding of external administration to provide competent advice on the matter. 

You could say that a sensible accountant will love dentists, not insolvent construction companies, as clients. This aligns with a typical accounting business model: Golf on Wednesdays, holidays in July, professional conferences scheduled quarterly. Accountants crave structure, which does not naturally gel with the chaotic and ‘lumpy’ demands of helping a client in a financial crisis. 

Add this to the fact that many accountants operate with 100 or more clients and there simply isn’t any time or incentive to drop everything and try and help a client in a financial crisis. Restructuring work for small-to-medium sized enterprises can’t easily be delegated to staff by a firm principal.