Table of Contents:
- What are accountants recommending that their potentially insolvent clients do?
- The majority of accountants recommend insolvency practitioners for further advice
- Insolvency practitioners are not duty-bound to act in the interests of directors
- Insolvency practitioners are limited in the advice they can give
- Insolvency practitioners are unlikely to recommend non-external administration options
- Arguably, insolvency practitioners are not a profession
- Are accountants sufficiently knowledgeable and motivated about insolvency/ restructuring to give advice?
- Accountants are not the ideal first stop for pre-insolvency advice
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 because: (a) accountants are biased towards recommending insolvency practitioners; (b) they have a poor understanding of potential insolvency/ restructuring solutions; and, (c) they are not motivated to undertake insolvency/ restructuring solutions. 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 problems with relying on insolvency practitioners for pre-insolvency advice
- 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 such as Sewell & Kettle Lawyers.
- Generic financial 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. The writer’s opinion is that this is the result of illegal kick-back arrangements and a long-term cultivation of relationships through invitations to entertainment events. However, there is no empirical support for these conclusions that can be pointed to.
There are a few reasons why this may not always be a good recommendation. We consider four such reasons below.
Insolvency practitioners are not duty-bound to act in the interests of directors
Insolvency practitioners do not have a duty of good faith or ‘fiduciary duties’ to any directors that they advise. Furthermore, if they are formally appointed to an insolvency, their obligation is to act in the interests of creditors, not directors.
Often directors sit down with liquidators to discuss their company and receive a strong recommendation to utilise voluntary administration to restructure the business. This advice is not written and the directors subsequently realise that they weren’t talking to someone who was taking into account all their interests and giving advice based upon the chances of success of a voluntary administration.
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 (i.e. taking money out of the company) that I really need to look at now before I appoint an external administrator?
- 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, it is almost inevitable that they will be biased towards recommending formal insolvency appointments. This means 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)).
The cold reality is that an insolvency practitioner will make many times more in revenue from a voluntary administration that converts to a liquidation than from a safe harbour restructure. The safe harbour restructure is a process where the directors remain in control of the business and undertakes a restructuring plan that protects them from any insolvent trading claims should the company be liquidated. It would be a reasonable process to undertake, unless there are very good reasons for a voluntary administration to be utilised.
Arguably, insolvency practitioners are not a profession
That’s not intended as a pejorative claim. It refers to the kind of work that they do. Insolvency practitioners, fundamentally, sell a product — liquidations and voluntary administrations. They are more like a stock broker, or a real estate agent, than a solicitor or doctor.
As prominent insolvency commentator, Michael Murray, observed, professions generally meet the following definition:
They are occupations in a chosen sector, with ongoing education and training requirements, regulated, and committed to ethical conduct and the public interest.
Insolvency practitioners do not (currently) appear to satisfy that definition. While there are various professional associations for insolvency practitioners (like ARITA), there is not a unified body or voice in Australia.
It may be more appropriate to say that the professional status of an insolvency practitioner is an accountant (as almost all are), and insolvency appointments are a product that an accountant can specialise in providing.
Further, the key ingredient of a profession is that they exercise their calling primarily in the interests of others. For doctors it is the patient’s health and for lawyers it is to be an advocate for their client. Insolvency practitioners don’t fit into that category and, although they are bound by many legal obligations, they don’t have a higher calling. This is a pity and arguably it has resulted in a history of unethical liquidators in Australia that is vastly out of proportion to their total numbers.
Why does it practically matter whether insolvency practitioners are bona fide professionals?
Ultimately, insolvency practitioners don’t have the extensive experience in advising that other professionals do, as that is not their focus. So, it stands to reason that they may not be the best option for pre-insolvency advice.
Many directors assume that if they meet an insolvency practitioner for a ‘free consultation’ that they have received high quality advice. On the other hand, they work out later that an informal restructure would have had a higher chance of success than a voluntary administration.
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 business 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 competent to recommend it as an option.
Even more astounding — 60 percent think that voluntary administration is good for small and medium sized enterprises (p 137). If this were actually the case, there would have been no need for the introduction of safe harbour informal restructuring in 2017 and the small business restructuring process in 2021. Nor would the Australian Small Business and Family Enterprises Ombudsman have found that voluntary administration was failing small and medium sized enterprises in their 2020 Insolvency Practices Inquiry.
At least there is an indication that some accountants understand. As one accountant put it:
“The system appears to be designed to destroy any business that approaches insolvency. Often the business needs a little time to restructure and recover and this is simply not available. Once an administrator is appointed, the end result is very rarely a good one for the business or for Australia.” (p strc137).
The key problem is that the voluntary administration process was designed in 1988 and is urgently in need of an update. Unfortunately, the business community doesn’t see voluntary administration as a restructure process – it is seen as tantamount to a liquidation.
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 recommend insolvency practitioners, even though there are good reasons why insolvency practitioners might not be the best option for pre-insolvency advice. They also seem to lack the general knowledge of restructuring and external administration that is required to competently provide 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 accountant 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.