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SMALL BUSINESS INSOLVENCY IN WORLD BANK SPOTLIGHT

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by Paul Gidley28.03.19

With Shaw Gidley’s special focus on small business insolvency, the latest World Bank Group report released in September 2018 has caught our eye.

The Report Saving Entrepreneurs, Saving Enterprises: Proposals on the Treatment of MSME Insolvency is the latest in a series[i]focussed on micro, small and medium enterprise (MSME) insolvency and this Report attempts to identify best practice in the field.

MSMEs are powerhouses of economies worldwide, making significant contributions to GDP, employment and economic growth[ii]. But, as we see daily, they are fragile in economic downturns[iii].

Since the 1997 Asian Financial Crisis and the 2007 GFC, the World Bank and G20 leaders have investigated how MSME insolvency regimes can encourage, or not, entrepreneurs to start up or start again to power recovering economies[iv].

Report analysed insolvency regimes worldwide to identify those that support MSME recovery or, in event of winding up, leave the business owner with the entrepreneurial spirit alive and kicking. It suggests a framework for best practice that includes:

  • liberal liquidation and discharge of business and personal debts for natural person (unincorporated) MSMEs
  • creditor-controlled, simplified and largely out-of-court restructuring where an MSME wants to preserve non-exempt business assets
  • access to the same simplified restructuring regimes for juridical entity (incorporated) MSMEs and natural person MSMEs with the option of creditors or an insolvency administrator escalating to corporate proceedings in complex cases.
  • set up of services specifically skilled in MSME insolvency to administer MSME-specific processes.

Liberal liquidation and discharge

The Report cites evidence of an international trend towards liberalised liquidation and discharge regimes because they encourage or preserve the entrepreneurial spirit.

However, there is no critique of evidence quality provided in the Report. Readers need to deep dive into the cited sources to judge how robust the evidence for this claim is. In fact, Wellard (2018)[v] in his ARITA journal review of the Report points out that evidence of a direct connection between liberalised bankruptcy and entrepreneurialism is far from conclusive, even in the USA, home of the “fail fast, fail cheap and move on” (Wellard, 2018, p.20) mantra.

In arguing for liberal liquidation and discharge of personal and business debts for MSMEs the authors state

“Experience has shown that instances of debtor fraud and other misbehaviour are exceptional and should not cast a pall over the overwhelming majority of honest debtors”

World Bank 2018 p5.

However, the magnitude of Australia’s struggles with illegal phoenixing suggests that debtor fraud and misbehaviour are alive and well. Liberalised insolvency processes may be incompatible with efforts to combat illegal phoenixing. Furthermore, MSME financing remains a challenge in Australia[vi] and financer confidence is unlikely to be improved by a liberal discharge regime.

Open access MSME-specific insolvency process

Currently, Australian MSMEs may need to use simultaneous personal and corporate insolvency processes increasing complexity, cost and time for the least-resourced, sometimes least financially-literate enterprises. Because of this, it has been suggested that they could benefit in cost-savings, efficiency and preservation of viable businesses from a single MSME insolvency process[vii] that straddles personal and corporate insolvency. This is echoed in the Report.

But when is business the ‘right’ size for the MSME process? The Report doesn’t prescribe an eligibility threshold but recommends open access to an MSME-specific process with a backstop of transition to corporate insolvency if challenged by creditors or an insolvency administrator.

Specialised MSME insolvency knowledge and skillset

The Report acknowledges that an open access MSME-specific process would require administration by someone up to the job of detecting fraud and system abuse, and qualified to develop restructuring proposals and identify when conversion to corporate insolvency processes is warranted.

Australia’s simplified personal insolvency regime (Debt Agreements) did not deliver the desired cost savings and better outcomes for individuals, in part because of the insufficient legislative and strategic knowledge of registered administrators[viii]. It will be important not to repeat the same mistake if a simplified MSME-specific insolvency regime were to be considered.

MSME insolvency regime change on the horizon?

In the ongoing challenge to balance fair outcomes between creditors and debtors a liberal discharge may swing too far in favour of debtors for Australian tastes. However, the MSME-specific process that combines personal and corporate insolvency could offer substantial relief in cost and complexity to small business owners. Whichever way the cards fall, it is evident that such a system will require well-qualified and ethical administrators.

If you have a client who needs guidance navigating the complexities of MSME and/or personal insolvency, our specialist small business and personal insolvency professionals will be able to provide expert advice tailored to their individual circumstances.

[i] World Bank (2018). Saving Entrepreneurs, Saving Enterprises: Proposals on the Treatment of MSME Insolvency (English). [Report]. Washington D.C. World Bank Group

[ii] World Bank (2011) Policy Research working paper 5538. Small and medium enterprise. A cross-country analysis with a new data set. Retrieved from: http://documents.worldbank.org/curated/en/967301468339577330/pdf/WPS5538.pdf

[iii] World Bank Group (2017). Report on the Treatment of MSME Insolvency. Retrieved from: https://openknowledge.worldbank.org/bitstream/handle/10986/26709/114823-WP-PUBLIC-weds-510-MSME-Insolvency-report-low-res.pdf?sequence=1&isAllowed=y

[iv] World Bank Group (2017). Report on the Treatment of MSME Insolvency. Retrieved from: https://openknowledge.worldbank.org/bitstream/handle/10986/26709/114823-WP-PUBLIC-weds-510-MSME-Insolvency-report-low-res.pdf?sequence=1&isAllowed=y

[v] Wellard, M. (2018). World Bank report on MSME insolvency. Implications for Australian law reform. Australian Restructuring & Turnaround Journal. December 2018 pp 18-21.

[vi] ASBFEO, 2018, February

[vii] Sobel-Read, K.B. & MacKenzie, M. (2017, September 29). Australia needs new insolvency laws to encourage small businesses. The Conversation. Retrieved from: https://theconversation.com/australia-needs-new-insolvency-laws-to-encourage-small-businesses-84776

[viii] ASIC (2016, January). Report 465. Paying to get out of debt or clear your record: The promise of debt management firms. Retrieved from: https://download.asic.gov.au/media/3515432/rep465-published-21-january-2016.pdf