Welcome to Zombie Land.
On 25 January 2020, the first Australian case of novel coronavirus (COVID-19) was confirmed in Melbourne. Fast forward seven months later and we have surpassed 25,000 recorded COVID-19 cases and over 600 deaths.1 As we learn to adapt to a "new normal" in both our personal and working lives, it's clear that the impact of this pandemic will be felt for many years to come.
Australia is in a recession for the first time in 29 years. According to the Reserve Bank of Australia (RBA) in its most recent statement on monetary policy2, our economy has experienced a severe contraction and is now in the early stages of recovery. The contraction over the first half of 2020, although smaller than anticipated three months ago, is still very large and the pace of recovery is expected to be slower than previously forecasted.
The Federal Government has been on the front foot in supporting businesses and their employees through introducing key stimulus initiatives through the tax system including:
- The JobKeeper Payment open to eligible employers so they can continue to pay their eligible employees and restart quickly when the COVID-19 crisis is over (initially until the end of September 2020 but now extended to March 2021 at a reduced rate).
- Tax-free cash flow boosts of between $20,000 and $100,000 to eligible businesses, delivered through credits in the activity statement system, when eligible businesses lodge their activity statements.
- From 12 March 2020 until 31 December 2020, the instant asset write-off threshold increased to $150,000 (up from $30,000) for businesses with an aggregated turnover of less than $500 million (up from $50 million).3
State and territory governments also provided relief for businesses through rebates of Payroll Tax and concessions on other state charges.
Apart from the financial measures, the Treasurer, Josh Frydenberg, announced regulatory changes including temporary changes to insolvency laws in March. These measures included:
- Response time for statutory demands for payment extended from 21 days to six months.
- Minimum debt amount required to initiate insolvency proceedings against a company increased from $5,000 to $20,000.
- Company directors provided with personal liability exemption from insolvent trading actions during the six-month moratorium period.
Commercial tenants were also provided protection with a temporary hold on evictions and a mandatory code of conduct for commercial tenancies to support small-and-medium sized enterprises (SMEs) affected by COVID-19.
The banks chimed in to defer loan repayments for six months with the total value of loans deferred by the banks since March now at least $200 billion on 643,000 loans4.
In summary, everything including the kitchen sink, has been thrown at saving Australian businesses and jobs.
Rise of the zombie
Consequently, from all the various measures introduced, new insolvency appointments have decreased sharply in the first half of 2020. In the June 2020 quarter, a total of 1,795 new appointments were recorded nationally compared to 2,911 in same quarter last year i.e. a drop of over 38%.5
Businesses that would have otherwise failed, have been kept alive by a combination of measures designed to give temporary support to going concern businesses during this difficult time.
Zombie companies are traditionally defined as: Indebted businesses that, although generating cash, after covering operating costs only have enough funds to service the interest on its loans, but not the debt itself. As such those businesses generally depend on banks and other creditors for its continued existence—effectively putting them on never-ending life support.
It's no big leap to suggest that the decrease in formal insolvency appointments is corelative to an increase in the number of zombie companies surviving purely on Government handouts, moratoriums from their banks and deferred payment arrangements from other creditors such as the Australian Taxation Office (ATO).
So, what happens when the support measures start winding back and those businesses have to face reality?
Paying the piper
Given the future economic trajectory is quite negative, most businesses will feel the pinch well before the stimulus measures are fully wound back and the banks begin to demand regular loan repayments.
Businesses will also face the harsh reality of dealing with the residual debts from deferred payment arrangements with landlords, trade suppliers and the ATO or face the threat of being wound up when the current moratorium ends. (As our article Responding to the legacy debt of 2020 illustrates).
RBA Governor, Phillip Lowe recently told the House of Representatives Standing Committee on Economics that the country would soon have to "confront the reality" that there will be businesses that are no longer viable because of the pandemic and that these businesses will have to close once temporary insolvency relief measures come to an end.
"There will be insolvencies. There will be bankruptcies. There will be some businesses that will not recover. That's the harsh reality of an economic downturn that's the worst in 100 years." 6
Getting the right advice
As insolvency practitioners we regularly deal with businesses that have been insolvent for quite some time before we are approached for assistance. Getting proper advice at an early stage is critical to achieving the best outcome for any distressed business.
Worrells have been providing high-quality insolvency and related services for over 47 years. We pride ourselves on offering reliable and practical solutions to those burdened with debt. With 29 partners and over 150 staff in 34 locations across Australia we are uniquely positioned to assist businesses and their advisors during these unprecedented and uncertain times.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.