In an ideal world and a new decade, everyone would win the lottery and in this financial slowdown, all your money problems would disappear. While there isn’t much Sajen Legal can do about the first one, we can certainly offer you advice to help you protect your personal and professional financial portfolio, banishing those economic woes.

Individuals as well as companies, big and small, were hit by the Global Financial Crisis. Some have emerged stronger from the slowdown, substituting cynicism with a new hope. Others are still struggling. Bankruptcy, although no new phenomenon, became commonplace at the end of the previous decade. 2008-09 alone witnessed 32,909 insolvency activities as reported by the Insolvency and Trustee Service. Of course, it was one of the key factors which resulted in the global credit crunch but Global Crisis or not, bankruptcy can hit anyone, anytime, anywhere.

A debtor may become bankrupt voluntarily or involuntarily. The former occurs when an Official Receiver accepts a bankruptcy petition presented by the debtor himself. The latter occurs when the court upon the petition of a creditor, makes a sequestration order against the debtor’s estate.

Bankruptcy is usually synonymous with an individual, whereas, insolvency applies to a company. However, in both situations, control of property owned by the indebted person or company is vested with either a liquidator or trustee in Bankruptcy. While some are still awaiting their discharge, a combination of sound financial planning for your future, right choices and invaluable advice could help you not only avoid bankruptcy but also encourage you, your business and household to flourish this year and others to come.

Common financial questions posed in the New Year include, ‘Should I buy a car or a house?’ Global markets are improving, albeit sluggishly, but is it advisable to secure a loan for buying an asset which depreciates eventually or would it be wiser to invest in property?

Investment goals play an important role here. If the purpose is to gain returns on the appreciation of the value of the assets, then it is practical to invest in assets such as stocks, unit trusts, mutual funds or property. A car, on the other hand is a depreciating asset and unless it is being used as a minicab or transportation service, it is not going to attract any income.

Other questions include, ‘Can I start a business without any capital’? The new era injects fresh inspiration into entrepreneurs and enthusiasts but some worry about a lack of capital and their ability to secure loans. Accompanied with this worry is the bigger apprehension of failing to make repayments and the dreaded option of bankruptcy.

Of course these are a few of the many important questions when making new plans. However, a secure plan needs to cover all avenues, not just the obvious ones. Where does one start? How can a business revive itself?

Apart from cost cutting, lay offs, outsourcing, reduced luxury holidays or spa memberships, businesses and individuals in order to financially revive themselves at the office or home could adopt the following simple but prudent tips:

• Set personal and professional goals and then zero in on what matters
• Use a budget and stick to it
• Create an emergency fund
• Reconsider unaffordable assets
• Resist taking out too many loans
• Settle, manage or consolidate your debts
• Understand your target audience
• Exploit your competitive gaps
• Think beyond pricing
• Acquire new skills

These are a few simple ways in which an individual or company can consciously avoid bankruptcy. For instance, proper planning and continually revisiting your business plan can help maximize opportunities in an evolving marketplace. Flexibility is also the key here, both in planning and in your approach. Of course your financial and legal advisors will offer you more structured and detailed advice but relying on your own resources and judgment will go a long way in saving you several pennies. Hiring good people is one example. Investing in the right people can define the difference between success and failure. Better customer relationships will also be built if internal relations are healthy.

At Sajen Legal, we offer our clients advice in times of difficulty, when faced with a serious order such as bankruptcy. We also strive to offer advice in preempting and avoiding such situations. Looking ahead, there is no shortage of good ideas and good people, opportunities and challenges. Implementing, attracting and boldly facing them will mark the beginning of a new era for individuals, families and companies.

The regular tribulations of the Global Financial Crisis in the guise of unemployment and financial struggles have been dwarfed by a more sophisticated evil. Fraudulent activities and organized misbehavior disguised under a trend, known as ‘Phoenix activity’, although not a new trend, is gaining momentum in Australia in recent times. What is Phoenix activity? Phoenix, the largest city in the US, also known as the Valley of the Sun and the Phoenix activity in Australia, echo the same philosophy to the mythological creature. The emergence of a new entity through fire and difficult times resurfaces to live again and start afresh. These Phoenix companies are ‘revived’ by directors who transfer assets of an indebted company into a ‘new’ company, with a similar name and identical activities of the previous company, doing business incognito but essentially are run by the same directors.

Further, the directors place the initial company into administration or liquidation with no assets to pay creditors, whilst enjoying the fruit of the Phoenix or new company. However, ASIC has been quick to catch on to such fraudulent gimmicks. It has been successful in removing 40 directors from office who have intentionally avoided their responsibilities and have defrauded their creditors.

The Australian Taxation Office and Treasury fear annual costs to be around $700 million to $1.3 billion in resolving these cases. An enforcement program is in place, which is funded by the Assetless Administration Fund.

ASIC Chairman, Mr Jeffrey Lucy, explained that the purpose of the Fund was to assist liquidators to discharge their duties in conducting thorough investigations and compiling reports, which would enable ASIC to implement enforcement proceedings.

However, this is not enough. Bridging the regulatory gap, protecting creditors and discouraging Phoenix activity, needs more stringent strategies in place. Whilst the Fund and the Corporations Act, among other statutory sources, serve in achieving these objectives, the Treasury has proposed stricter changes, which if implemented, will significantly alter the personal liability of directors.

The proposed paper, "Action Against Fraudulent Phoenix Activity"^[1] , recommends several key changes. To cite a few, for instance, the current taxation rules entitle the Commissioner to preempt tax liabilities by requesting a bond from a director where he foresees or considers a risk of Phoenix activity. The new rules recommend widening this preemption by including other liabilities. Further, a high penalty is also to be imposed for failing to provide such a bond.

Other changes apply to payment of liabilities. For example, the Director Penalty Notice is to be replaced with an automatic penalty and personal liability on the director after 3 months from the due date for payment of statutory liabilities. Earlier, directors were liable for just PAYG. Under the new regime, directors will also be held personally labile for outstanding superannuation, GST, excise and income tax.

The ideal outcome would be for a reduced number of Phoenix activities and directors who are more honest and diligent in their conduct and duties. Until this positive change completely sets in, ASIC will continue intervening but earlier on this time with the help of the stricter proposed rules, the Assetless Administration Fund and the information provided by liquidators. Directors, instead of feeling scared and threatened should view these changes positively and seek to turn around their companies and avoid severe legal penalties.

ASIC’s surveillance initiative ensures that company officers barred from running their companies comply with their disqualification or else they will face the threat of criminal proceedings.

It has been a little over a year since the Global Financial Crisis. The Australian economy is emerging boldly. This should inject a new impetus to companies and directors who are struggling to provide opportunities for genuine growth and trade and to discourage any unwanted Phoenixes. On the one hand, strict rules will punish dishonest directors but the innocent ones along with their creditors may wrongfully and unfairly bear the brunt of such a strict regime.

^[1] http://www.treasury.gov.au/contentitem.asp?NavId=002&ContentID=1647

In Queensland alone last year, according to the Insolvency Trustee Service Australia, there were around 1350 bankruptcies which were business related.  That does not include personal insolvency arrangements, which are arrangements with creditors designed to avoid bankruptcy. Statistics provided by a recent report commissioned by the Universityof Melbourne indicate an increase of over 12% in last year’s figures.  That same report also indicated the most common causes of bankruptcy were credit, health issues and mortgage default.  Surprisingly, more than 27 percent of bankrupts listed their occupation as managers, administrators or professionals so it’s becoming more of a middle class problem than one might expect.

Bankruptcy is only one aspect of the equation however, as the Bankruptcy Act applies only to individuals. Companies on the other hand are governed by the Corporations Act and rather than being made bankrupt, are placed in liquidation, administration or receivership.

On the corporate front, according to ASIC, therewere 1541 companies in Queensland that were placed in external administration during 2008. While figures for January only are out, there were already 236 insolvency appointments to companies in Queensland for 2009 compared with 140 for the same time last year.

Aside from the causes I mentioned above, anecdotally, and in my experience the most common causes of insolvency are:

1.                      cash flow issues –inattention to proper systems and procedures for the collection of revenue e.g.ineffective terms of trade and security for payment if credit is given, ineffective internal audit controls to prevent fraud, irregular debtor recovery and inadequate working capital;

2.                      inexperience in business matters – while someone may have the skills to carry out a particular trade or profession, even be the master of their particular craft, it does not follow they have the skills or wherewithal to run a business;

3.                      lack of planning – the overwhelming number of business failures I’ve seen in 20 years of practice are due to a lack of proper planning – cash flow and budget, business and strategic planning, marketing etc. The old saying might be trite but ‘fail to plan, you plan to fail’.

4.                      documentation – the number of times I have see people’s failure to properly document relationships is astounding. Be they of the nature of rights of equity holders in the business (partners, shareholders etc), supply and distribution chains, credit arrangements, banking etc. a failure to properly document the key business relationships can cause significant financial stress to a business. Litigation is an expensive process but in the absence of documentation properly reflecting agreements which cater for alternative dispute resolution, sometimes people have little choice other than to ‘bet the company’. Not everyone wins those bets.

5.                      inadequate advice – many people either do not obtain advice from their professional advisors (lawyers and accountants in particular) due to the perception the costs are too great. The cost of establishing and maintaining the correct structure at the start is cheap compared with the costs of litigation. It ought be looked at in much the same way as insurance – sometimes you just can’t afford not to have it. However, the overwhelming majority of people whose businesses fail do not have adequate structures in place to protect their key assets. Alternatively, if they do, they have failed to obtain regular advice on how to maintain the effectiveness of those structures over time.

6.                      Ignorance – it is not uncommon for people to adopt the ‘ostrich’ approach to difficulties that at first blush may seem insurmountable.  If there is one guaranteed cause of business failure it’s to stick one’s head in the sand and hope things will improve.  Dealing with problems, whether they be the tax man, a difficult partner or debtor who by the size of their account is extorting you into unprofitable arrangements, must be dealt with head on with the same confidence that led you into starting the business in the first place.

7.                      mediocrity – the ‘lifestyle’ of the Sunshine Coast seems to engender an overwhelming sense, or acceptance, of mediocrity.  Despite appearances (or is it wishful thinking), globalization affects the businesses of the Sunshine Coast every bit as much as it does New York, London or Sydney. We compete on a global stage and to do so we have to be the very best.  Mediocrity, be it in service, staff quality, product, attitude or culture, just will not cut it in the modern marketplace.

While these are all ‘technical’ causes of insolvency, of course there’s no guarantee that adherence to all the correct principles of business will save a business.  Often enough, the cause is an external event beyond the control of the business owner  - e.g. fraud,market failure, supplier failure and so on.  The important thing for people to understand is that it’s not always their fault and even if it is, if they actually have the courage to deal with the problems quickly enough they can either turn things around or at the very least escape the worst. There is no one I have ever met in the business world who hasn’t made a mistake but there’re plenty who aren’t brave enough to admit it – a lot of them fall victim to business failure.

The economic crisis (none dare call itrecession) has effects that sometimes are just too difficult to trace or monitor.  The effect of one business’ failure also has significant ramifications, like ripples on a pond.  How many of the 80 odd staff who lost their jobs at EcoNova have been able to obtain new jobs?  What happens to the businesses that relied on those people’s income to survive?  The failure of one business can lead to the failure of many others as no one operates in isolation. It really is amazing, when one thinks about it, as to the level of interdependence we all have even on a daily basis.  So, the cold hard reality is that some businesses will fail, no matter what they do and for reasons well beyond their control.

There are no guarantees in life and, as Sir Peter Abels was fond of saying, ‘while none of us have the right to earn a profit, we all have the right to fail’. At least those businesses that keep in mind the above matters are all likely to have a much better chance of surviving the recession.