Recent months have seen an increase in speculation as to whether we are seeing the first signs of distress appear in corporate Australia. Whilst the construction industry has laid bare its woes with the collapse of construction giant ProBuild and others, the cracks are appearing in several sectors, particularly where price increases cannot be passed on to the end customer.
We are reminded of the 2010 movie “Margin Call“, which portrays an unnamed US investment bank heavily invested in collateralised debt obligations (CDOs). The bank’s chairman, played by Jeremy Irons, speaking to his assembled lieutenants in the middle of the night at the precipice of the Global Financial Crisis (GFC), declares:
I’m here to guess what the music is going to do a week, a month, a year from now. That’s it, nothing more………and I’m afraid standing here tonight, that I don’t hear a thing… just silence.
Irons was making a prediction about the collapse of the CDO market, which subsequently took down several significant financial institutions around the globe and sent millions of people backwards in personal wealth.
Unlike Australia’s relatively unscathed economic journey through the Global Financial Crisis (GFC), the COVID-19 recovery could be very different. Whilst the benefits of the various stimulus programs were well advertised by the political set, the silent benefactor over the past two years for many Australian businesses has been the Australian Taxation Office (ATO) which many businesses have used as a defacto bank. The ATO had taken an accommodative approach to companies impacted by the pandemic and subsequently fell behind on their liabilities. However, borrowing from Irons’ analogy, it may be that the music has stopped for these companies and the ATO is no longer willing to be used as a quasi-bank.
Instead of maintaining silence, the ATO has written to the directors of some 50,000 businesses with a caution: the debts of the business will become personal liabilities of the directors in the event they remain unpaid. This type of action is known as a Director Penalty Notice (DPN). Based on information from CreditorWatch, more than half of the director letters issued related to company debts more than $100,000 and the construction and property industries are the main recipients with 28% of the letters issued.
The issuance of a DPN can have adverse impacts on a business in the short term, let alone the director to whom it has been issued. The GCI team has seen these situations first-hand in recent months and in the most extreme case, has involved a business appointing voluntary administrators. Recent data from the ATO indicates that 40 DPNs are being issued per day.
Our conversations with accounting, insolvency and restructuring practitioners indicates these letters are having a positive effect. More directors are proactively engaging with specialist advisors to understand how they can address this type of debt.
Through our Special Opportunities team, GCI has been involved in various discussions where a company is looking for additional capital and/or supporting a refinance to allow the company to work with the ATO to get on top of their tax debt (i.e. for instance an ATO payment plan). For example, a recent borrower was able to leverage their property equity to secure funding and clear their ATO debt in full.
We note insolvency numbers are now on the rise and in 2022 are forecast to double relative to the past two years. However, we see the ATO maintaining its accommodative approach to businesses which proactively come to the tax office with their concerns and a possible solution / proposal. We would encourage businesses to contact the ATO or their professional business advisors as soon as possible.
Authored by Hugh Selleck (Investment Director, GCI)