Innovation agenda's bankruptcy reform needs more caution

By Alex Malley

June 3, 2016

When Prime Minister Malcolm Turnbull announced we were entering an “ideas boom” at the launch of the government’s innovation statement in December, it was big on infographics and light on detail.

One of the central proposals was to look at the way bankruptcy and insolvency laws were structured with a view to encouraging a greater degree of risk-taking. It was going to help foster a culture of entrepreneurship and innovation.

Four months later and just a week before the election was called, a proposals paper was released seeking public views on measures to improve our bankruptcy and insolvency laws. While the caretaker conventions are now being observed and we’ll have to wait for at least a few more months to get back to the issue, it is nonetheless timely to think about the principles that sit behind the paper.

“Co-opting law reform into an innovation agenda is unwise and is likely to have unintended consequences.”

The paper opens with the assertion that “more often than not, entrepreneurs will fail several times before they achieve success.” While this might be true, it also true that upon each failure, innocent creditors go unsatisfied, some of whom might themselves be budding entrepreneurs.

It also says “to create an ecosystem that enables these entrepreneurs to succeed will require a cultural shift.”  This maybe so, but are changes to bankruptcy and insolvency law the appropriate approach?

The reforms include reducing the personal bankruptcy period from three years to one year, introducing a safe harbour for directors from personal liability for insolvent trading and banning what are termed ipso facto clauses which enable a provider to withdraw services upon the event of insolvency.

Though small in number, these reforms have wider potential negative impacts.

Australia has benefited from a cautious and deliberately well targeted approach to bankruptcy and insolvency law reform. Extensive industry consultation has played a key role in ensuring outcomes that are practical and provide certainty.

Tying such law reform to less directly relevant areas of economic policy has the potential to undermine the rigor we have become accustomed to expecting. The blurring of purposes within the law can create confusion and uncertainty.

The paper also states that “our current insolvency laws put too much focus on penalising and stigmatising failures.”  This infers a dishonest orientation which in fact applies only in exceptional circumstances. It also infers the law is somehow judgmental of individuals, whereas in a very deliberate manner, the law seeks to address abuse of limited liability and minimise the harms caused to creditors and shareholders. Powers such as those for disqualification from managing corporations have as much to do with protecting these interests as they do with punishing wrongdoers.

At the heart of the proposed changes is an assumption that the current laws act as a significant barrier to innovative and entrepreneurial activity. The purported linkages between the proposed law reforms and the mooted economic gains are tenuous. It is worth looking into the actual character of personal bankruptcies.

The Australian Financial and Security Authority maintains a comprehensive set of bankruptcy statistics. These show in 2013-14 that only 19% of personal bankruptcies were because of business-related reasons.

Prominent in non-business reasons are factors such as excessive use of credit, with the most significant cause being unemployment. Among causes of business-related personal bankruptcies, economic conditions dominate.

AFSA’s statistics also identify the occupation of individuals who have succumbed to bankruptcy. Overwhelmingly these occur amongst clerical and administrative workers, sales assistants, road drivers and labourers. The statistics on the age of insolvent debtors is also insightful, the most common in 2008 being 37 years, though by 2014, 43 years.

There is a real disconnect between the facts about who is affected by bankruptcy and the assumptions that underpin these proposed law reforms.

It is undisputed that the transformation of the Australian economy requires a swift and deliberate orientation to science and technology based innovation. It is also true that the various instruments of economic and legal policy need to be brought into harmony to lift Australia higher on the global rankings for innovation and competitiveness.

However, significant risk arises when laws such as those dealing with individual bankruptcy and corporate insolvency become blurred in their objectives and disconnected from the contexts in which they are applied.

We should never lose sight of the fact that insolvency and personal bankruptcy in particular, very often have catastrophic effects on the individual concerned and those around them.

Seeking to address the appropriate objectives of associated law from the narrow perspective of promoting entrepreneurial advantage downplays the significant and wider human dimension of the law’s protection of the vulnerable.

Actively fostering a culture of innovation and entrepreneurship is important and is to be commended. Co-opting law reform into an innovation agenda is unwise and is likely to have unintended consequences. One should not lead to the other.

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