Why Is Insolvency So Expensive? – february 2021
Feb 02 2021
Professional services are expensive. Full stop. Anyone who has been involved in litigation has sold a business, or engaged a management consultant will know that the cost of having a team of professionals undertaking a bespoke task is going to cost a lot of money. Whether you receive good value is a different question. An insolvency process is expensive, but is it good value?
To answer that question, it is useful to consider the following 3 issues: -
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- Are the hourly rates charged too high?
- Do insolvency practitioners undertake work that delivers no value?
- Does existing legislation and regulation unnecessarily drive up the cost of an insolvency process?
Hourly Rates
For many years ARITA (then known as the IPA) published a schedule of standard hourly rates that was heavily relied upon by Insolvency Practitioners (IP’s) as a default rate. IP’s in the larger multidisciplinary firms regularly pressed the IPA for increases in those rates to better align them with their firm’s general rates, whilst smaller practitioners on lower overheads happily enjoyed the benefits of a “one size fits all” rate that would have been hard to justify based on their own costs.
Eventually the IPA acknowledged that the process of setting a standard rate was not sustainable and rightly abandoned the rate in favour of the market setting its own rates.
Many firms continued to set their rates based on the old scale adjusted for inflation until it became apparent that the market could no longer bear continuing increases. As a result, rates remained stagnant for an extended period in the early 2000’s.
So the question remains, do these rates seem expensive compared to other disciplines of accounting?
Many creditors will reel in horror at paying $600-$700 per hour when in fact they may be paying their own accountant something far less. Other creditors engaged in larger businesses who regularly use medium-sized accounting firms may consider those rates reasonable. The reasonableness of the hourly rate will depend on the complexity of the work being performed as well as the size and reputation of the firm doing the work.
If you were having tax work done, would you expect that H & R Block would charge the same rate as a Big 4 firm for doing your tax return? Clearly not. H & R Block has systems in place for doing high-volume simple tax returns. work which we describe as compliance work. A Big 4 firm will provide cutting-edge advice on structuring and legal issues to ensure the lowest possible tax is paid. We expect to pay a premium for this advice.
The same is true for insolvency. Many would argue that insolvency work has become increasingly compliance-driven, and to a degree that is true. However when accepting an appointment an IP will be unaware of the potential issues that may arise from their investigations, and as a result, significant risks can exist for an IP that an ordinary accountant doing compliance work will not be exposed to.
Further, that general accountant can rely on his or her client to turn up next year and require the same service, whereas the IP will need to go out and market themselves in order to find their next assignment.
And in doing the annual accounts and tax return of a small business client, that accountant can usually rely on getting paid, and within a reasonable time frame, whereas the IP will have to wait a considerable time to recover assets from which they can be paid, or often go without payment. These are all factors which contribute to the reasonableness of the hourly rate charged by IP’s.
If I could compare insolvency rates to general accounting rates then I certainly would, however it seems that other accounting disciplines are not so fond of disclosure.
If the hourly rates being charged by IP’s are reasonable, why does the insolvency process seem so expensive?
Tasks
To answer that question, it is useful to revisit my earlier research which provided details of the particular tasks that IP’s were spending their time on.
Whilst we can all agree that insolvency can be an expensive process, let us have a look at what really makes up that cost and determine whether each of those elements is delivering value for money and deal with those areas which are not.
There is an expectation from stakeholders that IP’s spend the majority of their time realising assets, when in fact that task only accounts for between 13% and 17% of total remuneration.
Investigations are an important part of the insolvency process and often result in the recovery of assets not disclosed by Directors, however little value seems to be placed on this task by stakeholders, including Government. The conduct and reporting of investigations is an important part of the insolvency process to ensure that any wrongdoing is identified and dealt with according to the legislation. These investigations often lead to recoveries which would otherwise not be made.
The Government seems to have forgotten that this essential service is being undertaken by the private sector (IP’s) at no cost, and where there are no funds, it is often the IP that will be out of pocket.
Disappointingly, Creditor Reporting and Administration can account for up to half of the total cost of an insolvency administration and much work could be done in this area to streamline the process. Many firms have invested heavily in technology in order to streamline compliance processes, however the industry remains hamstrung by legislation and regulation which forces us to undertake tasks which either are inefficient or produce little benefit for stakeholders.
Legislation And Regulation
Despite repeated calls for a “root and branch” review of insolvency legislation that has not occurred. So much could be done to prevent IP’s from wasting time and money engaging in processes that provide no real benefit to stakeholders.
The failure to update legislation to deal with advancements in technology has resulted in IP’s continuing to send voluminous documents via a slowing postal system in order to meet legislative requirements. Additionally, the remuneration approval process which has become increasingly time-consuming for IP’s requires a complete overhaul.
In an attempt to provide a low-cost restructuring solution to small businesses the Government has introduced the Corporations Amendment (Corporate insolvency Reforms) Act 2020 (Cth) which took effect on 1 January 2021. This legislation provided for:-
- A new formal debt restructuring process for eligible small businesses, and
- A simplified liquidation pathway for eligible small companies to allow a faster and lower-cost liquidation process.
This legislation has been rushed through in order to deal with an expected wave of insolvencies, however has been done so with little if any consultation and as a result will fail to achieve its intended objectives.
Conclusion
Do existing insolvency processes deliver good value? Sadly, too many of the tasks that are required to be undertaken by IP’s pursuant to the existing legislation are either inefficient or deliver no value to stakeholders.
Further, those areas of the current legislation which are useful and well-intended (such as insolvent trading) can be very expensive to enforce and often successful recoveries will still fail to deliver results for creditors.
It is time to stop blaming IP’s for high costs, and seriously look at the legislation in order to create a system which allows IP’s to deliver good value. Any revamp of legislation needs to look at simplifying matters rather than creating further technical and compliance hurdles that are increasingly expensive for IP’s to jump.
For a free, no-obligation discussion, please feel free to contact Stephen Michell | Philip Newman | David Quin