How accountants can handle client insolvency

This article was current at the time of publication.

No accountant wants to lose a client, but with the end of government stimulus payments and with interest rates and inflation rising, it may only get tougher for some smaller businesses to stay solvent.

“Directors sometimes don’t realise they have a financial problem, often thinking that by not paying the tax they’re making money, but they’re not,” says Henry Kwok CPA, registered liquidator and partner at Chifley Advisory. 

“Accountants should look at the financial books and records and if there are continued losses – especially if there are large, accumulated taxation liabilities – it’s time to have a chat with your client. 

“Otherwise, they could be trading while insolvent and subject to personal liability.”

In the majority of – but not all – cases, clients are receptive to whatever course of action their accountant recommends.  

If you seek to provide services outside your usual client engagement, send a new terms of engagement letter detailing any new services you may provide. 

Additionally, consider being paid upfront for these services where possible.

Indeed, the small business sector faces a raft of challenges in 2023 – something that CPA Australia’s senior manager business policy, Gavan Ord, recently addressed.

“Normally, we will have a conversation with clients to see if we can help them to reduce their expenses,” says Teddy Kosasih FCPA, Pitt Martin Advisory principal. 

“We’ll look for alternative funding solutions – which is where our business partners and contacts come in handy – and at debtors to see if we can collect as much as possible.”

Act early for best outcomes

Depending on the severity of the financial predicament, Kosasih may also speak to an insolvency practitioner. 

The best solutions, however, are likely to come from having early and honest conversations with clients.

“Most of the time, they’ll accept the reality that they need to do something and create a plan,” Kosasih says.

While liquidation and administration (voluntary and involuntary) are both formal insolvency processes, the key difference is that administration looks to rescue viable elements of the business to allow trade to continue, while liquidation is simply a way of closing a company in an orderly manner.

Kwok estimates that in his experience roughly “40 to 60” per cent of small businesses manage to trade out of insolvency, depending on the nature of the businesses.

“It really depends on whether they’re willing to fundamentally change the business model,” he says.

Simplified debt restructuring

On 1 January 2021, the Australian Government’s Small Business Restructuring Process (SBRP) came into effect.

“It allows small businesses to restructure their debts with creditors to maximise their opportunity for survival,” Kosasih explains.

Directors remain in control and continue to trade their business during the restructuring period, creditors cannot chase repayment, the cost is fixed, and other formal insolvency options stay on the table.

To be eligible, business liabilities must be less than A$1 million, all outstanding employee entitlements (including super) are paid, and all tax lodgements for the company up to date. The process can only be undertaken once every seven years.

“It may be that just a change of business model and practices will fix the problem, but don’t leave it too late for any type of rescue option because, at the end of the day, we can only do so much,” Kwok says.

Always keep records

Regardless of the actions a client might say they’ll take, he strongly advises accountants to always take minutes during client meetings to avoid potential misunderstandings or even liability, “in some cases, directors will blame the accountants for the businesses’ failures”, Kwok warns. 

“Even though they’ve signed a disclosure in the financial statements, they might claim it was given to them without notice and that the accountant didn’t warn them about insolvent trading.”
By the same token, accountants need to be aware of their own legally enforceable obligations. According to Kwok, some aren’t.

Dealing with an insolvency practitioner

With the general exception of a director’s personal financial records (and with smaller businesses they’re often one and the same for the individual), under the Bankruptcy Act 1966 and Corporations Act 2001, an insolvency practitioner has the right to access the books of account and any papers an accountant has about their client.

Even if there’s information in the files about other people or businesses, client confidentiality becomes a moot point. 

As Kosasih explains, the administrator effectively now is the client.

However, Kwok says some accountants push back, commonly citing a client’s failure to pay for their services – be it lodging tax returns, auditing and preparing financial accountants, or giving them business advice – as a reason for withholding client records.

“But the law doesn’t take that into consideration,” he maintains. 

“If you don’t deliver the records, we can refer the matter to ASIC or AFSA for investigation and potential criminal prosecution.

Be upfront

“Upfront discussion is always best. Accountants need to tell us what the problem is and what’s in the business [net asset position] before we can offer an opinion on what’s best for the client. 

“Unfortunately, some accountants can be selective about the information they provide. When [all the information] comes to light, it can become very hard for a practitioner to offer the accountant and their client a way out.”

For example, Kwok says insolvency investigations sometimes lead to the recovery of hidden assets.

It’s important to remember that it’s usual for an administrator or liquidator to want to talk to the accountant helping the business.

It’s also common for the directors of an insolvent company to ask their accountant to help them fill out ASIC’s mandatory Report on Company Activities and Property (ROCAP), which will be reviewed by the administrator or the liquidator and – notably – compared against what they’ve found in their own review of the company.

“If we have a client who is, unfortunately, now insolvent, the best thing we can do is to cooperate with the administrator,” Kosasih says.

“Give them the information they need and help them with their inquiries. In turn, this will help the client to resolve their issues quickly and in the long run, cause us a lot less stress and effort.”

Key takeaways for accountants

Emphasise to clients the importance of staying current with all business tax obligations and employee entitlements.

Have upfront, honest conversations about business losses as soon as possible.

Confirm the amounts owed by debtors to the business and explore ways to reduce overheads.

Determine if the directors are willing to readjust or fundamentally change the business model.

Suggest options for restructuring debts with creditors such as the Australian Government’s Small Business Restructuring Process (SBRP).

Be sure to take minutes during client meetings.

Update any terms of engagement letter for any new services being provided.

Remain aware of your own legally enforceable obligations.

Don’t be evasive if asked by an administrator or a liquidator to provide a client’s financial information.

If your clients are suffering from financial distress, please take advantage of CPA Australia’s insolvency resources here and here