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If you are going to fail, fail good

Thursday 2 July, 2020
by Cris Parker, Director, The Banking + Finance Oath, Head of The Ethics Alliance

The world is facing what could be the biggest recession since the Great Depression. That tiny Covid-19 virus kicked off a trail of personal and economic disaster, expected to snowball into an avalanche of business bankruptcy. No-one can accurately predict how many businesses will go bust but, amid all the fear and tumult, a question is posed: If you are going to fail, can you do it ethically?

John Winter, the CEO of the Australian Restructuring Insolvency & Turnaround Association (ARITA), says emergency financial “lifelines” to business have broad community support, but inevitably have some unfortunate and unintended consequences. The assistance could – perversely – encourage struggling owners to dig themselves deeper into their financial holes.

The six-month expansion of insolvency trading laws (which offer directors temporary relief from liability for trading while insolvent) are encouraging “one last throw of the dice” for the owners of businesses that were already struggling before this crisis, he says. In ordinary circumstances, these may have been among the 10,000 businesses each year that slip into insolvency and wind up operations, paying off creditors, suppliers and providing for laid-off staff.

Among Covid-19 rescue packages are: Federal Government cashflow assistance worth up to $100,000 to retain workers, mortgage relief from banks, protection from eviction, rent relief from some landlords, and State-based grants. 

‘Kicking the can down the road’

When the money does eventually run out, these businesses that have delayed their demise will owe even more and the damage inflicted will be so much worse and more widespread.“All they are doing is kicking the can down the road,” he says. And that can is growing bigger with each kick. 

The size of this problem is indicated by the fact that the members of ARITA have reported their phones have fallen silent. “There's a natural level of insolvencies that occur,” Winter says. “From the Sunday the Government announced the insolvent trading moratorium would be in place for six months, the level of inquiry in the insolvency profession fell to absolutely zero.”

Winter says the change in the insolvent trading rules has removed any “handbrake” to that sort of behaviour. “Capitalism without bankruptcy is like Catholicism or Christianity without hell. You have to have scary consequences to make people moderate their behaviours,” he says.

Winter says he cannot see how businesses are going to repay the engorged debts after the six-month grace period. “A whole bunch of them have gone out and got these interest-free or pretty much interest-free loans from State and Federal governments. Their debt load has increased dramatically. “You're going to have a tsunami of insolvency. You have to have one.”

Human biases can override logic

People with businesses that were unsustainable – even before the recent bushfires and pandemic – now may think they have a “free pass”. Winter says people with failing businesses often go into denial, ceasing to read emails or letters from the banks and they indulge in wishful thinking.

“They start getting these fantasies of lottery winnings,” says Winter. Other reasons that business owners may avoid the inevitable include their psychological biases. They are often affected by the human characteristic of “loss aversion”, whereby people dislike losing more than they like winning.

As Dan Ariely, a professor of behavioural economics at Duke University, says: “The misery we get from losses is about twice as large as the happiness we get from gains”. This bias can discourage people from assessing their situation dispassionately and lead to an avoidance of risk and poor decision-making.

Another psychological trap is the Sunk Cost Fallacy, where people effectively "throw good money after bad". They feel that it would be wasteful to cut their losses and stop because they have already invested so much time and money in a venture.

Failing business owners may also fear the judgement of others, says Winter: “The government's giving you tens of thousands of dollars in gifts. They're giving you $750 a week for every staff member you've got – which might be more than you're paying some of those people. How on earth can you possibly be broke at this point of time?”

“The shame at the centre of business failure is a very powerful motivator. It is why mental health is often negatively impacted with company failure,” says Winter. 

Knowing when to fold ‘em

“When directors finally sit down and say, ‘yeah, I'm done, I'm handing the business over to a liquidator’, they also feel a massive sense of relief. They've taken so much weight on their shoulders because of the ethical concerns they face around the consequences for others.”

The timing of accepting the failure of a business is a moral issue: “When you are insolvent as a business, you know that you're not going to pay back the money you owe”. “You can't get more broke than broke, [but] what you are doing is significantly impacting those that you owe money to,” says Winter. 

“If you're running a small business, it's generally other small businesses you owe money to as well. You could actually be sending them broke with your wilful and egregious behaviour,” he says. Winter says that, as a matter of self-preservation, everyone should presume that the people they are doing business with over the next six month moratorium period are insolvent.

“If you're in any way providing a loan or credit or trading facility to anybody you're doing business with, you have to take extra steps to try and ensure you're going to get paid back.” Winter says, as the Covid-19 restrictions ease, directors of small to medium-sized businesses should have education and requirements around how they handle their debt. It should be backed up with an aggressive pursuit of "dodgy directors" who have misused the emergency mechanisms. 

Winter says he does not doubt that most small businesses will use their financial lifelines appropriately and hopes that will account for 90 per cent of companies.


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