Outcomes in insolvency – what should I expect?

Quite obviously many people that we deal with are in a position that can be very stressful as they are unsure of their future due to either personal or business solvency issues.
Whilst noting this scenario one of the issues in any insolvency situation be it personal or corporate is recognising the problem and seeking help to resolve it. Usually the earlier you deal with the problem the more options that are available.

I have seen directors whose company’s are only several days from being wound up by the courts rescued by the Voluntary Administration (“VA”) process. Whilst the rescue has been possible it would have been easier and less costly had this path been explored much earlier in the crisis. In order to assist people and companies in financial difficulty I thought it might be helpful to explore the  positives from a formal insolvency appointment. I’m not saying that it’s an exciting process, as mentioned at my introduction it is a stressful time, however the process does assist people to get on with their lives, viable businesses to survive and those that are not viable to be brought to a dignified end.

Our firms logo is “Light at the end of the tunnel”, an appropriate logo when you consider that whatever the final outcome we usually take away the financial stress for both individuals via the bankruptcy process and companies via Voluntary Administration or Liquidation.

I have seen over many years that stress can lead to family difficulties including the breakdown of relationships.

I look at it on the basis that a debtor or a director of a company might be lying awake at night knowing he or she has a non-viable business wondering how they might extract blood out of a stone to be able to meet all their debts and continue to live and operate their business life etc. Or they might be rueing something that has happened to their company that might have seen it viable but for the issue in question or perhaps the business has grown rapidly and needs parking space from its creditors to survive long term.

When a business survives all stakeholders benefit including creditors, employees the director and his/her family. If it cannot be rescued the positive is at least the bleeding stops, debt doesn’t continue to grow and creditors and the directors can start anew. If a business isn’t viable early identification is also very critical to avoid issues such as insolvent trading.

Over the coming months I will delve into particular case studies to demonstrate how the bravery of an individual or director in admitting they have a problem has assisted all stakeholders to what has been a traumatic period of time for all.

Mark Marlow

Personal Guarantees and Co-Guarantors – Liability exists despite Settlement

When loaning money, creditors commonly take security over a borrower’s assets. If this is not sufficient, the creditor may also seek security from related parties as collateral for the principal borrower’s obligations. One of the most common securities given is a personal guarantee.
Where two or more parties guarantee a loan or debt obligations of the principal borrower, issues may arise between the guarantors when one guarantor feels as though they have contributed more than the others. In general, there is a presumption that each co-guarantor should contribute equally towards the payment of a guaranteed debt. In the event that one guarantor pays more than their fair share generally they would have a right of contribution against the other guarantors in respect of the over payment.

The common example is where two individuals have guaranteed the obligations of a borrower and the borrower defaults on the loan against the bank, and one guarantor has repaid the debt in full, this guarantor would be entitled to seek a contribution from the other guarantor for 50 percent of the amount paid to the bank. While the proportions payable in respect of the contribution may vary depending on the number of guarantors and other equitable remedies available to the co-guarantors, the principle right of contribution claims from other co-owners remains the same.

This principle was confirmed in the case of Lavin v Toppi [2015] HCA 4. In this decision, the High Court also confirmed the need to seek diligent legal advice when settling claims with the bank as co-guarantor.

In this case Ms Lavin and Ms Toppi were both directors of a company. The directors also provided personal guarantees to the bank for the loan given to the company. The company was placed into Receivership and the bank, after realising its security, was still owed over $4 million. The bank sought payment of the shortfall from the co-guarantors. Following legal proceedings, Ms Lavin settled with the bank and paid an amount of $1.35 million towards the debt owed. Under the Deed of Settlement, the bank would not sue Ms Lavin for the balance of the guaranteed debt. The bank also commenced proceedings against Ms Toppi and recovered the balance of its debt (approximately $2.9 million) from asset recoveries.

Ms Toppi made a claim for contribution against Ms Lavin claiming an amount of $775,000 be paid, being fifty percent of Ms Lavin’s liability for the guaranteed debt less the amount paid in respect of the settlement. On 11 February 2015, the court gave judgement in favour of Ms Toppi and noted that any claim for contribution arises when the guarantors are called upon to pay the debt rather when the payment of the guaranteed debt is made. Accordingly, the settlement reached between the bank and Ms Lavin to which Ms Toppi was not a party had no bearing on Ms Toppi’s right of contribution.

The case highlights the importance for parties providing personal guarantees ensuring that they fully understand the potential implications and extent of their liability. In addition, individuals should seek professional advice when dealing with banks and negotiating settlements to ensure that their liabilities, not only to the bank, but to other guarantors have been fully discharged.

Should The Bankrupt Pay

In the past and certainly nowadays there is a general view in the community that bankruptcy is a form of punishment. Is this the case? This article discusses the perception of bankruptcy being a punishment as well as it being a new start.
The Australian Law Reform Commision in its report on insolvency in 1995 said the history of bankruptcy showed that it was a way forward for a person with a hopeless financial position to obtain relief from creditor pressure and make a new start. They went on to say it also protects the community from hopelessly insolvent persons as bankrupt are limited in the financial dealings in which they can engage.

Of course disgruntled creditor who has not been paid sometimes after many promises and letdowns would argue that bankruptcy should be a punishment for people they perceive have deceived them and caused them hardship because the bankrupt is unable to pay.

So there is always a balance, Experience indicates that the majority of bankrupts are basically honest people who have taken a financial risk or are poor managers of money or alternatively have some form of addiction. I say basically honest because many soon to be or bankrupts do desperate things not within their normal character.

The old adage “you cannot get blood out of a stone” is of course relevant. You could punish bankrupts and be totally negative, however, would the creditors get a better return?

The Bankruptcy Act allows bankrupts to retain certain assets (non-divisible assets) such as household furniture, tools of trade and a basic motor vehicle to be used as a primary means of transport. These give the bankrupts a dignified standard of living; allowing them to earn an income to provide for themselves and their family and to also hopefully make contributions to their estate for distribution to their creditors.

The anger of creditors in wanting bankrupts punished is totally understandable and in some cases justified, however punishment alone does not give any return to those aggrieved. Bankrupts needs to also be given the opportunity to make a contribution to their creditors and to be rehabilitated and to feel they are making a good contributor to society.

So the best result for bankrupts and creditors is for the best possible realization from the estate but with bankrupts seeing some light at the end of the tunnel, eg on discharge after three years with the knowledge that they have atoned for past mistakes or sins.

Working for a bankruptcy trustee you learn to read a situation quickly and apply the best method within the law of obtaining a win/win position for all concerned. A trustee, of course, works within the Bankruptcy Act. It is mostly a matter of not what you have to do but how you approach what you have to do that can change the outcome of a situation.

The Bankruptcy Act along with a good dose of logic and common sense give the opportunity for bankrupts and their creditors and the community to benefit from what appears to be a daunting final nail in the coffin, ie bankruptcy.

Tax Deductions on Expenses Incurred in dealing with Director Penalty Notices (“DPN”)

The DPN Regime was introduced by the Australian Taxation Office (“ATO”) in 1993 as a method to ensure corporate compliance with taxation liabilities. Under the DPN regime, directors could become personally liable for the company’s debts under certain circumstances. The primary objectives of the DPN regime were to ensure directors caused the company to meet its taxation obligations or if this was not possible, promptly seek professional advice with the view to placing the company into voluntary administration or liquidation.
Until recently DPNs had only applied to Pay As You Go (PAYG) withholding liabilities. However, in July 2012, the DPN regime was expanded to include Superannuation Guarantee Charge (“SGC”) liabilities. The regime was also amended to make directors automatically liable for PAYG withholding or SGC where such amounts have been both unpaid and unreported for more than three (3) months after its due date (known as the lockdown provisions). Under the new DPN regime a director cannot avoid personal liability where they have fallen foul of the lockdown provisions by placing the company into Voluntary Administration (“VA”) or Liquidation.The clear emphasis here is that directors need to ensure that at reporting the company’s obligations on time to still avail themselves to being able to avoid personal liability by subsequently placing the company into either VA or Liquidation.

In the recent Administrative Appeals Tribunal Decision of James Gerald Michael Healy v Commissioner of Taxation ([2013] AATA 281), Senior Member C R Walsh was required to consider the tax deductibility of various expenses incurred by Mr Healy in defending and addressing a DPN (and also in annulling his bankruptcy). While Mr Healy was primarily unsuccessful on a technical aspect (the expenses were not in fact incurred by Mr Healy as his brother paid them), Senior Member Walsh analysed the ability of directors to claim a tax deduction for expenses incurred “in managing his or her own tax affairs and in complying with a legal obligation in relation to another taxpayer’s tax affairs.”

Senior Member Walsh explained that Section 25-5 of the Income Tax Administration Act 1997 (“ITAA”) provides for a taxpayer to deduct expenses incurred for “complying with an obligation imposed on you by a Commonwealth law, insofar as that obligation relates to the tax affairs of an entity.” The definition of tax under the Income Tax Administration Act 1997 was considered to be sufficient to encompass amounts due under the PAYG withholding regime.Under the DPN, Mr Healy’s obligation as a director was to:

  • Cause the company to comply with its tax obligations (by paying them);
  • Make an agreement to repay the company’s tax debt;
  • Appoint a voluntary administrator to the company; or
  • Place the company into liquidation.

As such, Mr Healy’s obligation would be “complied with” if one of the above events occurred. In Falcetta v Commissioner of Taxation (2004) FCAFC 194, the Full Federal Court were of the view that under Section 25-5 of the ITAA, expenses relating to, amongst other things, preparation of income tax returns, managing and complying with a DPN and obtaining legal advice on these issues would be deductible. In that case, Mr Falcetta incurred legal expenses in obtaining advice regarding the DPN for unpaid PAYG withholding debts of the company. The ATO Interpretative Decision (ATO ID 2004/831) on this authority suggests that the legal expenses will only be deductible under section 25-5 of the ITAA 1997 of:

  • It is complying with an obligation imposed on the taxpayer by a Commonwealth law that relates to the tax affairs of an entity; and
  • The advice is provided by a recognised tax adviser.

Based on these recent cases, it appears that directors have further incentive to seek prompt professional advice regarding any DPN received.

The ATO continue to use DPNs actively as a tax collection measure for companies, particularly those in the SME sector where non-compliance with PAYG withholding and SGC is more significant. Importantly DPNs are sent to the residential address of the directors as per ASIC records. So encourage your clients to open the mail they receive to their home address, rather than leaving it unopened on the kitchen bench as we have seen occur on a number of occasions which generally limits the options available to them.

If you would like to know more about DPNs please do not hesitate to contact us.

Is Management the key driver of business success or failure?

Although external factors do play a part in the success or failure of a business, research shows that internal factors such as the quality of management is far more important.
The report prepared by the Australian Securities and Investments Commission (ASIC) on the reason for company failures has consistently concluded that the major reason for company failures is “poor strategic management “. The second most common reason cited for business failure is a failure to maintain proper books and records. This of course can be seen as one in the same as bad strategic management.

In June 2013, Jones Partners commenced a major research project into the state of the Australian Economy, Businesses at Risk and Insolvencies. At a function announcing the launch of this project, Mr Phil Ruthven Chairman of IbisWorld, drew some interesting conclusions. Refer to the video on an excerpt taken from the presentation.

Many economists consider that the Australian economy is in reasonably good shape. Clearly interest rates are low inflation appears to be under control and growth appears to be positive. Notwithstanding these happy statistics company liquidations continue to rise and Personal Bankruptcies remain at record high levels. Factors other than general economic conditions are clearly very relevant.

The ASIC report also demonstrates that the vast majority of company liquidations relates to small independent family owned businesses. In particular, 81% of companies that failed had less than 20 employees and 85% had less than $100,000 in assets. The small business sector is clearly under the most pressure at the present time and the major risk factor is the quality of management. The components of good management are not well defined particularly with reference to the small business sector. However, it is my belief that it is the personality drivers of individual business owners that defines management.

Economist Chris Nadarajah has been commissioned by Jones Partners to oversee this project and his report will be presented at a function to be held at the Institute of Chartered Accountants Australia on 29 July 2014. If you are interested in attending this meeting, please feel free to contact me.

Related Article:

Rates of Currency Exchange – Impact on Australian Businesses – Jones Partners

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Tax Deductions on Expenses Incurred with Director Penalty Notices (“DPN”)

The DPN Regime was introduced by the Australian Taxation Office (“ATO”) in 1993 as a method to ensure corporate compliance with taxation liabilities. Under the DPN regime, directors could become personally liable for the company’s debts under certain circumstances. The primary objectives of the DPN regime were to ensure directors caused the company to meet its taxation obligations or if this was not possible, promptly seek professional advice with the view to placing the company into voluntary administration or liquidation.
Until recently DPNs had only applied to Pay As You Go (PAYG) withholding liabilities. However, in July 2012, the DPN regime was expanded to include Superannuation Guarantee Charge (“SGC”) liabilities.  The regime was also amended to make directors automatically liable for PAYG withholding or SGC where such amounts have been both unpaid and unreported for more than three (3) months after its due date (known as the lockdown provisions). Under the new DPN regime a director cannot avoid personal liability where they have fallen foul of the lockdown provisions by placing the company into Voluntary Administration (“VA”) or Liquidation. The clear emphasis here is that directors need to ensure that at reporting the company’s obligations on time to still avail themselves to being able to avoid personal liability by subsequently placing the company into either VA or Liquidation.

In the recent Administrative Appeals Tribunal Decision of James Gerald Michael Healy v Commissioner of Taxation ([2013] AATA 281), Senior Member C R Walsh was required to consider the tax deductibility of various expenses incurred by Mr Healy in defending and addressing a DPN (and also in annulling his bankruptcy). While Mr Healy was primarily unsuccessful on a technical aspect (the expenses were not in fact incurred by Mr Healy as his brother paid them), Senior Member Walsh analysed the ability of directors to claim a tax deduction for expenses incurred “in managing his or her own tax affairs and in complying with a legal obligation in relation to another taxpayer’s tax affairs.”

Senior Member Walsh explained that Section 25-5 of the Income Tax Administration Act 1997 (“ITAA”) provides for a taxpayer to deduct expenses incurred for “complying with an obligation imposed on you by a Commonwealth law, insofar as that obligation relates to the tax affairs of an entity.” The definition of tax under the Income Tax Administration Act 1997 was considered to be sufficient to encompass amounts due under the PAYG withholding regime. Under the DPN, Mr Healy’s obligation as a director was to:

  • Cause the company to comply with its tax obligations (by paying them)
  • Make an agreement to repay the company’s tax debt;
  • Appoint a voluntary administrator to the company; or
  • Place the company into liquidation.

As such, Mr Healy’s obligation would be “complied with” if one of the above events occurred. In Falcetta v Commissioner of Taxation (2004) FCAFC 194, the Full Federal Court were of the view that under Section 25-5 of the ITAA, expenses relating to, amongst other things, preparation of income tax returns, managing and complying with a DPN and obtaining legal advice on these issues would be deductible. In that case, Mr Falcetta incurred legal expenses in obtaining advice regarding the DPN for unpaid PAYG withholding debts of the company. The ATO Interpretative Decision (ATO ID 2004/831) on this authority suggests that the legal expenses will only be deductible under section 25-5 of the ITAA 1997 of:

  • It is complying with an obligation imposed on the taxpayer by a Commonwealth law that relates to the tax affairs of an entity; and
  • The advice is provided by a recognised tax adviser.

Based on these recent cases, it appears that directors have further incentive to seek prompt professional advice regarding any DPN received.

The ATO continue to use DPNs actively as a tax collection measure for companies, particularly those in the SME sector where non-compliance with PAYG withholding and SGC is more significant. Importantly DPNs are sent to the residential address of the directors as per ASIC records. So encourage your clients to open the mail they receive to their home address, rather than leaving it unopened on the kitchen bench as we have seen occur on a number of occasions which generally limits the options available to them.

If you would like to know more about DPNs please do not hesitate to contact us.

 

Insolvent Builders & Home Warranty Insurance (“HWI”)

For many individuals or couples one of the biggest purchases in their lives will be the construction of a new home. Unfortunately over the years there have been many residential home builders that have gone into some form of insolvency administration and ceased to trade, leaving home owners with an incomplete home and lots of worries.
We are frequently appointed as Voluntary Administrators or Liquidators to residential home builders where they are insolvent. In one recent matter, there has been an instance where the HWI policies were not adequate to cover all costs incurred in completing the homes. We highlight in this article some important considerations customers should give if such an event occurs.

HWI is taken out by the residential home builder and is designed to cover customers. From 1 July 2010, the NSW Self Insurance Corporation, trading as the NSW Home Warranty Insurance Fund, took over as the sole provider of home warranty insurance in NSW. QBE Insurance (Australia) Limited and Calliden Insurance Limited were appointed as insurance agents of the NSW Self Insurance Corporation, through a contractual arrangement.

Importantly HWI provides a set period of cover for loss caused by defective or incomplete work in the event of the death, disappearance or insolvency of the residential home builder.

From 1 July 2002 a key element of a HWI policy is that it must indemnify beneficiaries (i.e. the customer) for non-completion of work due to early termination of the building contract. Insolvency of the residential home builder typically results in the termination of the building contract.

Critically from 1 February 2012, a HWI policy:

  • is required to be obtained where the contract price is over $20,000 or, if the contract price is not known, the reasonable market cost of the labour and materials involve is over $20,000; and
  • must provide cover of at least $340,000.

Relevantly claims for incomplete work are limited to 20% of the contract price (up to a maximum of the cover provided under the policy). It is this aspect that we believe is not always well understood by customers and indeed the residential home builder when insolvency occurs. We have set out below a recent matter we were appointed to highlight how HWI works when an insolvency event occurs resulting in the termination of the building contract.

Facts

  • Contract value for construction of home $300,000;
  • Costs paid as at insolvency event by home owner for first stages of construction $100,000;
  • Invoice issued by residential home builder for work completed but unpaid $25,000; and
  • Balance outstanding under contract at time of insolvency event / Liquidation: $200,000.

At the date of insolvency, the Insolvency Practitioner is often provided with a debtors listing relating to progress claims made by the residential builder. The recovery of each debtor is not always straight-forward and an accurate position regarding what the customer may owe (if any) can only be determined once the HWI is finalised. This can take many months to determine.

Given the above facts, the HWI and customer position unfolded as follows:

  • Following the liquidation of the residential builder, the customer lodged a claim under the HWI policy.
  • The Home Warranty Insurer arranged for an external consultant to inspect the dwelling to confirm / quantify the amount of works required to complete the contract.
  • The customer also had to prove to the Home Warranty Insurer the quantum of payments made to the residential home builder under the contract. In this case no “cash” payments had been made, but in circumstances where this occurs, this can create issues.
  • Three (3) quotes were obtained from different builders to complete the works. The Home Warranty Insurer then approved one of the builders to complete the works.
  • The certified costs to complete the dwelling were $250,000. Therefore, the customer paid the balance of the original contract price being $200,000 and made a claim for the additional $50,000 under the HWI policy.
  • In this case as the additional cost to complete the dwelling was less than 20% of the original contract price, the HWI covered the additional $50,000 that was required to complete the construction of the dwelling. Therefore there were no monies collectible under the outstanding progress claim in the Liquidation.
  • HOWEVER, if the certified costs had been for example, $285,000 (thus meaning the additional costs were greater than 20% of the contract price), then the customer would have had an uninsured loss to the extent of $25,000 that would have to be met from their own funds. In the particular insolvency administration concerned, there were 3 customers who ultimately had uninsured losses ranging from $25,000 to $60,000 per customer. Not insignificant!!

Unfortunately when an insolvency of a residential home builder occurs, it may take several months to work through this process and it will only be at the conclusion of the building contract once all of the costs are known, that the Liquidator would be in a position to determine if there is actually any debt owning by the customer.

It is important that customers get the right advice as to their position when their builder has been placed into some form of insolvency administration. We caution customers who want to go off miss-informed and complete the dwelling themselves as once this occurs they are likely to jeopardise any ability to claim on HWI.

 

Insolvency and Bankruptcy Numbers – Not What You Might Expect!

Welcome to our first Newsletter for 2014. A subject we are frequently asked about is what are the insolvency and bankruptcy statistics doing and what inferences can be gleaned from them. During the course of the calendar year we will be providing a regular commentary on movements. Set out in this article are graphs for NSW and Australia for corporate insolvencies and personal bankruptcies / personal insolvency agreements (“PIAs”) during the period 2010 to 2013 inclusive. Some key observations are:
Corporate Insolvencies

  • In both NSW and Australia appointments decreased by approximately 2% in the 2013 December quarter on the previous corresponding period (“PCP”).
  • In NSW there was a negligible change in insolvency appointments in 2013 on the PCP. However, nationally insolvencies increased approximately 1.8% in 2013 on the PCP.
  • In 2013 NSW maintained its average 39% of the national corporate insolvency market.
  • In 2013 creditors voluntary liquidations accounted for approximately 47% of all corporate insolvencies. Whilst some may express surprise about this, our own statistics broadly confirm this and given the relative ease via which this type of liquidation can be initiated by directors we believe it will continue to be widely used particularly by smaller corporates who no longer wish to continue in business.

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Personal Bankruptcies / PIAs

  • In both NSW and Australia appointments decreased by approximately 9% and 8% respectively in the 2013 December quarter on the PCP.
  • In NSW there was a decrease in bankruptcies / PIAs of approximately 12% in 2013 on the PCP. Nationally appointments decreased by 10% in 2013 on the PCP.
  • In 2013 NSW maintained its average 33% of the national personal insolvency market for bankruptcies and PIAs.
  • The three (3) postcodes with the highest number of bankrupts in 2012/2013 were:
  • 2770: Mt Druitt and surrounding suburbs;
  • 2560: Campbelltown and surrounding suburbs; and
  • 2170: Liverpool and surrounding suburbs.

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It will be interesting to monitor the numbers as the year unfolds as to where they may head and what inferences can be taken from them about correlations with the overall state of the national economy. Whilst there appear to be several economic challenges ahead (for example a notable decline in business capex spending) we generally feel that insolvency and bankruptcies levels are likely to remain flat throughout 2014.

Strengthening Our Presence in Greater Western Sydney – Narellan Office

We are excited and pleased to announce the opening of our new South West Sydney Office at Narellan. Daniel Soire, a Principal of Jones Partners and a Registered Liquidator, is a local Macarthur resident and will be supervising the Narellan office.
For many years now, Jones Partners has truly valued the importance of being accessible to professional advisors and business owners and individuals throughout Greater Western Sydney (“GWS”). The GWS region is a very significant contributor to the States GDP and has a huge diversity in the range of businesses that operate within it. Our continued presence (via our Norwest Business Park Office) has enabled us to develop strong relationships with other professionals such as accountants, lawyers and financiers, as well as and importantly assist business owners and individuals in this region who may get into financial difficulty. Having a very strong and keen interest in what happens in the region also helps us to understand the factors that can affect SME businesses as well as individuals.

The new Narellan office puts us closer to fellow professionals and SME businesses and individuals when they need expert insolvency, restructuring or bankruptcy advice in South West Sydney. We believe this proximity and not “the ivory tower” approach is what such stakeholders are seeking when looking for specialist advice in corporate and personal insolvency and restructuring.

Our continued and sincere focus throughout the GWS region reflects the importance we place on ensuring that SME businesses and individuals in this region get the “right advice” when they may be in financial difficulty. Jones Partners are a Chartered Accounting Firm that specialises in the provision of corporate and personal insolvency and restructuring services. For more information go to jonespartners.net.au

Strengthening our Presence in Greater Western Sydney

For many years now, Jones Partners has truly valued that importance of being accessible to professional advisors and business owners and individuals throughout Greater Western Sydney (“GWS”). The GWS  region is a very significant contributor to the States GDP and has a huge diversity in the range of businesses that operate within it. Our continued presence (via our Norwest Business Park Office) has enabled us to develop strong relationships with other professionals such as accountants, lawyers and financiers, as well as and importantly assist business owners and individuals in this region who may get into financial difficulty. Having a very strong and keen interest in what happens in the region also helps us to understand the factors that can affect SME businesses as well as individuals.
To further build on our presence and focus in the GWS region, we are excited and pleased to announce the opening of our South West Sydney Office at Narellan. As with our Norwest Business Park Office, the new Narellan office puts us closer to fellow professionals and SME businesses and individuals when they need expert insolvency, restructuring or bankruptcy advice in South West Sydney. We believe this proximity and not “the ivory tower” approach is what such stakeholders are seeking when looking for specialist advice in corporate and personal insolvency and restructuring.

Our continued and sincere focus throughout the GWS region reflects the importance we place on ensuring that SME businesses and individuals in this region get the “right advice” when they may be in financial difficulty. Jones Partners are a Chartered Accounting Firm that specialises in the provision of corporate and personal insolvency and restructuring services. For more information go to jonespartners.net.au