The temporary insolvency relief comes to an end on 31 December 2020. As a result, a significant wave of insolvencies may occur in early 2021. To preemptively combat this wave, the Federal Government has announced a reform to the insolvency regime for small businesses. This article looks at: 

  • what has prompted the reform; and 
  • how the changes will impact eligible businesses and their creditors. 

What Prompted the Reform?

Many creditors are currently biding their time, as temporary insolvency relief provided to debtors as a direct result of COVID-19 is due to expire on 31 December 2020. Once that temporary relief expires, however, there will be a significant increase in small businesses facing financial distress. As a result, some of these businesses will inevitably enter into external administration or liquidation.  

The proposed reform aims to allow small businesses to restructure more quickly and easily than the current regime permits. Hopefully, this will result in more Australian small businesses surviving the economic impact caused by COVID-19. However, in many instances, restructuring will simply not be possible. The proposed reform aims for those businesses to be wound up faster. In turn, this may result in higher returns for creditors.  

In addition to the economic distress caused by COVID-19, a number of problems have been identified with the current system. These problems have prompted the proposed reform.

For example, they include:

  • the fact that small business insolvencies follow the same process as complex large company insolvencies. This ‘one size fits all’ approach has proven to be fundamentally flawed; 
  • the high costs of voluntary administration, which can consume most, or sometimes all, of a small business’ assets. This makes small business owners reluctant to engage in the process; and
  • small business owners’ reluctance to put an external administrator in control of their business.

Who Is Eligible and When Will the Changes Come Into Effect?

Subject to the passing of legislation, the new process will commence on 1 January 2021. 

To be eligible, businesses must meet two criteria. Namely, the business must: 

  1. be incorporated; and 
  2. have liabilities of less than $1 million.  

Simplified Restructuring 

The reform has identified the need for transitional measures, which will be available to businesses until 31 March 2021. During the transitional period, eligible businesses will be able to declare their intention to access the new restructuring process to their creditors (possibly via an ASIC published notice). Once it has made a declaration, the business will have a period of three months to access the restructuring process. During this time, the business and directors will continue to access the existing temporary insolvency relief.  

The Proposed Restructuring Process

There are a number of elements to the proposed new restructuring process. 

First, the business approaches and appoints a small business restructuring practitioner, whose role will be to:

  • assist in determining whether the business is eligible;
  • support the company to develop a plan; 
  • certify and communicate the plan to creditors; and 
  • manage any disbursements if a plan is put in place.

Directors work with the restructuring practitioner over 20 business days to:

  • develop a restructuring plan;
  • identify creditors; and
  • provide supporting documents to creditors for consideration.  

The business continues trading under the control of its directors while the restructuring practitioner develops a debt restructuring plan. Trade can continue in the ordinary course of business. However, trade outside of the ordinary course of business will require the prior approval of the restructuring practitioner.
Once the process commences, creditors cannot take action against the business. Further, any personal guarantee the director of the business provides is not enforceable. 

The restructuring practitioner then:

  • sends the restructuring plan to creditors; and 
  • certifies whether they consider the business can meet the proposed repayments.  

Creditors then have 15 business days to vote on the plan.  

The company must pay any employee entitlements due and payable prior to creditors voting on a restructuring plan.
The plan requires a vote of 50% or more (based on debt value) for the restructuring plan to become binding on all unsecured creditors. Secured creditors will only be bound to the extent that their debt exceeds the value of their security interest. 

Finally, if the creditors approve the restructuring plan, the restructuring practitioner will administer the plan and make distributions to creditors. On the other hand, if the creditors reject the restructuring plan, the business may choose to: 

  • enter voluntary administration; or 
  • use the simplified liquidation process. 

Simplified Liquidation

Regulatory obligations on liquidators will simplify, to align with the asset base, complexity and risk profile of the company being wound up. A simpler process means there is potential for more money to become available for distribution to creditors and employees.  

Whilst the general liquidation framework will remain, key modifications may reduce both the time and cost of the process.

For example, these modifications include:

  • reduced circumstances where a liquidator can take action to clawback an unfair preference payment from a creditor unrelated to the company; 
  • reduced reporting obligations on potential misconduct of directors, unless there are reasonable grounds to believe that misconduct has occurred; 
  • removing requirements to call creditors meetings;
  • removing the ability to form committees of inspection; and 
  • simplifying the proof of debt and dividend processes.

The rights of secured creditors and the current rules pertaining to the priority in which the company pays creditors will not change.  

What Protections Will Be Put in Place?

The proposed reforms see the inclusion of a number of safeguards to prevent the misuse of the new process and ensure the protection of creditors’ rights. The safeguards include: 

  • only making the process available to a business or directors once within a prescribed period (currently proposed to be a period of 7 years);
  • giving the restructuring practitioner the power to stop the process should they identify any misconduct;  
  • ensuring the independence of the restructuring practitioner;
  • ensuring the rights of secured creditors do not change;
  • maintaining creditors’ right to vote on the business’ restructuring plan, with a majority vote necessary before the plan will become binding;  
  • prohibiting creditors related to the business (such as subsidiaries) from voting on the restructuring plan; and  
  • giving creditors the ability to convert a simplified liquidation back to a ‘full’ liquidation process. 

Key Takeaways

The proposed reform to restructuring and liquidation of small businesses aims to simplify and streamline a currently complex process. Whilst the Federal Government has unveiled its initial guidelines, however, there are still many details which remain unclear. If you need help with the restructuring or liquidation of a small business, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page. 

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