COVID-19 temporary relief: less creative destruction, more restructuring?
By Scott Sharry, Kym Condon, Caitlin McConnel and Kate Edwards
In a market replete with private equity firms scouting acquisition opportunities following steady growth and low interest rates in previous years, businesses should give serious thought to taking advantage of this moment in time to seek to effect a successful restructure or turnaround.
COVID-19 Temporary Relief

Australia has now entered its first recession in 29 years, and the Australian Government has implemented a number of legislative reforms and other initiatives to support and provide temporary relief to businesses, including stimulus payments, enhanced asset write-off and flexibility in the application of the Corporations Act 2001 (Cth).

Some commentators warn that Australia is set to face an "'insolvency tsunami" once these measures cease. While that may well be an inevitable consequence, the temporary reforms offer a unique opportunity for businesses to take stock and, with appropriate support, effect a successful restructure.

While the legislative amendments and relief packages are a legitimate response to the global pandemic, it is arguable they are also interfering with the natural and unavoidable process of "creative destruction" – the "industrial mutation that incessantly revolutionises the economic structure from within; incessantly destroying the old one, incessantly creating a new one", as conceptualised by Joseph Schumpeter in 1942.

Temporary measures

There are three significant relief measures in play:

Firstly, the Corporations Act has been amended (at the date of publication, until 25 September 2020) to:

  • increase the minimum threshold for statutory demands ($20,000) and extend the timeframe for debtors to respond (6 months); and
  • provide temporary relief to directors from personal liability for insolvent trading, where debts are incurred in the "ordinary course of business".

Secondly, tax legislation has been amended (at the date of publication, until 31 December 2020) to increase instant asset write-off thresholds to:

  • $150,000 for each asset (increased from $30,000); and
  • $500 million or less for the aggregated turnovers in an income year (increased from $50 million).

Thirdly, the ASX has provided relief to listed entities by simplifying the capital raising process. The temporary measures include:

  • an allowance of back-to-back trading halts (up to 4 days), enabling companies to consider, plan and complete capital raising;
  • a one-off increase to the limit on placements to 25%; and
  • a waiver on the one-for-one cap on standard non-renounceable entitlement offers.

The ASX Class Waivers were initially due to expire on 31 July 2020, but due to "the high and increasing levels of COVID-19 infections in major overseas markets, recent events in Victoria and the present uncertainty about the nature and level of government economic stimulus in Australia post September 2020", the ASX has extended its temporary emergency capital raising measures until 30 November 2020.

At the date of publication, there is commentary which suggests the Corporations Act amendments and stimulus packages will also be extended beyond their current timeframes.

Capital raising in the current climate

Presently, many companies are facing financial stress in respect of cashflow, liquidity and the ability to fulfil existing capital commitments; and formulating debt and equity raising strategies to relieve financial stress or establish a firm foundation for long-term success once the effects of the pandemic have subsided.

Industry leaders have outlined areas of opportunity for companies to access debt markets, including:

Equity capital markets are more robust than they were during the Global Financial Crisis (GFC), and the introduction (and extension) of greater ASX temporary concessions have alleviated the red-tape associated with urgent capital raising. Market activity suggests:

“ The interruption to the creative destruction process presents an opportunity for businesses to engage in a strategic restructure. ”

2020 & beyond

Just as Schumpeter suggested, there must be revolution or absorption in order to spur business cycles and innovation, strengthen market selection and reduce the withholding of resources by "zombie companies". Creative destruction is an important part of the economic cycle in that it enables those resources to be redistributed, for example by redirecting capital to legitimate restructures.

Insolvency regimes therefore carry important implications for the stability of financial systems and the economy generally, where the reallocation of capital is the centrepiece of enabling long-term productivity growth through efficient labour and financial markets.

While quantitative easing measures in Australia have arguably propelled market activity, the efforts could be identified as limiting economic efficiency by failing to cure, and instead prolonging, the ails of many beleaguered companies. Notwithstanding this observation, the interruption to the creative destruction process presents an opportunity for businesses to engage in a strategic restructure, whether it be by way of urgent capital raising, enacting the safe harbour provisions or by way of a voluntary administration.

One benefit of the voluntary administration process is that it affords the company and its administrators a moratorium period whereby potential restructuring options can be explored and considered. To the extent the appointment can precede a liquidity shortfall, there will be a greater chance of a successful restructure.

As to whether the relief packages will lead to a rush for voluntary administration appointments right before the informal safe harbour window closes, it remains the case that with appropriate advice and action, well-developed restructuring plans can deliver long-term benefits and protection. The benefit of an early restructure is avoiding a crowded market following the inevitable failure of some of the less productive entities that have survived in recent years due to, among other factors, ultra-cheap debt.

While these temporary measures can be praised for allowing the business community to pause to assess the implications of the current world events, in our view the measures should be lifted as soon as reasonably possible in order to allow the natural economic process of creative destruction to occur.

Having said that, in a market replete with private equity firms scouting acquisition opportunities following steady growth and low interest rates in previous years, businesses should give serious thought to taking advantage of this moment in time to effect a legitimate restructure or turnaround. This should be done sooner rather than later to avoid the potential bottleneck that may occur in 2021, which may see a spate of insolvencies causing lenders to become more conservative. Early strategic decisions will enable businesses to weather the storm that will be upon us once the relief packages transition into a thing of the past.