Insolvency reforms: Corporate Insolvency Reforms Bill raises more questions than it answers

By Jennifer Ball
16 Nov 2020
There remain a number of issues in the proposed insolvency reforms that need careful deliberation, particularly where the Regulations have yet to be released for consideration.

When the Morrison Government announced it was to undertake the most significant reforms to Australia's insolvency framework in 30 years as a part of its economic recovery plan to keep businesses in business and Australians in jobs, we cautiously welcomed the announcement, but noted that we needed greater detail to assess their likely impact. Some – but not all – of that detail is now available, with the release of an Exposure Draft bill and the introduction to Parliament on Thursday, 12 November 2020 of the Corporations Amendment (Corporate Insolvency Reforms) Bill 2020, which covered some of the key aspects of the reform package:

  • a formal debt restructuring process for "eligible companies";
  • extended the temporary relief for eligible companies intending to undertake a formal debt restructuring process;
  • a simplified liquidation process for eligible companies in a creditors' voluntary winding up;
  • refinements to the requirements for registration as a liquidator; and
  • the greater use of electronic documents and electronic signatures in an external administration.

The proposed reforms seek to provide an "eligible" company to restructure their debts and maximise their opportunity for survival. It is proposed that the directors retain control of the business, its property and affairs while developing a plan to restructure the business's debts with the assistance of a "small business restructuring practitioner" (SBRP). The reforms also seek to incorporate safeguards, which are to apply to protect against illegal phoenixing activity or other forms of corporate misconduct; a company cannot use a debt restructuring process if a director of the company has previously used the process or the simplified liquidation process within a period to be prescribed by the Regulations.

The Bill introduced to Parliament introduced a new section 458D not included in the Exposure Draft which defines the restructuring relief period as the period beginning on 1 January 2021 and ending on 31 March 2021. Under section 458E, a company is eligible for temporary restructuring relief if before the end of the restructuring period the directors make a declaration in writing that:

  • the company is insolvent or likely to become insolvency; and
  • the eligibility period for restructuring would be met; and
  • the board has resolved that a restructuring practitioner for the company be appointed; and
  • there is no restructuring practitioner, or restructuring practitioner for a restructuring plan which has not yet terminated, or an administrator for a DOCA for the company which has not terminated, or a liquidator or provisional liquidator.

Much of the detailed requirements relating to the proposed new debt restructuring process is to be prescribed in regulations which have yet to be released. We understand that this approach is driven by the Government's desire to bring in the reforms so that the legislation can come into effect by 1 January 2021, where there is limited parliamentary sitting time before the end of the year and COVID-19 temporary support measures will expire on 31 December 2020.

The fact that the regulations have yet to be released leaves many challenges in understanding the operation of the proposed new restructuring laws as a whole.

Key principles as to the restructuring process should, however, be set out in the primary legislation rather than the Regulations.

Nonetheless, we have enough detail in the Bill to understand the broad framework and, more importantly, to raise important questions on how the new regime will work in practice and be fair and useful to companies in stress and their creditors.

A simplified restructuring process

The proposed new debt restructuring process for small business draws heavily on the established voluntary administration framework set out in Part 5.3A of the Corporations Act 2001 (Cth) and shares many of its features. One example of this is the moratorium that will apply on third parties' ability to enforce rights against a company during the restructuring period. Another is the protection of secured creditor's rights. It also draws on some parts of the safe harbour and ipso facto reforms.

It is said that the reforms are to reduce the complexity and costs of the administration process, providing a greater role for the company directors in the process and allowing them to retain control over the company throughout. However, while the reforms are intended to encourage more small businesses to seek debt restructuring earlier so as to increase their chances of recovering viability, particularly after the expiration on 31 December 2020 of the COVID-19 insolvent trading relief, we are not sure the reforms will achieve this.

In our opinion, as the Bill is currently drafted, the complexity of the proposed new restructuring laws will likely make the regime less accessible for small non-complex businesses which may be hoping to access the new laws. Similarly, creditors of small businesses are often themselves small businesses who may have difficulty understanding the restructuring process and may also have to seek their own financial and or legal advice at a cost.

In addition to those aspects, greater clarity is needed on how to ensure the proposed laws are workable and fair where the effectiveness of the reforms will depend heavily on several key items of detail.

Eligibility criteria for companies

To the extent that these criteria include a liability of the company test, the Regulations will need to specify how such liabilities are to be calculated and which liabilities are to be included or excluded from that calculation. Further consideration should be had as to the appropriateness of any proposed liability cap; the Government is considering limiting the eligibility for the restructuring process to companies whose liabilities not exceeding $1 million.

We understand that the liability cap was selected on the basis that around "76% of companies entering into external administration in 2018-2019 had less than $1 million in liabilities". This statistic is pre-COVID-19 and does not currently represent actual business activity in Australia, which has been severely impacted by the pandemic. It does not, therefore, consider those liabilities incurred by companies during and after the pandemic and the proportion of businesses that have incurred, or will incur, over a $1 million in liabilities.

Interestingly, in response to the impact of COVID-19 on US businesses, the US Congress increased Sub-Chapter V's debt eligibility threshold to more than 10 times the proposed Australian $1 million threshold. Initially the debt ceiling in the US was US$2.7 million, which captured a comparable percentage of historical Chapter 11 cases. However, shortly after the Sub-Chapter V was enacted in August 2019 and took effect in February 2020, Congress increased Sub-Chapter V's eligibility threshold to US$7.5 million in response to the projected increased demand precipitated by the COVID-19 pandemic.

The anti-phoenixing restrictions on appointments of a SBRP where a person has been a director of the company within the 12 months immediately preceding the date of the restructuring appointment, while vital, may have unintended consequences where it does not contemplate any concurrent appointments of a SBRP to small corporate related groups or where companies are unrelated and may only have a single common director for a short period of time.

Creditors and suppliers' interests

The moratorium prevents any unsecured and some secured creditors from taking action against the small business during the 20 day restructuring process. Personal guarantees are unable to be enforced and there are also ipso facto restrictions. The intention of the moratorium is to allow the small business to continue to incur debt under the control of the directors for the 20 business day period during which the restructuring plan is to be developed and certified by the SBRP, at which time the legislation provides the company is deemed to be insolvent. It is proposed that the moratorium continue for the 15 business day period during which the creditors are to consider and vote for or against the certified restructuring plan.

Upon entering the debt restructuring process, the company must give notice on all public documents and negotiable instruments that it is under the restructuring process by adding the words "restructuring practitioner appointed" after the company's name. There is no provision, however, requiring companies to file a public notice and notify creditors immediately upon the commencement of a restructuring process. This process commences at the time that the directors resolve they "have reasonable grounds for suspecting" that the company is either insolvent or likely to become insolvent and proceed to make the appointment.

There is no provision for debts incurred during the restructuring period to be paid in full prior to payments being met to pre-restructuring creditors by the approved restructure plan. Neither is there any provision which provides priority to creditors over pre-restructure creditors in any subsequent liquidation.

We question whether practically, creditors and suppliers would be willing to trade on reasonable commercial terms other than cash on delivery terms, because of the risk that they may otherwise become an unsecured creditor if the restructuring plan is rejected by the creditors, or is terminated for other reasons. Alternatively, suppliers could withhold supply if payments are not made which can adversely affect the ability of the company to continue to trade. It is arguable that debts incurred during the development and implementation of the approved restructuring plan should be treated in the same manner as debts incurred while a company is subject to a deed of company arrangement under Part 5.3A.

Further, directors are required to seek the consent of restructuring practitioner if they wish to undertake transactions outside "the ordinary course of business". There does not appear to be any guidance in the Bill or the Explanatory Memorandum as to what is intended by that term and it may prove to be problematic in the future.

The small business restructuring practitioner

Regulations are expected to provide for matters relevant to the appointment of the restructuring practitioner including their functions, duties and powers for the restructuring plan, their rights, obligations and liabilities arising out of performance of their functions and duties and the exercise of their powers. While this may suggest that the restructuring practitioner will have a mainly advisory role with directors remaining in control of the company, the Bill suggests that the SBRP will have a far greater responsibility, including:

  • reviewing the books and records of the company;
  • acting as the company's agent;
  • investigating the affairs of the company so as to be able to express an opinion as to the company to meet its obligations under any restructuring plan proposed by the directors to the creditors;
  • assessing the merits of the restructuring plan and forming an opinion in the interests of creditors as a group whether the plan is better or worse that liquidation;
  • terminating the debt restructuring process at any time if the SBRP has a belief on reasonable grounds that:
    • the company does not meet the eligibility criteria for restructuring; and
    • it would not be in the creditors' interests as a group to make the restructuring plan therefore, the restructuring plan be terminated and the company be wound up.

The SBRP is also required to review and provide consent to any proposed transactions the company seeks to enter outside the ordinary course of business. There is little clarity to what the SBRP would need to satisfy themselves of whether to provide consent to these transactions and the extent of the responsibilities raises issues around shadow directorship.

Other additional powers include:

  • consent to a transfer or adjustment to members shares;
  • consent to security enforcement or exercise of third party property rights;
  • consent to legal proceedings against the company; or
  • consent to enforcement of ipso facto rights.

Creditors appear not to be able to replace the SBRP who must be independent. While the Government's announcements stated that the SBRP would have limited control over the operations and assets of the business and design of the restructuring plan so as to keep costs of the whole process at a minimum, given the above responsibilities for the SBRP, this does not appear to be the case.

There is also uncertainty as to the ability of the SBRP to take on any subsequent appointment as a liquidator following the rejection of a restructuring plan by the creditors. The safeguard to this concern is that the insolvent company is handed back to the directors if the restructuring plan is rejected by the creditors, who themselves will determine and resolve to either appoint a voluntary administrator or liquidator to the company under the proposed simplified liquidation process. This will also avoid any possible conflict of interest arising with the SBRP and where the SBRP is not a fully qualified liquidator able to take on a liquidation appointment.

Role of secured creditors

Secured creditors' rights are consistent with the voluntary administration in that they remain unaffected. The Bill however does not address the extent to which a company is entitled to deal with assets that are subject to security during a restructure and what protections a secured party has if such dealings occur.

There is no doubt that secured creditors will still be able to influence the process where they retain the ability to appoint a receiver or manager. There is also the issue of personal insolvency with the most common form of finance to small businesses coming from loans which are supported by related party personal guarantees, usually given by company directors and their spouses and secured against their residential homes. A small business owner may be unlikely to engage with a SBRP where they are at risk that the bank may enforce the guarantee over their home. Including such guarantees within the 20 business day initial moratorium period is not much comfort where having a restructuring plan approved by creditors means the bank is still entitled to then enforce its security under any guarantees that might have been given by the director who is to implement the restructuring plan.

Interaction with other laws

Voidable transactions

In addition to our comments above concerning debts incurred during the restructuring period being provable in any subsequent liquidation, there are also concerns around a technical issue regarding voidable transaction provisions which apply where the winding up is immediately preceded by the restructuring.

Where the majority of the creditors do not vote in favour of the restructuring plan, the insolvent company reverts back to the directors who then make a determination as to its future. This has the effect of creating a gap between the restructuring process and any subsequent liquidation which in turn, could distort the operation of the relation back day.

Personal Property Securities Act 

Concerns were raised with the Exposure Draft regarding the vesting of unperfected security interests under the Personal Property Securities Act 2009 (Cth) (PPSA). Vesting of security interests should remain limited to the existing grounds of voluntary administration and liquidation and restructuring should not be a trigger for vesting under the PPSA. The Bill now seeks amendments to deal with this


Likewise, concerns were raised with the Exposure Draft that the potential for directors to be served with penalty notices issued by the Commissioner of Taxation under the Taxation Administration Act 1953 (Cth) will have a negative impact on any restructuring process for a small business. A new director is not liable to director penalties for amounts due before appointment as a director if within 30 days the company appoints a voluntary administrator or commences winding up. Therefore, for the small business insolvency regime to succeed, the Taxation Administration Act may need to be amended to allow a similar waiver for directors of a small business undergoing a restructure. The Bill now seeks amendments that deal with these concerns.

Conclusion: Good intentions, but careful execution is vital

It is appreciated that the intention is that the small business insolvency regime is to commence on 1 January 2021, at the conclusion of the temporary emergency support measures extended by the Government to expire on 31 December 2020.

Creditors and suppliers need to feel confident that they will be protected if they continue to trade with the small business during the restructure period. The Government needs to ensure there is a balance of the needs and interests of the whole of the creditors at the same time as keeping the process less complex and less costly for those small business wanting to use the small business insolvency reforms. There still remains some issues that need careful deliberation particularly, where the regulations have yet to be released for consideration. Treasury should, however, be commended for tackling the difficult issues around the restructure of small businesses to enable them to restructure in a cost effective and simple way where possible or, if not possible, to allow them to transition to a cost-effective streamlined liquidation process.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.