Major shake-up of restructuring laws for small business: great in theory, but more information please

By Jennifer Ball
01 Oct 2020
The new debtor-in-possession model for small business restructuring is aimed at allowing viable small businesses to seize the initiative to quickly restructure to survive the economic impact of COVID-19, but we need greater clarity on key elements of the proposed insolvency framework.

From 1 January 2021, the greatest changes to Australia's insolvency laws since the early 1990s will be in place. That is the Federal Government's intention, at least, as announced last week by Treasurer Josh Frydenburg. This will follow the expiration on 31 December 2020 of the extended COVID-19 insolvency relief measures. While the creation of a new regime for small businesses to restructure is a welcome one, much will depend upon the shape of the legislation. Below are the main questions we're asking about the legislation, and that we will need to see answered in any Bill.

The insolvency reforms at a glance

The Federal Government has recognised voluntary administration law is no longer geared towards small businesses in that the "one-size-fits-all" insolvency process has become too complex, too lengthy and too costly  and is unable to adapt to the needs of a small business when it seeks to restructure debt. The Government's response (presumably inspired in part by the many calls for a similar regime to the US' Chapter 11) has three elements, which it describes as:

  • "A new formal debt restructuring process for small businesses to provide a faster and less complex mechanism for financially distressed but viable firms to restructure their existing debts, maximising the chance of them surviving and contributing to economic and jobs growth.
  • A new, simplified liquidation pathway for small businesses to allow faster and lower-cost liquidation, increasing returns for creditors and employees.
  • Complementary measures to ensure the insolvency sector can respond effectively."

What this actually translates to is a "debtor-in-possession" model:

  • incorporated businesses with less than $1m in liabilities can engage a small business restructuring practitioner (SBRP) who must remain independent (similar to an administrator in a VA). Creditors will be provided with a notice by some technological means which will outline how information, relevant to the restructuring process, is able to be accessed by them.
  • at that point unsecured and some secured creditors cannot take action against the company, nor can a personal guarantee be enforced against a director or one of their relatives, or an ipso facto clause be triggered;
  • the business and the SBRP have 20 business days to develop a restructuring plan and remuneration proposal.
  • SBRPs will not be required to take on personal liability for the company's debts incurred during the restructure process (like voluntary administrators) and the directors are to remain in control of the small business
  • during the 20 business day period during which the SBRP and the small business develop the restructuring plan, the business will be permitted to trade in the ordinary course of business. To trade outside the ordinary course of business, prior approval of the SBRP will be required.
  • before that plan is put to creditors, having been certified by the SBRP that the plan can meet the proposed repayments and the business has disclosed its affairs, any employee entitlements which are due and payable must be paid in full;
  • creditors (excluding related creditors) have 15 business days to submit a proof of debt and vote on the plan and the proposed remuneration for the SRBP;
  • secured creditors' rights and the statutory priorities afforded to creditors such as employees will not be modified;
  • the plan and remuneration are binding on unsecured creditors if more than 50% of creditors by value endorse them. Secured creditors are bound by the plan only to the extent their debt exceeds the realisable value of their security interest;
  • related party creditors will be restricted from voting on the restructuring plan;
  • if the plan is rejected, the business may go into voluntary administration or use a new simplified liquidation process;
  • if the plan is endorsed, the SBRP administers the plan and makes distributions in accordance with it, but is not required to take on personal liability for a company or manage its day to day affairs.

Apart from the bar on related creditors' voting on the plan, there are two other protections: the same company or directors cannot use the process more than once within a prescribed period (proposed at 7 years), and the SBRP can stop the process where misconduct is identified.

Not all businesses will be able to access the scheme on 1 January 2021, so as a transitional measure they can inform creditors via a notice on the ASIC website of their intention to access the scheme and then continue to utilise the existing temporary insolvency relief (which otherwise expires on 31 December 2020) for up to three months until they can engage a small business restructuring practitioner. These notices can be made until 31 March 2021.

So that is the shape of the scheme. What aspects will we need greater clarity on in the legislation to ensure it is workable and fair?

The $1m threshold

The new process will only be available to incorporated businesses with liabilities of less than $1m. This is based upon some statistics sourced by Treasury that indicate around 76% of companies entering into external administration in 2018-2019 had less than $1m in liabilities. Arguably this debt threshold of liabilities of less than $1m is too low, but it might be that this could be raised once the new regime is in operation and there is more certainty about the business forecast.

Small business restructuring practitioner

The small business restructuring proposes that a new class of insolvency practitioner be created namely, the SBRP. We know that a registered liquidator is able to register to undertake the role and individuals could also choose to register solely as a SBRP. There is no indication at the present time, as to what qualifications the SBRP will require to have to be able to register as a SBRP. The SBRP however, will play a crucial role in advising and assessing a business' suitability for the new reorganisation regime, and in guiding it through its restructure. Therefore, the SBRP needs to be competent to undertake such work, be independent of the business and able to recognise any improper practices such as related party transactions and or "phoenix company" activities.

Payment of employee entitlements in full

The proposed requirement that the small business must pay any employee entitlements which are due and payable in full before any restructuring plan can be put to creditors. This may present an obstacle for many small businesses that have been heavily reliant upon the Government's emergency COVID-19 support measures, such as JobKeeper, since March 2020

Getting everyone on board with the moratorium

The moratorium preventing any unsecured and some secured creditors from taking action against the small business will allow the small business to continue to incur debt under the control of the directors. This moratorium is proposed not just for the 20 business day period to develop the plan but also the additional 15 business days for the creditors to consider and vote for or against the restructuring plan. It is not clear whether the small business is required to make any public disclosure that it is subject to the moratorium. It will remain to be seen as to whether creditors, both secured and unsecured, are prepared to support the small business during the moratorium period and how it might other classes of creditors such as employees and landlords.

Although it is also not clear at present, it is assumed that during the moratorium there are no voidable transaction risks other than any improper practices such as related party transactions or illegal "phoenix company" activities. Likewise, and similar to the safe harbour scheme, presumably there will be a temporary relief from any risk of personal liability to directors for insolvent trading.

Developing the restructuring plan

There is no indication at present whether the restructuring plan will be a pro forma document or bespoke. A prescribed form could ensure some consistency; without it, the individual practitioners would need to develop their own precedents over time. Without some sort of starting point for a plan, practitioners at the start of the new regime will be making it up as they go, which would not be ideal with a tight 20 business day turnaround.

What creditors will need to be informed

It is not yet clear what information the small business and the SBRP need to assemble and provide to creditors however, one would assume that there would be required to be full transparency of all financials and other information in a form that is simple, uncomplicated and easily digestible so that the creditors can make an informed decision on the proposed restructuring plan and proposed remuneration of the SBRP.

Secured vs unsecured creditors

A vote to accept the plan will bind all unsecured creditors and will bind secured creditors only to the extent their debt exceeds the realisable value of their security. The existing order of priority of key creditors (including secured creditors and employees) will remain preserved so there is no change to the rights of secured creditors and similar types of debts are treated consistently. It is unclear whether secured creditors' security rights will continue to attach to new assets post the creditors' acceptance of the plan. This may possibly lead to a failure of any small business restructure if the circumstances are that the directors and shareholders, who would be responsible for getting the business back up and running, have granted guarantees (usually supported by mortgage security over their residential properties), which guarantees are enforced by a secured creditor post the approval of the restructuring plan.

Interaction of other insolvency laws

It is not clear how the other existing insolvency laws such as voidable transactions; directors' statutory duties under sections 180 to 184 of the Corporations Act 2001 and the duty to prevent insolvent trading; the PPSA and the taxation laws, are to interact with the proposed reforms or whether they are to apply during the moratorium period.

We are optimistic and support the proposal by the Government to shift to a debtor in possession model for small businesses that will help more small businesses restructure and survive the economic impact of COVID-19. It is important that any distressed small businesses have the option of accessing a process that provides the necessary flexibility to restructure small business in an orderly and costs effective manner. We will provide further information on the reforms as they are developed by Government, noting that the new processes are to be available for small business from 1 January 2021.

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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.