On 23 September 2020, the Treasurer, Mr Josh Frydenberg announced that the Federal Government is planning to overhaul Australia’s insolvency laws, adopting an US-style model to assist small businesses in a post-Covid world, to either restructure or fold. It is the most significant and ambitious proposed reform of Australia’s insolvency laws in almost 30 years.
The proposed changes
There is little doubt that small businesses in particular have been hard hit by the Covid-19 crisis. Current insolvency practices do not necessarily work best for small and family businesses who may have little control over the winding up process.
The proposed new system will be two-tiered, with larger companies expected to work within the existing insolvency regime, whilst smaller companies can adopt a simpler system. A “small” company is defined as any incorporated business with liabilities of less than $1 million. This $1 million threshold will cover approximately 76 per cent of businesses who are currently subject to insolvencies.
The changes will permit small business owners to remain in control of their company and assets, as opposed to immediately being placed in the hands of an administrator or creditors. The Government’s reforms draw on key features of the US Chapter 11 Bankruptcy Code, which permit small businesses to restructure their debts while remaining in control of their business.
The changes in detail
An insolvent small business will have 20 business days to propose a debt restructuring plan, during which the business can continue trading. The new process will provide a small business restructuring practitioner to assist the business prepare the debt restructuring plan, certify the plan to creditors, and oversee disbursements once the plan is in place. While the practitioner is engaged in the restructuring process, there is a moratorium on unsecured and some secured creditors taking actions against the company. Creditors will then have a further 15 business days to vote on whether to accept the proposed debt restructuring plan, including the remuneration of the practitioner to deliver on the plan. Employee entitlements that are due and payable must be paid out in full before the plan is voted on by creditors. In addition, in order for the binding plan to be approved, it must be supported by more than 50 per cent of the creditors by value.
There will also be safeguards in place to prevent corporate misconduct, including illegal phoenix activity, with related creditors prohibited from voting on the restructure plan, and the same company or same directors prohibited from using the insolvency process more than once every seven years.
If the proposed debt restructuring plan is not approved by the creditors, the business can go into voluntary administration or a new liquidation process with simplified obligations around reporting requirements and conducting meetings.
The proposed benefits of the new system
The proposed new system will see the insolvency model move from a rigid one-size-fits-all “creditor in possession” model to a more flexible “debtor in possession” model.
By enabling owners to remain in control, businesses should be more open to entering into the insolvency process sooner, providing them with an opportunity to restructure and increasing their chances of surviving the Covid-19 pandemic.
For those small businesses which cannot be revived, the liquidation process will also be simplified to make it quicker and easier by reducing the liquidators’ investigative process, mandatory meetings and reporting requirements. The objective is to avoid a lengthy legal process which consumes the business assets, leaving creditors with next to nothing.
The Treasurer commented that “Under the present system, the majority of businesses that enter voluntary administration are deregistered within three years. However, many of these businesses could remain viable concerns if they had more flexibility to restructure their affairs.” The Government believes that the proposed changes will allow viable businesses to survive the recession which has been caused by the Covid-19 pandemic.
Wave of insolvencies expected
The Government’s proposed new laws have been announced in response to what has been described as an imminent “wave” of insolvencies.
According to current ASIC data, the number of companies going into administration in 2020 is down by 46 per cent as compared to the same period in 2019. At present, approximately 2,000 fewer businesses have gone into administration than would otherwise be the case. This is because many unviable businesses are currently being “propped up” by the Federal Government’s JobKeeper wage subsidies. In addition, the cost of putting a small business into administration or liquidation can often consume the remaining business assets. It is an expensive process which can be counter intuitive for businesses who are already struggling financially.
However, Deloitte Access Economics modelling, estimates approximately 240,000 small businesses are at risk of failure.
This concern has already been raised in the financial sector from ASIC, the Reserve Bank and the Small Business Ombudsman, with the risk that a wave of insolvencies is imminent once the Government’s emergency protections for business owners abate at the end of this year. These emergency protections were introduced on 22 March 2020 for an initial period of six months. They were extended on 7 September 2020 to 31 December 2020. The protections include limiting creditor’s statutory demands, extending the time for companies to respond to creditors’ demands from 21 days to six months, and removing personal liability for insolvent trading. Similar provisions for personal bankruptcy are also in place until 31 December 2020.
The new laws are designed to assist the system to cope with the expected and imminent increase in insolvencies, as well as addressing perceived rigidities in the current system. The Government believes the proposed scheme provides the best opportunity for viable businesses to adapt in a post Covid-19 marketplace.
The approach is consistent with what the Productivity Commission has called for, stating that “the objective of the insolvency regime should be to provide a genuine opportunity for restructure for economically viable companies.”
The Federal Government is also proposing several initiatives to encourage more insolvency practitioners into the field, to cope with the expected increase in insolvencies. These initiatives include waiving registration fees for a period of two years and creating a new class of insolvency practitioners specialising in the new simplified small business process.
The objective is to reduce costs for small businesses, reduce the time spent on the insolvency process and ultimately assist small businesses in getting to the other side of the pandemic. For those businesses which clearly cannot survive, it is hoped that the new arrangements will encourage them to engage in the administration process early, with some business assets still intact.
The move has been welcomed in the financial marketplace by several business support entities, including the Australian Chamber of Commerce and Industry (ACCI) and the Australian Restructuring Insolvency & Turnaround Association (ARITA).
The Business Council of Australia commented that the Government’s plan will permit companies to plan a path out of insolvency, keep crucial supply chains working and assist businesses in keeping their doors open. The Australian Small Business and Family Enterprise Ombudsman stated that the new rules “are in line with the recommendations outlined in the Insolvency Practices Inquiry final report, handed down in July .”
However, not all organisations are supportive of such an expediated program of reforms. The Law Council of Australia warned against the Government rushing into implementing insolvency reforms without engaging in the usual industry consultation process.
The Government’s intention is for the new insolvency regime to commence from 1 January 2021, following the lifting of the temporary Covid-19 insolvency relief measures.
The new measures could pave the way for further longer-term insolvency reforms which extend the proposed flexibilities to a broader range of businesses beyond the pandemic economic conditions. However, caution needs to be exercised to ensure that the proposed reforms do not have any unforeseen negative outcomes. This is where a comprehensive program of industry consultation is vital.
Sources: ABC News, Federal Government to adopt US-style insolvency rules to help with expected wave of business closures, 24 September 2020, accessed 28 September 2020.
Treasury Department, Temporary Relief for Financially Distressed Businesses, Fact Sheet, Australian Government Economic Response to the Coronavirus, accessed 28 September 2020.