Insolvency law reforms for small business

The Australian Government has announced proposed major reforms to corporate insolvency laws, including a new formal debt restructuring process and a new simplified liquidation process for eligible incorporated small businesses with liabilities of less than $1 million.

On 24 September 2020 the Australian Government released a fact sheet 'Insolvency reforms to support small business' (Proposal) outlining proposed major reforms to corporate insolvency laws to support small business recovery following the expiry of temporary COVID-19 insolvency law relief at the end of 2020.

The Proposal is in response to liquidity challenges faced by many Australian small businesses impacted by the COVID-19 pandemic, and in recognition that current insolvency processes are not generally appropriate for small business insolvencies.

The measures in the Proposal would commence from 1 January 2021, and apply to eligible incorporated small businesses with liabilities of less than $1 million. In setting this eligibility threshold, the Government noted that around 76% of companies entering into external administration in financial year 2019 had less than $1 million in liabilities.

The Proposal is subject to the passage of enabling legislation, which is yet to be released.

Key elements of the Proposal

The three key elements of the Proposal are:

1. Small Business Restructuring: a new 'formal debt restructuring process' for eligible incorporated small businesses with liabilities of less than $1 million, to allow a faster and less complex process to restructure existing debts and maximise their chances of survival.
2. Small Business Liquidation: a new 'simplified liquidation pathway' for eligible incorporated small businesses with liabilities of less than $1 million, to allow faster and lower cost liquidation process.
3. Further measures: to ensure that the restructuring and insolvency sector can respond to the measures in the Proposal and the needs of small businesses.

Small Business Restructuring

The key features of Small Business Restructuring include:

• Shifting eligible small businesses to a 'debtor in possession' restructuring model, drawing on some features of US Chapter 11 bankruptcy, and allowing eligible businesses to restructure existing debts while remaining under the control of directors.
• A newly created class of insolvency practitioner namely a 'small business restructuring practitioner' (SBRP) will help determine if a small business is eligible for the process; support the company to develop a restructuring plan and review its financial affairs; certify the plan to creditors; and manage disbursements once the plan is in place.
• Restructuring plans will have to be developed within a 20 business day period, followed by a period of 15 business days for creditors to vote to approve the plan.

Role of the Small Business Restructuring Practitioner

A small business in financial distress would appoint a SBRP to advise on:

• eligibility of the small businesses to access Small Business Restructuring;
• developing restructuring plans with respect to their financial affairs;
• certifying the plan to creditors; and
• managing disbursements once the restructuring plan is in place.

Unlike voluntary administrators, SBRPs will not be required to take on personal liability for a company's debts incurred during the process, or manage its daily affairs. Under the Proposal, directors will remain in control of the small business.

In the 20 business day period during which a restructuring plan is being developed, businesses will be permitted to trade in the ordinary course of their business.

For businesses seeking to trade outside the ordinary course of business, prior approval of the SBRP would need to be obtained.

How Small Business Restructuring would work

The new process is proposed to operate as follows:

Eligible small businesses facing financial distress would approach a SBRP who will advise on the appropriateness of the new process for the company. The SBRP will charge a flat fee for assisting with the development of the restructuring plan.

The directors of the company would resolve to appoint the SBRP. Upon appointment of a SBRP, unsecured and some secured creditors will be restricted from taking action against the company, personal guarantees will not be able to be enforced, and the stay on the enforcement of ipso facto clauses will apply as during a voluntary administration.

A notice that the process has commenced will be provided to creditors by a technology neutral means, which outlines how information relevant to the process can be accessed by interested parties.

The directors and the SBRP will work collaboratively with the business during a period of 20 business days to develop a restructuring plan (including a remuneration proposal to cover their management of the plan once in place).

Creditors will have 15 business days to submit a proof of debt and vote (through an online platform or other technology neutral means) on the proposed restructuring plan (including the proposed remuneration of the SBRP). Companies must pay any employee entitlements which are due and payable before a plan can be put to creditors. A 50% majority of creditors by value would be required to approve the plan.

If the restructuring plan is approved by creditors, the business continues and the SBRP will administer the plan by making distributions to the creditors in accordance with the terms of the restructuring plan. If the plan is not approved, the directors may opt to go into voluntary administration, or utilise the alternative Small Business Liquidation process under the Proposal.

Transitional measures for temporary insolvency relief until 31 March 2021

For a three month period from 1 January 2021 to 31 March 2021, the government has proposed that an eligible small business will be able to declare its intention to access the Small Business Restructuring process to its creditors, including through ASIC's published notices website. This is in order to address the issue of eligible small businesses not being able to access the process immediately whilst insolvency practitioners become familiar with Small Business Restructuring and to register as SBRPs. Following their declaration, the existing temporary insolvency relief in place until the end of 2020 (relief from insolvent trading liability under section 588GAAA of the Corporations Act 2001 (Cth) (Corporations Act) and the curtailment on the issuing of creditors' statutory demands) would then apply to the business for a maximum period of three months, until they are able to access a small business restructuring practitioner or other insolvency practitioner.

Creditor rights and safeguards during Small Business Restructuring

The Proposal sets out measures to protect the interests of creditors including:

• the independence and obligations of the SBRP in the process;
• preservation of key creditors rights – secured creditors will be unaffected and similar types of debt will be treated consistently; and
• proposed restructuring plans must be approved by creditors holding a 50% majority in value to be binding.

Additional safeguards include:

• creditors related to the company proposing a restructuring plan will be restricted from voting on the plan;
• companies and directors will be limited to accessing the restructuring reforms to only once during the prescribed period (proposed to be 7 years); and 
• empowering the SBRP to stop the process where misconduct has been identified (e.g. illegal phoenix activity).

Small Business Liquidation

Under the proposed new Small Business Liquidation process, liquidators' regulatory obligations would be simplified, so that they are more appropriate for the size and scale of eligible small businesses with liabilities of less than $1 million. (This is the same eligibility threshold that would apply for Small Business Restructuring).

How Small Business Liquidation would work

The reforms propose to retain the general framework of the existing liquidation process, while introducing modifications to reduce time and costs associated with investigative functions.

The time and cost savings under Small Business Liquidation are proposed to be achieved through the following modifications:

• Reduced circumstances in which a liquidator can seek to clawback an unfair preference payment from a creditor that is not related to the company.
• Only requiring the liquidator to report to ASIC on potential misconduct where there are reasonable grounds to believe that misconduct has occurred.
• Removing requirements to call creditor meetings and the ability to form committees of inspection.
• Simplifying the dividend process and the proof of debt process.
• Maximising technology neutrality in voting and other communications.

Creditor rights and safeguards during Small Business Liquidation

According to the Proposal, the rights of secured creditors and the statutory priorities afforded to creditors such as employees would not be modified.

Safeguards will be included to prevent companies from using the process to undertake corporate misconduct, including illegal phoenix activity, including:

• allowing creditors to convert the Small Business Liquidation back to a 'full’ liquidation process;
• preventing directors from using the process more than once within a prescribed period (proposed at seven years); and
• requiring company directors seeking to use the process to declare that they believe the company is eligible and has not engaged in illegal phoenix activity.

Further measures

The Proposal also sets out the following permanent and temporary measures to expand the availability of insolvency practitioners to deal with an expected increase in the number of businesses seeking to undertake formal restructuring and insolvency processes:

• Temporarily waiving fees associated with registration as a registered liquidator for approximately two years until 30 June 2022.
• Increasing the flexibility of registration requirements for insolvency practitioners by removing requirements which are 'overly rigid'.
• Making the key parts of the external administration process under the Corporations Act 'technology neutral' so that external administrations can be carried out more efficiently and practitioners can focus on the substantive requirements of their role.
• Establishing a new classification of insolvency practitioner whose practice will be limited to SBRP roles.
• Consultation to be undertaken on the appropriateness of permanently raising the minimum threshold at which creditors can issue a statutory demand on a company.

A step in the right direction for small businesses

The proposed reforms represent a step in the right direction for small businesses facing financial distress, particularly in light of the expiry of the temporary COVID-19 insolvent trading safe harbour and the increased statutory demand thresholds at the end of 2020.

We support the proposal by government to shift to a 'debtor in possession' model for the majority of businesses that face financial distress on the basis that it will streamline the process of, and reduce costs in, the formal debt restructuring process. That said, the Proposal does not disclose some important details that will be pertinent to businesses, creditors and the restructuring and insolvency sector alike. We look forward to the draft legislation being released as well as a meaningful consultation process being undertaken, by way of direct consultation with Treasury or through a Parliamentary inquiry.

The essential elements of the Proposal are broadly supported by the Australian Restructuring Insolvency and Turnaround Association and the Turnaround Management Association Australia, however there are matters relating to the Proposal that should be further considered by Government prior to release of the draft bill.

We observe the following matters that warrant further consideration:

• While it has been announced that incorporated businesses with less than $1 million in liabilities will be able to access the proposed Small Business Restructuring and Small Business Liquidation processes, it is unclear on what basis such liabilities will be calculated. For example, will contingent liabilities count toward the $1 million cap? What will be the treatment of new liabilities incurred while the restructuring plan is being developed?
• Further detail is required about the scope of the moratorium on enforcement of creditors' rights during the period of 35 days during which restructuring plans are developed and voted on. For example, landlords and property owners are key classes of creditor to whom this aspect of the reforms will be of interest.
• The reforms include the announcement of a new class of insolvency practitioner (the SBRP) whose practice will be limited to the proposed Small Business Restructuring process only. While there is merit in reducing red tape in order to streamline the ability of businesses to access restructuring services, the SBRP should still be appropriately qualified and accredited by an appropriate professional body. There will also need to be adequate training for SBRPs in relation to the Small Business Restructuring process. The Proposal is also silent on the requirements for SBRPs to hold adequate and appropriate professional indemnity insurance.
• The Proposal says that creditors related to companies availing themselves of the Small Business Restructuring process will be restricted from voting on the restructuring plan. Further detail is required about who will be a 'related' creditor and whether the SBRP will have any involvement in determining whether a creditor is related to the debtor company.
• The interaction of the proposed reforms with other aspects of corporate insolvency law – including voidable transactions, creditors' statutory priorities, interaction with taxation and personal property securities laws, director penalty notices, and directors' duty to prevent insolvent trading – warrant meaningful engagement between Treasury and interested parties before the measures are legislated.
• To the extent that employee entitlements are required to be paid out in full before the restructuring plan is voted on by creditors, where will these funds come from, and what will be the trigger to make, for example, leave entitlements 'due for payment' before termination?

We anticipate these matters will be comprehensively addressed during a period of consultation and reflected in the draft bill.

The Proposal also states that consultation will be undertaken on the appropriateness of permanently raising the minimum threshold at which creditors can issue a statutory demand on a company (which is normally $2,000). This is a significant development affecting debtors, creditors and insolvency practitioners.

We will provide further updates on these reforms as and when additional details are made available.

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