Insolvency reforms for small business

From 1 January 2021, the proposed law aims to establish a cost-effective alternative to provide the best opportunity for small and micro businesses with less than $1m in liabilities to continue under the current owners.

It is currently estimated that there are circa 800,000 SMEs with turnover below $2m on JobKeeper that would be eligible to utilise this new restructuring procedure.

There are major issues to be clarified in the interim to determine the practical implementation of how the law will operate in reality, and how potential abuse of the process is safeguarded.

What is going to change?

A new formal debt restructuring process for small business with less than $1m in liabilities 
Although it appears a major change in approach, the reality is that the change represents a streamline of the current Administration approach for small businesses given the costs, red tape and reporting obligations of the current Administration regime that can make the process uncommercial for Directors and creditors as the costs erode the process.

A new simplified liquidation pathway to enable faster and lower cost liquidation
There are less details available about this process; however, major aspects appear to be reduced investigation, creditor meeting, statutory reporting, simplified dividend process and use of technology to produce a more efficient process.

Other complementary measures
This encompasses other Government initiatives including:

  • Extension to the insolvency trading relief (in place since March 2020) to 31 December 2020
  • Changes to quantum for creditors to pursing winding up applications (in place since March 2020)
  • Encouraging the use of technology in administrations
  • Fee waivers for new liquidators and having a new category of practitioner to be Small Business Restructuring Practitioner.

Who is eligible for the new formal debt restructuring & how does it work?

The key aspects of the proposed laws are:

  • Companies with liabilities under $1m
  • A moratorium from creditor actions (including personal guarantees) will occur following a resolution of the Board/Directors to appoint a Small Business Restructuring Practitioner (SBRP) to assist with the collation of a Plan
  • Directors remain in control while they collate the Plan with the assistance of the SBRP
  • The Plan is circulated to creditors within 20 business days (4 weeks)
  • The Plan can be in any format the directors determine that are expected to involve a discount or delayed timing of any return to creditors. Consideration of the Plan and expected return is likely to be compared to a potential return in a liquidation scenario
  • Employee entitlements are paid up to date and settled in full as part of the process
  • The SBRP send the Plan and supporting documents to creditors along with certification that the business can meet the proposed repayments and has properly disclosed its affairs
  • Creditors have 15 business days (3 weeks) to consider the Plan, then accept or reject the Plan
  • All Creditors are bound by the Plan if 50% of the value of creditors vote in favour of the Plan. Secured Creditors are only bound for any shortfall after realisation of the security interest
  • Related parties are excluded/prohibited from voting
  • Avoids the costs and time of Voluntary Administration, Deed of Company Arrangement (DOCA) that reduces funds available for creditors.

What happens if Creditors do NOT accept the plan?

The Directors can then consider options that include Voluntary Administration or the simplified Liquidation process. It’s unclear if a further proposal can be submitted or if there is any ability for appeal to Court or another oversight mechanism.

Are there any safeguards?

The Government has identified the following safeguards:

“Safeguards will be included to prevent the process from being used to facilitate corporate misconduct such as illegal phoenix activity. They include a prohibition on related creditors voting on a restructuring plan, a bar on the same company or directors using the process more than once within a prescribed period (proposed at 7 years), and the provision of a power for the practitioner to stop the process where misconduct is identified.”

The practical outcome of the above and ability to mitigate abuse of the process will be critical to maximising the impact of the change. There is always risk of abuse of any procedure for use of  Phoenix transactions (transactions that strip assets away and leave creditors in existing structure) where independence is not enforced and supervision inadequate.

Other potential issues relating to adequate record keeping like if a creditor claim is  not reported by a Director that would have  made the entity not eligible (debts then above $1m) or is the creditor bound if it is not involved in the process will need clarification.

So, what is unclear and needs to be resolved before 1 January 2021

There are a number of aspects that need to be clarified to solidify the process:

  • The qualifications required for the SBRP – will they be Liquidators or other parties
  • What the fixed pricing of the process is and whether it will be commercially viable for SBRPs to ensure the quality of the process. Some parties are indicating $10k to $30k for the role depending upon complexity of the affairs and the proposal and number of creditors. $30k is close to the cost of a small VA under the current regime
  • Its unclear why suppliers would supply further goods or services unless on Cash On Delivery (COD) terms once notified of the moratorium given the uncertainty of payment and lack of personal liability for any party. This could impact the viability of the process and the funding structure required
  • How the plan is explained/disclosed and detailed – will ASIC create a standard template – including what investigations into the company’s affairs and potential recoveries in a Liquidation are required to be reported to creditors
  • If there will be ASIC or Court oversight to deal with disputes on voting, disclosure or eligibility issues
  • Secured Creditors approach, including if they are limited by the moratorium, included in the value vote and bound even if they vote against the Plan
  • How safeguards are implemented and monitored.

Overall

The changes represent a step towards commercial arrangements for SME businesses that have been used in other jurisdictions and enables Directors to consider options available and then put the preferred option to creditors.

There is similarity with the Safe Harbour corporate plans where Companies/Directors can assess the options and pursue an improved return for creditors compared to Liquidation.

Creditors may have to consider more commercial arrangements and implications for their own businesses due to customers using this process. That could result in one Plan (Plan A) resulting in major suppliers then subsequently proposing their own Plan/s due to the reduced return under Plan A.

Effectively, Directors with assistance of an independent, skilled and experienced SBRP are empowered to put a commercial compromise to creditors for consideration to enable the business to continue with the reduced costs (compared to the Voluntary Administration process) enabling further funds to be available for creditors.

If the safeguards are implemented to protect the interest of creditors and the sanctity of the process and the unclear aspects above resolved, then this process may achieve the Governments aim, to enable more businesses to survive the impact of 2020 and continue into the future.

There is more to come on this change as issues are clarified over the next 3 months before the new regime is implemented from 2021 onwards. We will provide further updates as it develops. 

See the Federal Government’s media release for more information.