ARMAGEDDON OR SALVATION? | Government overhauls insolvency framework

By Tony Lane

In a broadly unanticipated move, the Morrison Government has announced their commitment to make the most significant reforms to Australia’s insolvency framework in 30 years, as part of their economic recovery plan to support small businesses as they emerge from COVID-19 and beyond.

The reforms will embrace key features of the laws of other jurisdictions – including elements of the US Chapter 11 Bankruptcy laws – and will allow incorporated businesses with liabilities of less than $1 million to remain in control while they deal with debt – giving them the flexibility to either restructure or wind down their operations in an orderly manner.

These measures follow on from the temporary regulatory measures, announced in March and extended in September, to help financially distressed businesses get to the other side of COVID-19.

With these new processes available for small businesses from 1 January 2021 (subject to yet to be revealed draft legislation being passed by Parliament), the reform package is no doubt a largely welcome relief for companies in financial distress, but one that also raises a number of additional considerations.

At a glance

Key elements of the proposed reforms include:

  • The introduction of a new debt restructuring process for incorporated businesses with liabilities of less than $1 million, drawing on some key features of the Chapter 11 bankruptcy model in the United States.
  • Moving from a rigid one-size-fits-all “creditor in possession” model to a more flexible “debtor in possession” model which will allow eligible small businesses to restructure their existing debts while remaining in control of their business.
  • A rapid 20 business day period for the development of a restructuring plan by a small business restructuring practitioner, followed by fifteen business days for creditors to vote on the plan.
  • A new, simplified liquidation pathway for small businesses to allow faster and lower cost liquidation.
  • Complementary measures to ensure the insolvency sector can respond effectively both in the short and long term to increased demand and to meet the needs of small business.

Source: Australian Treasury Media Release, 24 September 2020

How will it work?

  1. A small business facing financial distress approaches a practitioner to discuss their options. The practitioner advises that the new reorganisation process is the most appropriate option in their circumstances, and the owners accept the advice. The practitioner proposes a flat fee for their work in helping the business develop a restructuring plan.
  2. Following a resolution of the board, the business signs up the practitioner as their small business restructuring practitioner. On commencement, unsecured and some secured creditors are prohibited from taking actions against the company, a personal guarantee cannot be enforced against a director or one of their relatives, and a protection from ipso facto clauses (that allow creditors to terminate contracts because of an insolvency event) apply (with the same protections applying as during voluntary administration).
  3. The business owner works alongside the practitioner over a 20 business-day period to develop a plan to restructure the business’s debts and provide supporting documents for creditor consideration. During this time, the owners continue to control the business and can trade in the ordinary course of business. The practitioner also develops a remuneration proposal to cover their management of the plan once in place, which will operate as a percentage fee of disbursements made under the plan.
  4. The practitioner sends the plan and supporting documents to creditors and certifies whether they consider the business can meet the proposed repayments and has properly disclosed its affairs. Creditors have 15 business days to vote on the plan, including the proposed remuneration for the practitioner. The business must pay any employee entitlements which are due and payable before a plan can be put to creditors.
  5. If more than 50 per cent of creditors by value endorse the plan, it is approved and binds all unsecured creditors. Creditors vote as one class. Secured creditors are bound by the plan only to the extent their debt exceeds the realisable value of their security interest. To support the integrity of the process, related-party creditors are not entitled to vote.
  6. If the plan is approved, the business continues and the practitioner administers the plan by making distributions to creditors according to the terms of the plan. If voted down, the process ends, and the company owners may opt to go into voluntary administration or to use the simplified liquidation pathway proposed in this paper.

Source: Australian Treasury Insolvency Reforms Fact Sheet, 24 September 2020

Winners & losers

As with all large scale reforms, this change carries with it a level of complexity.  The following are some stakeholders we are placing under the spotlight, watching closely and available to support across various areas of our firm should the proposed measures be put into place:

PositivesNegatives
The support for small business is an obvious win here, with the proposed framework designed to enable them to quickly restructure and work to survive the impact of COVID-19.  Where structure is not possible, they will be able to wind up faster – with the aim being to enable greater return for creditors & employees.The process remains in the hands of creditors and at this stage little is known about the transition mechanisms between a rejected restructure plan, simplified winding up and the existing arrangements of voluntary administration and liquidation.  The denial of related party votes may in some instances unfairly prejudice family groups where internal sources of funds have been properly obtained.
PositivesNegatives
The process remains in the hands of creditors.  If a proposed restructuring plan for an SME is not approved, then the company owners may opt to go into a traditional voluntary administration or use the proposed simplified liquidation process – meaning a faster outcome for creditors, though the detail around the transition mechanisms is unclear.The existing COVID-19 insolvency relief measures have undoubtedly created a plethora of ‘zombie companies’ – those racking up debt with no hope of, or intent to, repay that debt.  Regardless of their simplicity, these reforms may yield no benefit for creditors of such companies.  As has been recently stated…if there is nothing to save, there is nothing to save (and therefore nothing to give to creditors).  The reforms will likely mean that there will be an expectation that creditors (banks, suppliers, employees, sub-contractors and more) will continue to permit businesses to add to their existing debt while any restructuring is taking place – potentially resulting in this larger debt tally unable to be paid back.  We would also expect to see creditors seeking to advance their positions against debtor companies by whatever means possible, including greater use of the PPSA.
PositivesNegatives
With the proposed creation of small business restructuring practitioners, there is an opportunity for experienced advisors who specialise in business improvement, business performance, virtual CFO, business intelligence and more to take this opportunity to help turn around distressed businesses and their owners and work towards a road map post pandemic.  The specialisation appears to be not unlike the nearest corollary of Pt IX Debt Agreement administrators in an Australian bankruptcy context.The opportunity for new advisers to throw their hat in the ring can also unfortunately open up the playing field for unqualified, inexperienced or unethical practitioners to facilitate illegal phoenix activity or asset stripping in order to keep businesses afloat who may ultimately be better off clearing the decks and going down the existing insolvency route.   We support the existing advocacy that this remains an area in which the Government must pay close attention and seriously consider regulating, to ensure that businesses are working with ‘true’ experts in the restructuring and turnaround arenas to give them a clear direction when they need it most.
PositivesNegatives
The proposed reforms to the registration of liquidators and trustees is optimistic and should allow for greater diversity and more practitioners returning to the profession, where currently less than 10% of registered insolvency practitioners are female.However, we note that over 78% of business insolvencies have been reported to involve companies with debts of less than $1 million.  The further fracturing of the regime will mean many insolvency firms with have to re-model their businesses to take into consideration a reduction in ‘traditional’ work.  Further, if the government reduces the requirements on minimum education and competency to become a registered liquidator, then the positive moves arising from the Hayne Royal Commission would take a step back.  It is vital that the high standards of the profession are maintained during and in spite of these challenging times as dealing with other people’s livelihoods is never a role to be taken lightly.

Looking forward

As mentioned, these proposed reforms are the most significant changes to the Australian insolvency framework in over 3 decades since the Harmer Report and the advent of voluntary administration itself  Forming part of the Government’s planning to ensure Australia emerges from the pandemic with a stronger, more resilient and more competitive economy, there is no doubt that much is in the works to help give all stakeholders better certainty & confidence going forward.  We can know little more until the detail in a draft bill comes before Parliament.

Need help?

At Vincents we are proud to be well-positioned across all touch points for insolvency and reconstruction reform, as one of Australia’s few, fully integrated mid-tier professional services firms.  We have a clear mission to work with our clients to give them a greater clarity and direction – and right now this couldn’t be more pivotal.

If you’re a business owner struggling to understand your options – reach out to us.  Our business advisors, mortgage brokers/refinancers and insolvency and reconstruction professionals are all in the unique position to work together on financial distress matters – all under the one roof and committed to helping you gain insight and take control of your financial future.

Want to know more?

If you would like to find out more about the issues raised in this article, please contact Tony Lane, our Insolvency & Reconstruction Director, for assistance.

An Important Message

While every effort has been made to provide valuable, useful information in this publication, this firm and any related suppliers or associated companies accept no responsibility or any form of liability from reliance upon or use of its contents.  Any suggestions should be considered carefully within your own particular circumstances, as they are intended as general information only.

 

 

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