Small Business Insolvency Reforms Update

The Treasury has provided further insight this month into the operation of the proposed reforms that will see the most significant changes to the Australian insolvency framework in almost 30 years.

With a wave of insolvencies expected in 2021 as the measures introduced by the Government to combat the economic effects of COVID-19 come to an end, it is important that businesses, creditors and advisors are aware of the impact of the small business insolvency reforms.

Executive Summary

The draft Rules and Regulations that will give effect to the amendments were released on 17 November 2020 for a nine-day period of consultation, which closed on 24 November 2020.

The changes are proposed to take effect from 1 January 2021.

The purpose of the amendments is to introduce new external administration and restructuring processes suitable for small business with a view to reducing complexity, time and costs.

The key elements to the reforms are:

1. the new small business restructuring, which involves the appointment of a Small Business Restructuring Practitioner (Practitioner) to assist the directors in restructuring the existing debts; and
2. the new simplified liquidation process – which seeks to reduce red tape and associated costs with the current liquidation process.

A new class of registered liquidator will be established to act as a Practitioner.  They are required to be a registered accountant with a public practicing certificate and be a registered liquidator.

It is envisaged that a Practitioner will be remunerated by fixed fee for the small business restructuring appointment, that will provide certainty in respect of their fees.

While there are some elements to the reforms that will assist in keeping businesses in business, there appears to be significant scope for abuse by those who seek to defraud creditors.

Small Business Restructuring

The proposed small business restructuring model draws on the existing voluntary administration process but moves from a “creditor in possession” model to a “debtor in possession” model.

The directors will retain day-to-day control of the company while a restructuring plan is developed in consultation with a Practitioner.

For a company to be eligible:

1. the company must have less than $1 million in (actual and not contingent) liabilities on the day of the proposed restructuring to be eligible for the small business restructuring process; and
2. the directors of the company must not have previously utilised the small business restructuring process within the seven years preceding the proposed appointment of the Practitioner.

A company is taken to be insolvent upon the appointment of the Practitioner.

For a restructuring plan to be executed and presented to creditors for their approval, a Practitioner must certify they believe on reasonable grounds that the company has met eligibility criteria to enter the process and would be able to discharge its obligations under a plan should one be agreed to by creditors.

The restructuring plan will provide details addressing the company’s property and how the property will be dealt with under the plan.

Within 5 business days after the restructuring begins, directors must provide a declaration of the position of the company to the Practitioner, and state whether the company has entered any uncommercial, insolvent or similar transactions.

This requirement is intended to safeguard against potential activity designed to defraud creditors.  However, in practice, it is common under the existing regimes to see incomplete declarations with material omissions by directors.

Effect of Restructuring Plan on Creditors

If a restructuring plan is accepted, an unsecured creditor is bound to the extent that the creditor has an admissible debt or claim.

Consistent with the existing regimes, secured creditors will only be bound to the extent that their debt is unsecured, they consent to the plan or the court makes an order binding them.

Whilst a restructuring plan is in place, creditors cannot commence or continue wind up or enforcement proceedings.

Ending The Restructuring Process

The regulations provide companies with several avenues for ending the restructuring process.  This includes where the company:

1. makes a declaration that restructuring has ended;
2. enters into a restructuring plan with its creditors; and
3. fails to propose a restructuring plan within the relevant period, or that plan lapses.

Unlike voluntary administrations, when the restructuring process after being voted down by creditors, creditors cannot elect to place the company into liquidation via a creditors’ voluntary liquidation, and a court application will be necessary.

Simplified Liquidation Process

The other key aspect of the proposed reforms is the introduction of the simplified liquidation process, which seeks to allow faster and lower cost liquidations as an alternative to the current regime.

The simplified liquidation process will only be available in a creditor’s voluntary liquidation.

For a company to be eligible:

1. the company must have less than $1 million in liabilities, not including contingent liabilities;
2. the company must have resolved to be wound up voluntarily;
3. the directors must have given the liquidator a report as to the company’s affairs and a declaration that the company is eligible for the simplified liquidation process; and
4. the company’s tax lodgements are up to date.

The key features of the simplified liquidation process include the replacement of creditors’ meetings with electronic reporting and voting, and the removal of a liquidator’s obligation to report to ASIC about suspected wrongdoing.  These strategies have been introduced to reduce timeframes and costs.

The draft regulations also provide that payments to unrelated creditors in the sum of (or sums totalling) less than $30,000 that may otherwise be captured by the unfair preference regime will not be a voidable under the Corporations Act 2001 (Cth).

Next Steps

We expect that the Bill will be considered and passed by Parliament shortly, given that the amendments are due to take effect on 1 January 2021.

We will provide a further update when the legislation and subordinate legislation has passed.

Please contact our specialist team if you wish to discuss.