Small business insolvency reforms – What you need to know to inform your clients

In preparation for the approaching possible ‘tidal wave’ of insolvency appointments likely to commence in early 2021, the Federal Government has announced its intention to roll out a simplified restructuring solution for micro and small businesses, based on the US ‘debtor in possession’ model. Additionally, there will also be a simplified liquidation process, aimed at streamlining the procedure for small entities, saving on time and therefore costs of administration.

These reforms have been earmarked to begin from 1 January 2021, which tie in with the expiry of the temporary insolvency relief measures on 31 December 2020.  

Here is what you need to know about how the proposed procedures will look and operate, subject to being passed as legislation.

Restructuring – think of it as a mini, less formal voluntary administration/deed of company arrangement process    

Below are the key elements of the proposed restructuring process-

• A small business in financial distress seeks out an insolvency practitioner for assistance with their situation.
• Guidance from the insolvency practitioner reveals that opting to use the small business turnaround pathway is the way forward.
• The directors pass a resolution to enter into the process and engage with a Small Business Restructuring Professional (SBRP) – most likely an insolvency practitioner. 
• Similar to the existing voluntary administration (VA) regime, once the process commences, unsecured creditors and some secured creditors cannot enforce their rights of recovery, personal guarantees cannot be enforced and ‘ipso facto’ clauses in contracts (automatic default clauses) are prohibited from being activated.
• The directors/business owners work closely with the SBRP during a 20 business day period to formulate a restructuring plan and to propose an offer for creditors to consider, much like a deed of company arrangement (DOCA) proposal in the existing VA regime.     
• During the 20 business day period, operations carry on as usual, with control maintained by the debtor company directors.
• The SBRP then issues a report to creditors, including the details of the proposal for creditors to consider and over what timeframe the proposal is intended to run. The SBRP also signs off on the elements of the proposal and importantly, that the entity can fulfil its obligations under the proposal. The SBRP’s report will also contain details on how the SBRP will be remunerated for their role in the process.
• Creditors then have 15 business days to vote on the proposal and 50% in value of those voting must approve the proposal for it to be adopted.   
• If the plan is adopted, the SBRP administers the plan and distributes the funds to creditors in accordance with the plan.
• If the plan is not adopted, the directors have the options of the simplified liquidation process (discussed in further detail below) or regular liquidation or voluntary administration.

Other key features of the process include-

• Liabilities must be less than $1M; however, it is not clear if this threshold includes secured creditors and/or related party debts.  
• To be eligible to access the process, all employee entitlements, including superannuation (and superannuation guarantee charge) must be paid in full.
• All taxation lodgements must be up to date.
• To safeguard against abuse and/or facilitation of illegal phoenix activity:

– Related party creditors are prohibited from voting on the restructuring proposal;

– The same company and/or directors can only use the process once every seven years (TBC); and

– The SBRP will have the power to stop the plan if misconduct is identified after its commencement.   

• The rights of secure creditors will not be effected under the process.

I have set out below our initial comments on the process and as you will read, there are more questions than answers as the concept is still in its relative infancy-

• Overall, we welcome the reform as it is true that a full blown VA process is often cost prohibitive for MSMEs.
• Is the process really any quicker though? A DOCA proposal under the VA regime can be voted upon, in theory, within 15 to 25 business days by creditors. This compares to the new regime of 35 business days
• Who will be a SBRP? One would assume a Registered Liquidator would be the likely person to fill the role, in order for creditors to extract confidence and trust in the process, but it may not be.  
• What happens to debts incurred after the process begins to when the creditors cast their vote – a period of 35 business days? Under the VA regime, the administrator is personally liable for the debts that are incurred, which gives creditors some comfort that they will be paid for post-appointment goods and services. Without that comfort, it is questionable whether a supplier would continue to advance credit with the uncertainty about the success or otherwise of the proposal?
• What degree of the investigation will be conducted into the conduct of the directors and the company’s affairs generally for creditors to understand if the proposal really is a good deal? Liquidation may in fact produce an enhanced return for creditors when the ‘safe harbour’ insolvent trading relief expires on 31 December 2020 and a Liquidator can pursue a director for insolvent trading.
• Where will a struggling company obtain funding from in this environment to offer to creditors?
• What will prevent ‘the bank’ from enforcing its rights?
• How will the ATO vote in respect of the proposal? If its track record in the VA/DOCA regime is anything to go by, if the ATO is a creditor, it may well vote against any such proposal.
• Should creditors hold the power to vote for liquidation versus simply rejecting the proposal and handing back power to the directors?

Simplified liquidation process  

In addition to the streamlined restructuring model, the Federal Government has also proposed a simplified liquidation pathway proportionate with the entity’s asset base, risk profile and overall complexity.    

To be eligible, the entity must again have liabilities of less than $1M and the process will be similar to the existing liquidation pathway, with modifications around the following:

• The depth and degree of an investigation conducted by the Liquidator and reporting to ASIC;
• Reducing the scope of the unfair preference recovery process, restricting claims to only creditors that are related to the company in liquidation;
• Removing the requirement to call for meetings of creditors and ability for creditors to form a committee of inspection (although both of these are quite rare with SME liquidations nowadays);
• Streamlining the dividend declaration and distribution process;   
• Maximising the use of technology for the distribution of information to creditors, in respect of reporting voting on resolutions.

It is clear that there is a lot of water to flow under the bridge in relation to these proposed reforms, and we will keep you informed of its development as approach the end of the year.

If you have any questions about these measures, feel free to get in touch with me – I would welcome the chance to discuss them further over a coffee.