Ahead of the October budget, the treasurer has announced proposals to overhaul insolvency laws in Australia, to introduce provisions to allow struggling businesses to continue trading whilst a restructuring plan is developed. The changes, which share similarities with US Chapter 11 bankruptcy provisions, are yet to be legislated, but are proposed to commence with transitional provisions from 1 January 2021.
If legislated, the proposed overhaul of insolvency laws will replace the current temporary measures for struggling businesses, which have recently been extended and are scheduled to end on 31 December 2020. The government is also seeking to introduce a simplified liquidation process which is intended to allow faster and lower-cost liquidations. The measures are designed to deal with an expected increase in the number of insolvencies arising due to the COVID-19 pandemic and to deal with the transition from the temporary measures for distressed businesses. The government‘s temporary measures for financially distressed businesses have contributed to a 46% reduction in insolvency appointments from March to July 2020, compared to the same period last year.
The government has also flagged consultation over permanent changes to the debt threshold required to issue a creditors statutory demand or a bankruptcy notice.
Key features of proposed formal debt restructuring process
If legislated, the changes will dramatically expand safe harbour provisions by allowing distressed businesses with liabilities of less than $1 million to remain in business whilst a restructuring plan is developed and implemented. In announcing the proposals, the Treasurer has highlighted the following characteristics of the proposals (which are subject to being legislated):
- ‘Debtor in possession’ model adopted to allow insolvent businesses to remain trading and retain employees and stock whilst a restructuring ‘plan’ is developed.
- Insolvent trading restrictions removed whilst restructuring - upon seeking advice from an insolvency practitioner, an insolvent business operator will have 20 days to prepare a restructuring plan, during which time, the business may continue trading.
- New formal debt restructuring process - Upon an insolvent business operator developing a restructuring plan, creditors will have 15 days to vote on the restructuring plan, which will be binding on all unsecured creditors if 50% of creditors by value (excluding related party creditors) vote in favour of the restructuring plan. For businesses with less than $1 million in creditors, the process is likely to largely replace the current requirement for directors of insolvent companies to appoint external administrators in order to obtain a moratorium from enforcement action by creditors, and in order to put a restructuring proposal to creditors. The proposed process can also be effected in less time. The proposed laws will only require a majority of creditors by value alone to vote in favour of a proposal, whereas at present, in a voluntary administration, a majority of creditors, both in number and in value, is required to approve a deed of company arrangement proposal.
- Protection from creditors - once the company has resolved to “sign up” an insolvency practitioner to oversee a restructuring plan, the debtor will have protection from secured and unsecured creditors, and creditors will not be able to enforce personal guarantees against directors or their relatives. Creditors will also be unable to exercise ‘ipso facto’ provisions, which allow contracts to be terminated due to an insolvency event.
- Limited measures to prevent misuse - Whilst the legislation has not been released yet, it is reported that directors may only access provisions once every seven years, and the insolvency practitioner is empowered to stop the restructuring process where misconduct (which is not defined) is identified.
- Employee entitlements to be paid - employee entitlements must be paid before creditors can vote on a restructuring proposal.
- Transitional provisions - from 1 January 2021 to 31 March 2021, a business which intends to access the proposed debt restructuring process may publish a notice on the ASIC Insolvency Notices website, after which, the business will retain the protections which apply under the COVID-19 temporary relief measures (relief from creditors statutory demands, and insolvent trading liability for directors).
Lower cost liquidations - restriction of unfair preference claims
Whilst there is limited information available on this proposal, the government has proposed to introduce a faster and lower-cost liquidation process, the restriction of claw backs of unfair preference payments to creditors received prior to liquidation, along with widespread changes to the liquidation process, which is likely to reduce the amount of investigations undertaken by liquidators. The proposals include:
- restriction of circumstances where a liquidator can “clawback” an unfair preference payment to an unsecured creditor;
- reducing the requirement to report misconduct to ASIC to circumstances where there are ‘reasonable grounds to believe’ that misconduct has occurred;
- Reducing requirements to call creditor meetings, and simplification of processes for communication with creditors, accepting proofs of debt and declaration of dividends to creditors; and
- Adoption of ‘technology neutral’ communications with creditors, and voting arrangements.
Restriction of registration requirements for insolvency practitioners
Also announced are proposals to increase the number of registered insolvency practitioners and the establishment of a new classification of insolvency practitioner who will be limited to overseeing the new simplified restructuring process only. If legislated, the fees associated with registration as a registered liquidator will be waived for approximately two years until 30 June 2022, which is proposed to encourage more practitioners to register or re-register, in order to deal with the increased demand for insolvency practitioners in the time ahead.
Russell Kennedy Insights
Whilst the measures to reduce the compliance costs of conducting external administrations are welcome, the balance of the proposed changes, which the government acknowledges are the most significant in over 30 years, present a radical change for creditors and will impact upon the provision of credit in the Australian economy. The measures may encourage unsecured creditors to adopt more stringent payment terms and to require debtors to provide adequate, enforceable security if the extension of credit is part of the creditor’s terms of trade. Russell Kennedy can provide advice on the documentation of security interests, and enforcement measures, including pursuant to the Personal Property Securities Act 2009 (Cth).
If legislated, the proposals will likely adversely impact tax compliance by small business entities, and the limited measures to discourage misconduct or abuse are open to abuse by unscrupulous operators. The relaxed requirements for registration as an insolvency practitioner, along with measures which will reduce the number and extent of investigations undertaken in the course of an external administration, may result in reduced compliance with director‘s duties, and an increase in creditor-defeating measures, including illegal phoenix activity.
Like the Chapter 11 bankruptcy provisions in the United States, the measures are likely to encourage entrepreneurship and an appetite for risk by business operators. However, the reductions in costs and consequences associated with business failure are likely to increase the incidence of failures in small businesses with creditors of up to $1 million. An increased failure rate among small businesses is likely to affect banks and credit providers to these entities, and may increase the risks associated with lending to small businesses in the medium term.
Russell Kennedy will monitor the developments on these proposals, and will provide further updates. Russell Kennedy has also published other insights on legislative and regulatory changes during COVID-19, including relevant to the Mandatory Code of Conduct for Commercial Leases and information for creditors on voidable transactions. To visit our COVID-19 Alert hub, click here.
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