Treasurer Josh Frydenberg has announced dramatic reforms to Australia's insolvency regime.
The reforms will significantly alter the insolvency framework for small businesses, by allowing insolvent companies with liabilities of under $1 million to remain in control of their business rather than immediately being placed into the hands of administrators. The proposal adopts a similar model to the US Chapter 11 regime, which allows companies to restructure their debts while remaining in control of their business. No reform has been announced for companies with liabilities over $1million.
The reforms provide a roadmap to manage the exit from the moratoriums on insolvency and bankruptcy enforcement, which were recently extended1 to 31 December 2020. The extension of the moratoriums, without more however, did not actively promote or assist restructuring activity and potentially created the conditions for entities to slip further into distress without any real impetus to arrest the decline.2
The reforms provide for two new formal processes.
New formal restructuring process for small businesses
The following regime is proposed to apply to eligible companies in distress:
- Companies will have 20 days to establish a 'Restructuring Plan' with an appropriate small business restructuring practitioner, which establishes that entity's plan for restructuring their debt and continuing to trade.
- Creditors must vote on the restructuring plan within 15 days.
- If more than 50% of creditors by value endorse the plan, it will be approved and bind all unsecured creditors. Creditors will vote as one class. Secured creditors are bound only to the extent their debt exceeds the value of their security interest.
The new process draws on key features of the US Chapter 11 bankruptcy process, by allowing businesses to continue to trade under the control of their owners, while a debt restructuring plan is prepared and voted on. Under the current regime, company owners immediately lose control of their business once administrators are appointed.
The regime will introduce the role of a 'small business restructuring practitioner' to determine if a company is eligible for the regime, assist a company review its financial affairs and certify the plan to creditors. Unlike administration, a small business restructuring practitioner will not be required to take on personal liability for a company to manage its day to day affairs.
New simplified liquidation pathway for small businesses
A new liquidation regime will also apply to companies with liabilities of less than $1 million. This simplified liquidation process is intended to retain the existing framework, but with modification to reduce time, cost and regulatory obligations. It includes the following changes:
- Reduced circumstances in which a liquidator can clawback an unfair preference payment from a creditor.
- Liquidators will only be required to report to ASIC on potential misconduct of directors where there are reasonable grounds to believe the misconduct has occurred.
- The requiri>ents to call creditors meetings and form committees of inspection may be removed.
- The process involved to lodge a proof of debt and distribute dividends will be simplified.
- The use of technology in voting and other communications between liquidators and creditors will be maximised.
The statutory rules regarding payment of priority creditors (such as employees) will not be affected.
A cultural shift
These new processes give companies (and their directors) greater control of their business when facing financial distress than has ever previously existed in Australia's insolvency regime. This is a dramatic departure from Australia's cultural and political approach to insolvency.
Until now, Australia's insolvency regime has been historically biased toward debtor (and director) culpability and creditor control. This largely reflects the cultural and business expectation that 'someone pays'. This is what is often referred to as the 'creditor-in-possession' approach, by which creditors' interests are protected.
Although these reforms did not result from any formal consultation process, the Federal Government's exit strategy from the moratoriums has been the subject of considerable public debate and private submissions over the past few months. Those submissions tended to side on either the creditor or debtor-in-possession models.
For example, the Australian Small Business and Family Enterprise Ombudsman recommended a suite of tools with the stated purpose of protecting small business owners. A key aim was to minimise the cost of any external administration and to allow the business owner to remain involved in the management of the business. Similarly, the Australian Institute of Company Directors called for the introduction of a formal debtor in possession process, modelled on the US chapter 11 approach.3
The announced reforms appear to provide a hybrid debtor controlled regime for smaller businesses, but leave intact Australia's present insolvency regime for larger businesses.
Other proposed changes
As part of the suite of proposed reforms, the Federal Government has also proposed to introduce a number of other permanent and temporary reforms designed to encourage more insolvency practitioners to assist with the anticipated increase of insolvency related matters in the coming months. These include:
- establishing a new classification of insolvency practitioners whose practice will be limited to the new regime;
- allowing companies to declare their intention to access the restructuring process, and then benefit from the moratorium on insolvent trading for up to three months until the process commences; and
- creating more flexibility in the registration of insolvency practitioners.
The moratoriums on insolvency and bankruptcy enforcement, although welcomed and necessary, potentially had the perverse effect of preventing real restructuring activity and discouraging distressed entities to take restructuring advice, and act on that advice.
Regardless of anyone's view on the reforms, the early announcement is welcome and ought to provide a real impetus to eligible companies to seek advice and restructure their affairs as the safeguards come to an end.
The reforms are expected to take effect from 1 January 2021. Details of any legislative changes are not yet available.
1 The moratoriums were first announced in March 2020 and initially applied until 25 September 2020. On 7 September 2020, the moratoriums were extended from 25 September 2020 to 31 December 2020.
2 In addition to the position of ARITA and AICM, the Law Council of Australia has warned against any further extension.
3 The reforms also appears to have various similarities to the recently introduced UK Restructuring Plan model, although without any court involvement.
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