Insolvency Law Reform Commentary

INSOLVENCY LAW REFORM COMMENTARY

 

1.0 INTRODUCTION

The Federal Government has recently proposed a raft of changes to insolvency legislation that will take effect from 1 January 2021 in order to better serve Australian small businesses. The proposed changes mark the biggest shift in the Australian insolvency framework since the advent of the voluntary administration regime in 1993. It is proposed that a small business debt restructuring process and a streamlined liquidation process will be made available to Australian small businesses with liabilities of less than $1 million.

 

The measures have been proposed with the intention of making insolvency services more accessible to small businesses and to reduce the time businesses spend in external administration.

 

Whilst O’Brien Palmer broadly welcomes the proposed changes and is cautiously optimistic that they will have a positive impact on stakeholders of small businesses, there are a number of elements of the proposed changes that may be cause for concern.

2.0 SMALL BUSINESS DEBT RESTRUCTURING PROCESS

The small business debt restructuring process will constitute a new, formal insolvency appointment.

2.1 THE SMALL BUSINESS RESTRUCTURING PROFESSIONAL (“SBRP”)

The proposal adopts a ‘debtor in possession’ model where control of the company remains with the director. Following a resolution of the board, a SBRP of their choosing will be appointed to the Company. The role of the SBRP will be to:

(i)     help determine if a company is eligible to appoint a SBRP;

(ii)     support the company to develop a plan and review its financial affairs;

(iii)     certify the plan to creditors; and

(iv)     manage the distribution of funds under the plan, called the debt agreement, if it is approved by creditors.

The Australian Securities and Investments Commission (“ASIC”) has recently clarified that only a Registered Liquidator may consent to act as a SBRP. We applaud this decision from ASIC as it recognizes the critical need for suitably qualified insolvency professionals to bring their expertise in overseeing the process.

In its present draft form, the legislation does not clarify whether practitioners will assume personal liability for debts incurred during the restructuring process, however we consider it unlikely that this will be the case. It is broadly accepted that one of the principle reasons that the voluntary administration process works is that the practitioner is personally liable for debts incurred during the administration.

This provides assurance to landlords, suppliers and other creditors that debts incurred during the administration will be paid. It is unclear from a reading of the draft legislation who will assume liability for debts incurred during the process, or, in fact, whether debts incurred during the process will be paid out under the debt agreement or in the ordinary course of business. These are both key issues that need to be addressed prior to the process coming into effect, as it will fundamentally impact the ongoing relationship with suppliers and creditors during the debt restructuring process.

2.2 THE PROCESS

Following the resolution of the Board to appoint a SBRP, a notice will be issued to creditors outlining how information relevant to the process can be accessed. A restructuring plan is then developed by the director(s) with the assistance of the SBRP. The SBRP will then consider and certify the plan based on his or her assessment of the financial position of the company. Within 20 days of the SBRP being engaged, the plan, accompanying information and certification will be issued to creditors. Within 15 days of the plan being issued, creditors will vote on whether to accept the plan. In the event that a majority of creditors vote in favour of the plan, the plan commences and the SBRP is appointed to oversee its implementation. Alternatively, if a majority of creditors vote against the plan, the process ends and the directors may choose to enter into another insolvency process.

2.3 PROPOSED SAFEGUARDS & THE IMPACT ON CREDITORS

It is essential that there are adequate safeguards in place for the new process, otherwise it runs the risk of becoming a haven for illegal phoenix activity. In order to allay concerns surrounding inappropriate use or flagrant abuse of the new process, ASIC has proposed to implement the following safeguards:

(i)     A prohibition on related party creditors voting on the restructuring plan.

(ii)     A bar on the same company or directors using the process more than once within a prescribed period (proposed at 7 years).

(iii)     The provision of a power for the practitioner to stop the process where misconduct is identified.

Furthermore, creditors that will be impacted most by the proposed debt restructuring process. In order to protect their interests, ASIC has proposed that the following measures be put into place:

(i)     The SBRP administering the process must remain independent. The practitioner will have important obligations they must fulfil on behalf of creditors (such as certifying the plan).

(ii)     Certain creditor’s rights will be preserved. For example, similar types of debts are treated consistently as they would in other external administrations.

(iii)     Creditors retain the right to vote on the debtor company’s proposed plan and the plan must achieve the requisite majority to be binding.

Whilst we support the process generally and the safeguards proposed by ASIC, we reiterate the sentiments of the Australian Restructuring Insolvency & Turnaround Association (“ARITA”), in that there are a number of issues that need to be addressed and further safeguards put in place, summarised as follows:

(i)     One of the main reasons for the introduction of the process is to reduce the amount of time a company spends in external administration. However, the proposed timeframe of 35 days is presently longer than that of a voluntary administration.

(ii)     The work in certifying a plan may be just as substantial as that in a voluntary administration. Care needs to be taken as to what this obligation will entail so as to keep costs to a minimum in order to ensure accessibility to small businesses preserve funds for the benefit of creditors and.

(iii)     In the event the plan fails, we query whether a company should be able to appoint a voluntary administrator, as it would appear highly unlikely a Deed of Company Arrangement would be successful if a debt restructuring plan previously failed.

(iv)     The manner in which the process will affect the rights of secured creditors needs to be further clarified, as a reading of the draft legislation raises a number of queries as to whether their rights are adequately protected.

(v)     Creditors be given the opportunity to resolve that the company be wound up at the meeting to consider the restructuring plan.

(vi)     Measures put in place to ensure restructuring plans do not go on for too long or directors commit to payment levels beyond that which is feasible.

(vii)     Restructuring plans automatically convert into a liquidation after a certain period of time, currently suggested to be six (6) months.

The proposed safeguards are a starting point, but there remains a number of issues that need to be addressed prior to the small business debt restructuring process being enshrined into the legislature.

2.4 TRANSITIONAL MEASURES

As a transitional measure, from 1 January 2021, eligible incorporated small businesses will be able to declare their intention to engage with the process to its creditors, including through ASIC’s published notices website. Following a declaration being made, the company will be afforded the existing temporary insolvency relief in respect of insolvent trading and responding to statutory demands for three (3) months, until such a time as they are able to formally begin the process. This transitional measure will apply to 31 March 2021.

Whilst we recognise the intent of this proposed transitional measure, we agree with the position of ARITA that, in practice, the transitional measures are problematic as creditors may be hesitant to extend credit to a company that has flagged that it is in financial distress.

3.0 STREAMLINED LIQUIDATION PROCESS

The legislative framework for liquidation in Australia, including mandated investigations to be carried out by a liquidator, is suited to large corporate failures. However, most liquidations in Australia relate to small businesses, with 78% of insolvencies having creditors of less than $1 million.

Under the proposed streamlined liquidation process, a liquidator’s regulatory obligations will be simplified, so that they are commensurate to the asset base, complexity and risk profile of eligible small businesses. This will free up value for creditors and employees, and allow assets to be quickly reallocated elsewhere in the economy, supporting productivity and growth.

The simplified liquidation process will retain the general framework of the existing liquidation process, with the following proposed modifications to reduce time and cost:

(i)     Reduced circumstances in which a liquidator can seek to clawback an unfair preference payment from a creditor that is not related to the company.

(ii)     Only requiring the liquidator to report on potential misconduct where there are reasonable grounds to believe that misconduct has occurred.

(iii)     Removing requirements to call creditor meetings and the ability to form committees of inspection.

(iv)     Simplifying the process for dividends and proofs of debt.

(v)     Maximising technology neutrality in voting and other communications.

It is worth noting that there is presently no requirement to call a meeting of creditors in a liquidation and committees of inspection are rarely formed in the liquidation of small businesses. From the perspective of creditors, reducing the circumstances in which a liquidator can seek to clawback an unfair preference payment will have the effect of reducing the pool of funds available for distribution. In the COVID-19 environment, where many administrations will be assetless, this reduces the possibility of a return being available to creditors.

We welcome the Federal Governments draft measures for both creditors and liquidators to move a streamlined liquidation to a full liquidation in certain circumstances including. However, we support the following further measures as proposed by ARITA:

(i)     That the streamlined liquidation process be made available only to those companies with amounts of less than $250,000 owed to unrelated creditors. As it stands, 78% of liquidations have debts of less than $1 million. That quantum of debt does not appear to be not appear to be an appropriate benchmark for the lower level of scrutiny that the streamlined liquidation process will inherently afford.

(ii)     That a liquidator only be obliged to report misconduct to ASIC where the liquidator has become aware of misconduct.

(iii)     Creditors’ rights to request meetings be removed.

(iv)     An option available to liquidators recommending to creditors that a streamlined liquidation be moved to a full liquidation. We consider that such an amendment.

We believe that these further amendments will ensure that the streamlined liquidation process will meet its intended targets of reducing the time spent by the Company in external administration and reducing the costs incurred by the liquidator, thereby increasing the pool of funds available to creditors, whilst at the same time affording appropriate safeguards for creditors.

4.0 FURTHER INFORMATION

To date, the Federal Government has only released exposure drafts for amendments to be made to the Corporations Act 2001. Accordingly, we await the Federal Government’s release of the exposure draft for the amendments to be made to both the Insolvency Practice Rules (Corporations) 2016, Insolvency Practice Schedule (Corporations) 2016 and Corporations Regulations 2001 for further particulars in relation to the small business restructuring and streamlined liquidation processes.

5.0 CONCLUSION:

Whilst we broadly welcome the insolvency reforms proposed by ASIC, there remain a number of issues that need to be addressed prior to the small business restructuring process and streamlined liquidation being rolled out on 1 January 2021. In saying that, we remain cautiously optimistic that with the right safeguards, the proposed reform will have a positive impact on directors, employees and creditors of small businesses in financial distress.

In the event you or your client requires any further information in relation to the proposed new insolvency processes, or any of the existing mechanisms available to directors of companies in financial distress, we invite you contact our office.

O’Brien Palmer