TGIF 25 September 2020: Federal Government announces extensive SME business insolvency reform

This week’s TGIF discusses the key elements of the Federal Government’s recently announced reforms to insolvency laws for businesses with liabilities below $1 million.

Key takeaways 

• The reforms introduce a debtor-in-possession reorganisation model for businesses with liabilities under $1 million, which means that directors stay in control for an initial period of 20 days.
  
  
• During that 20 day window, the business can continue trading while the directors formulate a debt reorganisation plan.
  
  
• Draft laws to be put before Parliament within weeks with a view to regime commencing 1 January 2021.

Proposed reforms 

In its 2015 report on Business Set-up, Transfer and Closure, the Productivity Commission commented on the perceived lack of restructuring culture in the Australian corporate world. However, while the US Chapter 11 model was seen as more restructuring friendly, the Commission recommended against its wholesale adoption in Australia. 

Five years later, facing the prospect of a wave of corporate insolvencies, the Government has turned to Chapter 11 as a basis for reforms aimed at giving distressed businesses a better chance to avoid liquidation.

The reforms are based on the Chapter 11 debtor-in-possession model. Companies with liabilities of less than $1 million will be protected from enforcement by unsecured and ‘some secured’ creditors for 20 days. During that period, the directors and any appointed small business restructuring practitioner can develop a reorganisation plan. 

Creditors will then have 15 days to vote on this plan. Where a bare majority of creditors by value vote in favour of the plan, the business will continue trading under the now binding terms of the reorganisation plan. If creditors vote against adopting the plan, the business will enter administration. 

Before it can hold a vote on the reorganisation plan, the company will need to pay in full any employee entitlements due and payable.

In addition, the Government has flagged: 

• implementing additional anti-phoenixing measures concerning related-party creditors voting on the reorganisation plan; and
  
  
• the introduction of a ‘streamlined liquidation process’ which would waive the fees associated with appointing liquidators and decrease investigative and reporting requirements for businesses with liabilities of less than $1 million.

Legislative timeline

The Treasurer aims to have the reforms before Parliament within weeks with a view to having the debtor-in-possession reform model commence on 1 January 2021. 

This would coincide with the lifting of the temporary moratorium on statutory claims below $20,000 and the safe harbour for directors trading while insolvent.

Comment

As ever, the devil will be in the detail. Many crucial aspects of the proposed reforms are yet to be presented to the public. Relevantly:

1. The treatment of secured creditors, or classes of secured creditors, has not yet been explained.
   
   
2. The Chapter 11 model depends on extensive judicial supervision. The same is unlikely to be true for the Australian version. The reforms will instead introduce small business restructuring practitioners whose role will be to help manage the reorganisation. The challenge will be to strike an appropriate balance between efficiency, flexibility and adequate oversight.
   
   
3. As part of the briefing for the reforms the Treasurer notes that businesses with liabilities under $1 million account for 76% of the businesses currently subject to insolvencies. While the move to a two-tiered system of insolvency may provide welcome flexibility, the pool of businesses the reforms will apply to will still be diverse.
   
   It may be that the reforms are more effective for businesses with no consolidated or majority creditors, businesses with a casual workforce and those offering services or goods that can be realised as working capital immediately.
   
   
4. External administrators play an important investigatory role. If that role is limited under the reforms, creditors and shareholders may take it upon themselves to bring proceedings to inspect books and records and consider possible claims.