New insolvency reforms to support small business recovery proposed to commence from 1 January 2021

The recently announced proposed insolvency reforms draw on key features from Chapter 11 of the Bankruptcy Code in the United States and aim to help more small businesses restructure and survive the economic impact of COVID-19.

The reforms will cover around 76% of businesses subject to insolvencies today, 98% of whom have less than 20 employees.[1]

The reforms are to commence from 1 January 2021 (subject to the legislation passing), following the expiry of the temporary insolvency relief measures put in place by the Federal Government in March 2020.

The package of reforms features three key elements:

1. 1. A new formal debt restructuring process for small businesses to provide a faster and less complex mechanism for financially distressed but viable businesses to restructure their existing debts.
   2. A new, simplified liquidation pathway for small businesses to allow faster and lower-cost liquidation.
   3. Complementary measures to ensure the insolvency sector can respond effectively to increased short and long-term demand.

New debt restructuring process for small businesses

The ‘debtor in possession’ process will be available to incorporated businesses with liabilities of less than $1 million.

Under the process, it is proposed that a business can continue to trade in the ordinary course of business under the control of its owners, while a debt restructuring plan is developed over up to twenty business days (with the assistance of a small business restructuring practitioner). The plan is voted on by creditors within 15 business days (related creditors will be prohibited from voting). If more than 50% of creditors by value endorse the plan, it is approved and binds all unsecured creditors. Secured creditors are bound by the plan only to the extent of their debt which exceeds the realisable value of their security interest.

The small business restructuring practitioner will be involved in the process by:

• helping to determine if a company is eligible for the process;
• supporting the company to develop a plan and review its financial affairs;
• certifying the plan to creditors; and
• managing disbursements once the plan is in place.

To address any transitional issues as practitioners become familiar with the new process (including registering as small business restructuring practitioners), an eligible small business will be able to declare its intention to access the simplified restructuring process to its creditors. Following the declaration, the existing temporary insolvency relief (which otherwise expire at the end of December 2020) would then apply for a maximum period of three months, until the business is able to access a practitioner.

Figure 1 provides a visual overview of the proposed new restructuring process.[2]

Simplified liquidation pathway for small businesses

The simplified liquidation process will retain the general framework of the existing liquidation process, with modifications to reduce time and cost. The simplified process will be available to incorporated businesses with liabilities of less than $1 million.

Key modifications under the pathway include:

• Reduced circumstances in which a liquidator can seek to clawback an unfair preference payment from a creditor that is not related to the company.
• Only requiring the liquidator to report to ASIC (under section 533 of the Corporations Act 2001 (Cth)) on potential misconduct where there are reasonable grounds to believe that misconduct has occurred.
• Removing requirements to call creditor meetings and the ability to form committees of inspection.
• Simplifying the dividend process (where creditors receive a return proportionate to their debt) and the proof of debt process (where creditors provide information as to the debt they are owed, which is assessed and accepted or rejected by the liquidator).
• Maximising technology neutrality in voting and other communications.

The rights of secured creditors and the statutory rules as to the payment of priority creditors such as employees will not be modified.

Creditors will also be entitled to convert the liquidation back to the ‘full’ process in certain circumstances and directors will not be entitled to use the ‘simplified’ process more than once within a prescribed period (proposed at seven years).

Further measures to support the Australian insolvency system

The Government is introducing a number of permanent and temporary measures to expand the availability of insolvency practitioners to deal with an expected increase in the number of businesses seeking to restructure or liquidate including:

• Temporarily waiving fees associated with registration as a registered liquidator for approximately two years until 30 June 2022 to encourage more practitioners to enter or re-enter the market.
• Making changes/removing rigid requirements to allow for more flexibility in the registration of insolvency practitioners.
• Making the key parts of the process set out in the Corporations Act 2001 (Cth) ‘technology neutral’ so that external administrations can be carried out more efficiently.
• Establishing a new classification of insolvency practitioner whose practice will be limited to the new simplified restructuring process only.

The Federal Government also intends to engage in consultation on the appropriateness of permanently raising the minimum monetary threshold at which creditors can issue a statutory demand on a company.

Key takeaways

We welcome the new process and its aim to better serve small businesses, creditors and employees. We will watch with interest how the process develops. Given the reforms are designed to assist small businesses to quickly and efficiently develop a restructuring plan to survive, buy-in from key stakeholders such as secured and unsecured creditors, suppliers and employees will be essential. As with any business facing solvency issues, early action to seek appropriate advice is important. We await with interest the draft legislation to give effect to the new process.

Authored by:

Scott Couper, Partner
Rachel Zagorskis, Associate

[1] The Hon Frydenberg MP and The Hon Michael Sukkar MP, ‘Insolvency reforms to support small businesses recovery’ (Joint Media Release, 24 September 2020).
[2] Australian Government, Fact Sheet: Insolvency reforms to support small business (24 September 2020).