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Morrison Government Announces Insolvency Law Reform Measures as the Winding Back of Temporary COVID-19 Relief Looms

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By Alicia Hill, Principal and Nicholas Mason, Law Clerk

On 24 September 2020 the Morrison Government announced significant reforms to Australia’s insolvency framework. The reforms are targeted at the small business sector and provide for a new debt restructuring process for businesses with liabilities of less than $1 million. The changes are expected to commence on 1 January 2021 and anticipate a rise in the volume of insolvencies within the small business sector as various COVID-19 government support measures are wound back.

Elements of the Reform Package

The impending changes to the Australian insolvency framework can be distilled into three core elements:

  • An altered debt restructuring process: a new “debtor in possession” model for businesses with liabilities of less than $1 million is intended to be simpler, more flexible and more efficient than the voluntary administration alternative.
  • Streamlined liquidation pathway: a new streamlined pathway will be available to incorporated businesses with liabilities of less than $1 million. This reform is intended to reduce the time and cost associated with the liquidation process and promote better returns for creditors.
  • A suite of complimentary measures designed to ensure that the insolvency sector can respond effectively to the expected increase in insolvencies resulting from the economic fallout of the COVID-19 pandemic.

Debt Restructuring Process

The reforms introduce a new “debtor-in-possession” restructuring process available to incorporated businesses with liabilities of less than $1 million. The new debtor in possession models means that the directors of the company will work with a small business restructuring practitioner (SBRP) to develop and implement a debt restructuring plan.

While this plan is developed, directors retain control of the company, a moratorium prevents creditor enforcement and the company is permitted to continue trading in the ordinary course of business. The plan is then voted on by creditors and will be approved if more than 50% of the company’s creditors (by value) vote in favour.

If the plan is approved, the business continues and the SBRP administers the plan by making distribution to creditors according to the terms of the plan. If voted down, the process ends, and the company owners may opt to go into voluntary administration or use the simplified liquidation pathway outlined below.

Simplified Liquidation Pathway for Small Businesses

In a fact sheet developed by the Australian Government following the announcement of the reforms, it was acknowledged that current state of regulation surrounding liquidation is generally better suited to large, complex company failures. The framing of insolvency law in this manner belies the fact that most liquidations in Australia relate to small business, where the cost of liquidation can consume all or most of the remaining value of a company, leaving little value for creditors.

The new liquidation pathway is tailored to small business. It modifies investigation, creditor meeting and reporting requirements which apply to the current liquidation process to reduce burdens of time and cost. The key modifications 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 on potential misconduct where there are reasonable grounds to believe misconduct has occurred;
  • Removing requirements to call creditor meetings and the ability to form committees of inspection;
  • Simplified dividend processes and proof of debt process;
  • Maximising technology neutrality in voting and other communications.

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

Complimentary Measures to Support the Insolvency System

On 22 March 2020, the Federal Government announced temporary relief measures for financially distressed companies. This included an increased threshold at which creditors could issue a statutory demand and relief for directors from personal liability for trading while insolvent.

As this relief ends on 31 December 2020, Government is introducing a number of permanent and temporary measures in response to the expected number of businesses seeking to restructure or liquidate:

  • Temporarily waiving fees associated with registration as a liquidator until 30 June 2022 to reduce barriers to entry for insolvency practitioners;
  • Removing red-tape in relation to the registration of insolvency practitioners;
  • Making key parts of the process set out in the Corporations Act 2001 (Cth) technology neutral to allow administrators to focus on the substantive requirements of their role;
  • Introducing a new classification of insolvency practitioner whose practice will be limited to the new debt restructuring process only.

The Response from Practitioners

The proposed changes outlined above have been largely welcomed by bodies representing insolvency practitioners in Australia. The Turnaround Management Association identified a lack of clarity over the definition of a SBRP as a potential area of concern. However, a draft of the Corporations Amendment (Corporate Insolvency Reforms) Bill 2020 specifies that only a registered liquidator may consent to act as a SBRP.

This recognition was welcomed by the Australian Restructuring Insolvency & Turnaround Association (ARITA) who acknowledged the critical expertise only registered liquidators can bring in a distressed debt situation.

If you have any questions about the changes discussed in this article or insolvency matters more generally, please contact Alicia Hill on 8540-0200 or alicia.hill@mst.com.au