Everything You Need to Know About Proposed Insolvency Law Changes

On 24 September 2020, the Australian Federal Government announced a number of proposed major changes to insolvency law in support of small business impacted by COVID-19.

This announcement comes in response to JobKeeper cuts, COVID-19 insolvency relief expiring at the end of this year and recognition that ordinary insolvency processes are not generally appropriate for small businesses.

In this article, we look at what these reforms will mean for you and your business if the enabling legislation is passed.

How will the insolvency law changes work?

The proposal draws on America’s Chapter 11 bankruptcy laws which provides owners control over their business while they restructure.

More specifically, it includes a new formal debt restructuring process, a simplified liquidation process and further changes which ensure the restructuring and insolvency sector can respond to the measures and needs of small businesses during these challenging times.

They will apply to incorporated businesses with liabilities of less than $1 million facing financial distress, which currently accounts for 76 per cent of businesses subject to insolvencies today.

The changes are expected to commence 1 January 2021 for a prescribed period of 7 years.

The new debt restructuring process

At the heart of the reforms is the issue of who controls an insolvent company.

Under the proposed changes, small business will not have to hand over control to creditors via an external administrator as soon as their declare insolvency. Instead, directors will appoint a Small Business Restructuring Practitioner (or ‘SBRP’) who will work collaboratively with the business during a 20-business day period to develop a restructuring plan.

A SBRP will advise on:

eligibility of the small businesses to access Small Business Restructuring;
developing restructuring plans with respect to their financial affairs;
certifying the plan to creditors; and
managing disbursements once the restructuring plan is in place.

Businesses seeking to trade outside the ordinary course of business will also need prior approval from an SBRP.

A notice will be provided to creditors which will mean during this period, unsecured and some secured creditors will be restricted from taking action against the company and personal guarantees will not be able to be enforced.

Creditors will then have 15 days to vote on a plan which will need to be approved by the majority. Notably, any employee entitlements will need to be paid before the creditors can vote on the plan.

Unlike voluntary administrators, a SBRP will not take on personal liability for company debts due to the control directors retain over the business.

The proposal also includes a number of additional safeguards which empower SBRP’s to stop the process where misconduct has been identified, prevent creditors related to the company from voting on the plan and limit access to restructuring reforms to only once during the proposed period.

The new liquidation process

For liquidation, the reforms will simplify liquidators’ regulatory obligations to reflect the size and scale of small businesses, those with liabilities of less than $1 million.

Various modifications to the existing liquidation process have been introduced which reduce time and cost. This includes:

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) 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.

Further measures

The proposal additionally expands the availability of insolvency practitioners to deal with the expected increase in the need to restructure or liquidate.

These changes include:

Temporarily waiving fees associated with registration as a registered liquidator for approximately two years until 30 June 2022.
Making changes to allow for more flexibility in the registration of insolvency practitioners by removing requirements which are overly rigid.
Corporations Act ‘technology neutral’ so that external administrations can be carried out more efficiently and practitioners can focus on the substantive requirements of their role.
Providing temporary relief for eligible companies waiting to access the new restructuring process.
Establishing a new classification of insolvency practitioner whose practice will be limited to SBRP roles.

Safeguards will also be in place for new liquidation process which allow creditors to convert back to a ‘full’ liquidation process, require directors to declare that the company is eligible and not engaged in illegal phoenix activity and prevent directors from using the process more than once in the 7-year period.

In summary

If successful, the proposal will introduce the most substantial changes to Australian insolvency law in around 30 years having with significant implications for debtors, creditors and insolvency practitioners.

For the full list of reforms please click here.