New insolvency law reforms for SMEs

Monday, 01 February 2021

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Zilla Efrat

    An overhaul of Australia’s insolvency framework is a lifeline for small businesses struggling to survive the economic impact of COVID-19. Here's what directors need to know.

    The most significant reforms in insolvency law in almost 30 years kicked in on 1 January — the day after the temporary safe harbour relief (aimed at supporting directors during COVID-19) ended. While the changes have been generally welcomed, a host of concerns and uncertainties exist. The reforms introduce a single, simpler, faster insolvency process for small businesses and draw on some “debtor in possession” aspects of the US Chapter 11 bankruptcy protection model. They should also reduce situations where directors are “too broke to go broke” because of the high costs of liquidation.

    The government says the reforms will cover about 76 per cent of businesses subject to insolvencies today, 98 per cent of which have fewer than 20 employees. They are limited to businesses with liabilities of less than $1m, although Paul Apáthy, a partner at Herbert Smith Freehills, says it’s not yet clear how this is to be calculated.

    For the first time, they give smaller businesses an additional option when it comes to insolvency or administration. Treasurer Josh Frydenberg has described the reforms as “the most significant changes to Australia’s insolvency framework in 30 years”, which will “help more small businesses restructure and survive the economic impact of COVID-19”.

    KPMG restructuring services partner Gayle Dickerson believes the reforms could be just a toe in the water for insolvency reform. She sees potential for the reforms to be expanded to larger and institutional corporates and says it’s possible the threshold will creep up. “This model aligns more closely to overseas jurisdictions such as the US, Singapore and recent UK changes,” says Dickerson. “The UK has moved very quickly to implement new restructuring reforms, which have not been limited to small business. Virgin Atlantic was one of the first companies to take advantage of this.”

    Dickerson says directors of bigger companies should be developing their awareness and considering how they will respond if companies they deal with start using the new process.

    Potential predators

    As part of the regime, eligible small businesses will be able to approach a new broader class of small business restructuring practitioners (SBRPs) for advice. SBRPs will help determine if a small business is eligible for the process, help the company develop a restructuring plan, certify the plan to creditors and manage disbursements once the plan is in place.

    John Winter, CEO of the Australian Restructuring Insolvency & Turnaround Association (ARITA) worries this will allow lower-qualified advisers to run the insolvency processes.

    “For the past decade, successive governments have required higher levels of training and standards of insolvency practitioners — and we’ve met and exceeded those standards,” says Winter.

    The AICD considers it crucial that a broader range of appropriately qualified persons be available to help companies and their directors restructure. This will increase access to the proposed regime given the large number of small businesses that may avail themselves of this process, relative to the number of liquidators. Ensuring SBRPs satisfy certain criteria (such as being a member of a reputable professional association) will help ensure “dodgy operators” aren’t able to take on the role.

    Who’s in control and who’s protected

    The changes allow distressed companies to remain in business while the restructuring plan is developed over a period of 20 business days. During that time, companies will be permitted to trade in the ordinary course of their business.

    However, as Craig Shepard, a partner at advisory and investment firm KordaMentha, notes: “The objective states that control of the company remains with the directors, but a lot of the draft legislation contradicts this, such as the small business restructuring practitioner having to consent to certain transactions and having the ability to impose conditions on transactions.”

    He says there’s also uncertainty as to what protections are available for creditors who continue to trade with a company while the plan is being developed (see breakout). “These creditors are not currently provable in any subsequent liquidation and they don’t have the protection of the practitioner being liable for them, like they do in a voluntary administration,” he says. “Another question is whether secured creditors will be prevented from freezing bank accounts, which would stifle a company’s ability to continue to trade through offset provisions. Also, there are no details about the requirements of the restructuring plan or how the plan will be enforced.”

    According to the CreditorWatch Business Risk Review for September 2020, Victoria had the highest number of businesses entering into administration in September, compared to other states. Victoria’s number rose 23.8 per cent, compared to 11 per cent for the whole of Australia.

    Guidance for directors

    • Get advice early so there’s a better chance that there’s something left to save in your business.
    • Insolvency laws are complex. Don’t think you can navigate them on your own.
    • Ensure you meet the eligibility criteria for “safe harbour” from 1 January; don’t assume you will automatically be eligible.
    • Ensure you hold regular minuted board meetings.
    • Ensure you receive up-to-date and accurate financial information, including cashflow forecasts.
    • Ensure all off-balance-sheet payment plans are included in the adjusted indebtedness and payment forecasts.
    • Test assumptions and how different scenarios will respond to an evolving landscape.
    • Keep on top of your market disclosure requirements.
    • Review any opportunities to raise capital, recut agreements (such as rent) or reduce employee numbers.
    • Engage openly with credit providers so they can become part of the solution.
    • Avoid overly complicated plans. Simple plans will be best understood and are most likely to garner support.
    • Ensure the business has sufficient post-restructure liquidity to thrive.

    Other uncertainties

    Shepard says the new regime envisions greater use of technology. Voting, submissions of proof of debt and communications will be done online. While welcome, he says the technology isn’t widely used or developed as the Corporations Act 2001 (Cth) hasn’t allowed it until recently. “Available industry software generally requires a unique code to be issued to each creditor to access the portal, which is currently mailed,” he says. “The current industry software doesn’t have online voting because it is not permitted under the Corporations Act, although we understand at least one of them is close to releasing a version with online voting. And, not all practitioners use the industry software.”

    Clint Joseph, the WA lead of KPMG’s Working Capital Advisory Practice, says companies will need to continue to comply with their Australian Taxation Office and employee obligations to participate in the new process. But he notes that the small businesses in distress are often not up to date in these areas and may not be able to participate. He adds that it isn’t clear whether the restructuring period ends when the restructure plan is approved (in which case, a period of plan administration might follow) or whether it ends when the plan requirements are fulfilled. “The two periods need to be clearly established,” says Joseph. “It’s also not clear what happens when the restructuring period ends without a restructuring plan being approved.”

    Creditors’ view

    Without the right settings applied to the government’s insolvency reforms, creditors worry that their ability to support viable businesses will be reduced when these start to show signs of potential insolvency.

    Nick Pilavidis GAICD, CEO of the Australian Institute of Credit Management, is also concerned that despite good intentions, the details of the new insolvency regime may have adverse consequences for creditors and the companies they support.

    So is Grant Morris, national credit manager at Southern Steel Group, the largest privately owned steel distributor in Australia. He is particularly concerned about the lack of details on how the new insolvency regime for small businesses will treat preference payments.

    The government announced that the regime would reduce circumstances in which a liquidator can seek to clawback an unfair preference payment from a creditor that is not related to the company. But the legislation has one line noting that the regulations will determine the circumstances where preference claims will be pursued.

    “The appointment of a restructuring adviser is deemed to be an automatic act of insolvency which then puts us as creditors on immediate notice that any assistance provided, and payments subsequently received, would be attempted to be clawed back as ‘a preference’ by a liquidator should the restructuring fail,” says Morris. “Many strong businesses like ours are in a position to assist with a temporary extension of payment terms or repayment arrangements, but again face the prospect of preference claims should the customer not trade out. This reduces our ability to support the businesses that most need it as we need to mitigate against the risk of preference claims, which may not be made for three years. It isn’t fair that businesses like ours that do everything we can to support our customers are penalised for accepting repayment arrangements, when other businesses don’t provide support through repayment arrangements or generous payment terms.”

    Pilavidis and Morris are uneasy about the new broader class of SBRPs. “Creditors need to have confidence in the process,” says Pilavidis. “If the adviser isn’t of a high standard and creditors aren’t comfortable that the adviser will be looking out for their interests, they will naturally have a bit of hesitation and are thus less likely to support a restructuring plan.”

    “Only a qualified insolvency practitioner should be the restructuring adviser to provide the confidence to suppliers or financiers to support any reasonable proposal, adds Morris.

    “Unlike a voluntary administration, advisers are not responsible for any debts incurred during their appointment, and the confidence of suppliers or financiers is therefore paramount. The risk is that they support and provide further credit only to see it diminish in the proposal, which may see a return to creditors of just a few cents in the dollar — this includes the exposure made during the supporting period.”

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