Demystifying Small Business Insolvency
In this fifth instalment of the Demystifying Insolvency series, we focus on the insolvency reforms to support small businesses.
On 24 September 2020, the Federal Government announced that from 1 January 2021, changes will come into effect which will have a significant impact on the current insolvency framework for small businesses. The changes will reduce the complexity, timing and costs for small businesses that are associated with the current insolvency framework.
The changes will be introduced in circumstances where:
The regulatory changes that the Federal Government has already implemented are due to expire on 31 December 2020 (see our COVID-19 updates in relation to Debt Recovery and Insolvency).
The economic impact of COVID-19 is likely to continue into 2021, especially for small businesses.
The current system in place imposes the same obligations on all businesses, regardless of the size or complexity of the administration.
Small businesses are often reluctant to engage insolvency practitioners early due to the costly and lengthy processes which reduces their opportunity to restructure and survive.
This bulletin explores theses recent changes and sets out the key elements from the reforms.
The reforms have introduced three key changes:
A new formal debt restructuring process for small businesses which provides financially distressed but viable businesses with a quicker and simpler mechanism to restructure debts and survive.
A new and simplified liquidation pathway for small businesses to allow faster and less costly liquidation.
Complementary measures to ensure the insolvency sector can respond effectively to the needs of small businesses in both the short and long term.
We explore each of these elements below.
A New Formal Debt Restructuring Process
Who does it apply to? Incorporated businesses with liabilities less than $1 million.
How will the new process work?
Step 1 – A financially distressed business approaches an insolvency practitioner to discuss the situation and obtain advice.
Step 2 – The board of the small business resolves to appoint the insolvency practitioner as their small business restructuring practitioner. Once a practitioner is appointed, creditors cannot take action against the business or personal guarantors.
Step 3 – Over a 20 business-day period, the business owner and practitioner work together to develop a restructuring plan for the business’ debts and prepare supporting documentation for the plan. This will include a remuneration proposal for the practitioner. During this time the business owner continues to run the business. This is set out in further detail below.
Step 4 – The practitioner sends the plan and supporting documents to creditors and certifies whether they believe the business will be able to comply with the plan, make proposed payments on time and has made proper disclosure. Creditors have 15 business days to vote on the plan and consider the proposed practitioner remuneration.
Step 5 – If more than 50% of creditors by value endorse the plan, it is approved and binds unsecured creditors and secured creditors.
Step 6 – Once a plan is approved, the business continues to trade, and the practitioner makes distributions to the creditors in accordance with the plan. If the plan is not approved by creditors, the process ends, and the business may consider an alternative insolvency process.
Debtor in Possession Model – The reforms allow all small businesses to keep trading under the control of the actual owners while a debt restructuring plan is voted on by creditors. Businesses can continue to trade in the ordinary course of business during this time while the business owner works with an insolvency practitioner.
Role of the insolvency practitioner – The practitioner will work side by side with the business owner to develop a restructuring plan, determine if the small business is eligible for the new process, assist the business in developing a plan and reviewing its financial affairs, seek approval from creditors in relation to a restructuring plan and manage costs once a plan is in place.
Protection for Creditors
The insolvency practitioner remains independent.
Creditors vote on the plan.
Key creditor rights (e.g. payment of distribution in priority) are preserved.
Related creditor voting on a plan is prohibited.
Simplified Liquidation Pathway
The unfortunate reality for some small businesses is that plans will not be approved by creditors and the business will need to consider whether or not to place the company into liquidation. Currently, the costs of liquidation can be extensive and may consume most or all the remaining value of the company.
The reforms have attempted to provide a simplified liquidation procedure which aims to cut costs and streamline the process. These key changes include:
A reduction in investigative requirements of liquidators.
Removal of requirements to call creditor meetings.
Requirement to only report to ASIC on potential misconduct.
Simplify the payment of dividend and proof of debt processes.
Utilising technology in voting and other communications
This option is also only open to incorporated businesses with liabilities of less than $1 million
Further Measures to Support the Insolvency Sector
To assist in implementing these reforms as at 1 January 2021, the Federal Government will introduce the following measures:
The establishment of a new classification of insolvency practitioners who deal solely with the simplified restructure process set out above.
Waiving registration fees for liquidators for approximately 2 years until 30 June 2022.
Removal of rigid requirements for the registration of insolvency practitioners.
Embracing technology to allow external administrations to be carried out more efficiently.
Provision of temporary relief for eligible businesses who wish to access the simplified restructure process. The business can announce its intention to access the simplified restructure process which will provide it with temporary insolvency relief for up to 3 months until the process commences.
The introduction of these changes and reforms by the Federal Government have been implemented to ensure that small businesses survive the COVID-19 pandemic. In light of the uncertainty surrounding how long the pandemic will last, it remains to be seen whether these reforms will be successful in helping small businesses survive in the current economy. Over the next few months, small businesses and insolvency practitioners should endeavour to familiarise themselves with the reforms to ensure they are well equipped to deal with any issues that may arise.
Note: This publication has been prepared from the initial information provided by the Federal Government of Australia as at the date of publication and may be subject to change following the passing legislation to give effect to the Small Business Insolvency regime.