Australia's new "debtor in possession" corporate insolvency regime for small business

Regime to commence from 1 January 2021

In brief

On 24 September 2020, the Treasurer announced that the Australian Government would introduce new legislation to give effect to:

  • two new insolvency regimes for companies with liabilities of less than A$1m:
    • a "debtor in possession" restructuring plan process (RP Process); and
    • a simplified liquidation process (Simplified Liquidation);
  • measures to increase the availability of insolvency practitioners to deal with the expected increased number of small businesses seeking to restructure or liquidate due to the economic consequences of COVID-19; and
  • transitional measures to provide temporary insolvency protections for eligible small businesses that cannot find an Insolvency Practitioner or Small Business Restructuring Practitioner to undertake the RP Process during the period to 31 March 2021.

The reforms are earmarked to commence on 1 January 2021, following the expiry of the Government's temporary relief for financially distressed companies on 31 December 2020 - discussed here. However, given the current timing on the removal of JobKeeper support, and transitional measures referred to above, a gradual take up of the RP Process is likely through to 31 March 2021.

The legislation is still to be released, and so the details of the new regime are not clear at this stage. However on 24 September 2020 the Treasurer did release a Media Release and Fact Sheet.

Restructuring Plan Process (RP Process)

RP Process

The new RP Process is as follows:

  • The directors of a distressed Company pass a resolution to retain a "small business restructuring practitioner" (SBR Practitioner) and once appointed, the SBR Practitioner confirms whether the Company is eligible to access the RP Process.
  • During the RP Process:
    • there will be a moratorium preventing creditors enforcing unsecured and some secured claims against the Company as well as personal guarantees provided by the Company's directors or their relatives; and
    • there will be a stay preventing contract counterparties enforcing against the Company ipso-facto clauses triggered purely by the Company entering the RP Process (which is similar to the ipso facto protections afforded to companies that enter voluntary administration, substantial controllerships and creditor schemes of arrangement).
  • The Company then has 20 Business Days to prepare a plan to restructure the business's debts (Plan) with the assistance of the SBR Practitioner. Before the Plan can be put to Creditors:
    • the SBR Practitioner must certify the Plan, including that the Company can meet the proposed repayments under the Plan and that it has properly disclosed its affairs; and
    • the Company must pay any employee entitlements that are due and payable.
  • The SBR Practitioner then sends the Plan, supporting documents and certification to Creditors and the Creditors have 15 Business Days to vote on the Plan. That vote will determined by a simple majority of creditors in value (excluding related-party creditors), with all creditors voting as a single class. This is in contrast to the voting in voluntary administration, which requires a majority in value and number, with the administrator having a casting vote.
  • If the Plan is approved, the business continues and the SBR Practitioner administers the Plan by making distributions to creditors. If the Plan is not approved, the RP Process ends and the Company's directors may choose to enter administration or the simplified liquidation process described below.

If approved by creditors, the Plan will bind all unsecured creditors. Secured creditors will only be bound to the extent their debt cannot be satisfied out of the realisable value of their security interest(s).

The RP Process is a debtor-in-possession model. As such, the Company's directors will remain in control of the Company and be able to continue to trade the business in the ordinary course while the Plan is being developed. The prior approval of the SBR Practitioner will only be required for trading that is outside the ordinary course of business.

At this stage, details about what a Plan can and cannot do are scant. The Government has simply indicated that "key creditor rights" will be preserved - specifically that there will be no changes to the rights of secured creditors and similar types of debts must be treated consistently.

There is also no indication as to whether, and to what extent, Courts will have oversight and whether creditors will have the same or similar rights to what they have in external administrations.

Eligibility for RP Process

At this stage, the Treasurer has indicated that the criteria for an entity accessing the RP Process will be as follows:

  • it must be an incorporated company (ie. not personal sole-traders);
  • the Company must have "liabilities" of less than A$1m (though it is remains unclear whether this includes secured debt and/or related party debt and whether it requires, for example, liquidated obligations that are due and payable); and
  • prior to the Plan being put to creditors, the Company must have paid all employee entitlements that are due and payable.

Interestingly, there does not appear to be a strict requirement that the Company is "insolvent". At this stage, the Treasurer's Fact Sheet simply refers to small businesses "facing financial distress" passing a resolution to appoint a SBR Practitioner. Of course, it may be that the draft legislation contains this additional criterion or at least a requirement that the directors resolve that in their opinion the Company is insolvent or likely to become so (ie. similar to what the directors would be required to resolve if they were appointing a voluntary administrator under s436A of the Corporations Act 2001) (Corporations Act).

The SBR Practitioner

The Treasurer has released the following details about the role of SBR Practitioners:

  • a SBR Practitioner will be paid:
    • a flat fee for their work in assisting the business to develop a Plan; and
    • (if the Plan and their remuneration proposal is approved) a percentage of the "disbursements" for their work in managing the Plan;
  • a SBR Practitioner must remain independent throughout the SBR Process;
  • a SBR Practitioner will not be required to take on personal liability for a company or manage its day to day affairs;
  • the role and powers of the SBR Practitioner will be more streamlined compared with an administrator;
  • practitioners can choose to register as SBR Practitioners only. The qualifications required to register as a SBR Practitioner will be in line with the requirements of the role only; and
  • registered liquidators will also be able to manage the RP Process.

At this stage, there is no detail on the qualifications that will be required for SBR Practitioners (including any requirements as to professional liability insurance).

Safeguards

In addition to the "key creditors rights" described above which are to be preserved, the Treasurer has also indicated there will be safeguards in place to prevent:

  • corporate misconduct and phoenix behaviour, including the SBR Practitioner having the power to stop the RP Process where misconduct is identified; and
  • the same companies or directors using the process more than once every 7 years.

If the Plan is not approved, the Company can enter administration or the new Simplified Liquidation described below.

What we are still waiting to find out

We will be updating this note once the draft legislation is released. However, at this stage, it remains unclear:

  • what qualifications will be required for a SBR Practitioner;
  • what the parameters of an acceptable Plan will be (i.e. beyond that the rights conferred on secured creditors by their security cannot be compromised and that similar types of debts must be treated consistently), including whether guarantors of Company debt or other third party claims can also be released by the Plan;
  • whether secured creditors can be bound by a Plan if they vote in favour of it (even if their debt does not exceed the realisable value of their security interest);
  • whether the existing protections for employee entitlements (including section 444DA of the Corporations Act) will apply;
  • whether there will be any Court oversight and whether the standard creditor rights available in external administrations will apply to this regime (including any right to replace the SBR Practitioner); and
  • what the corporate misconduct safeguards will look like including whether the SBR Practitioner will be required to investigate the Company's affairs and/or report to creditors on their likely return under the Plan (vis-à-vis liquidation). At this stage, the only action which an SBR Practitioner appears to be able to take if they discover misconduct is to stop the RP Process - though, perhaps the significance of this power should not be understated, given that the bar on the same company or directors using the RP Process more than once every 7 years would preclude the Company simply appointing a further SBR Practitioner.

Simplified Liquidation Process

The Australian Government will also introduce with effect from 1 January 2021, a simplified liquidation process (SLP) with reduced investigation and meeting requirements and more streamlined reporting. The SLP is designed to offer a cheaper and faster liquidation process for companies with liabilities less than A$1m.

What will remain the same?

The SLP will retain the general framework of the existing liquidation process, including:

  • the same rights for secured creditors;
  • the same statutory rules as to the payment of priority creditors, such as employees;
  • the requirement that liquidators investigate and report to creditors about the company’s affairs and inquire into the failure of the company.

What will be different?

However, the SLP will involve certain modifications to reduce time and cost including:

  • there will be fewer circumstances in which a liquidator can seek to clawback unfair preferences from unrelated creditors;
  • liquidators will not be required to submit section 533 reports to ASIC, unless there are reasonable grounds to believe there has been corporate misconduct;
  • there will be no requirement to call creditor meetings or the ability to form committees of inspection;
  • there will be a simplified dividend and proof of debt process;
  • liquidators will be free to choose the most appropriate method / technology when communicating with creditors and facilitating voting.

Safeguards

The Australian Government has indicated that safeguards will be implemented to prevent misuse of the new SLP, including:

  • allowing creditors to convert the SLP to the full liquidation process; and
  • directors would be required to declare that they believe the company is eligible and has not engaged in illegal phoenixing.

Other measures to expand availability of SBR Practitioners

The Australian Government has announced that it will introduce a number of measures to expand the
availability of insolvency practitioners to deal with the expected increase in the number of companies seeking to restructure or liquidate due to the economic consequences of COVID-19.

These new measures include:

  • encouraging insolvency practitioners to enter the market by temporarily waiving fees associated with registration as a registered liquidator until 30 June 2022;
  • allowing more people to register as insolvency practitioners by removing rigid requirements that do not provide demonstrated benefit in ensuring the integrity of the profession;
  • making the key parts of the process set out in the Corporations Act ‘technology neutral’ so that external administrations can be carried out efficiently and administrators can focus on the substantive requirements of their role; and
  • establishing a new classification of insolvency practitioner whose practice will be limited to the new RP Process only.

The Australian Government has also announced that it will commence a consultation on the appropriateness of permanently raising the minimum threshold at which creditors can issue a statutory demand on a Company.

Transitional Protections for SMEs that cannot find a SBR Practitioner

The Australian Government has flagged that notwithstanding the above measures, some companies will likely experience issues accessing the RP Process immediately on 1 January 2021, given it will take time for practitioners to familiarise themselves with the new regime and register as SBR Practitioners.

As such, the Australian Government has announced that the following process will be available to eligible small businesses to help bridge the transitional issues:

  • an eligible small business will be able to declare its intention to access the RP Process to its creditors (including through ASIC's published notices website) (Declaration). The ability to make such a Declaration will be available until 31 March 2021; and
  • following the Declaration, the existing temporary insolvency relief (ie. relief from insolvent trading liability and responding to statutory demands from creditors) would then apply to the business, for a maximum period of 3 months, until they are able to access an SBR Practitioner or other insolvency practitioner.

This alert was prepared with the assistance of Aleksandra Pasternacki, Graduate at Law. 


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