Federal Government announces changes to insolvency laws for Small Business

On 23 September 2020, Treasurer Josh Frydenberg announced the most significant insolvency reform in the last 30 years.

Adopting elements similar to the US Chapter 11 Bankruptcy provisions, the changes will allow directors of businesses to retain control via a debtor-in-possession (DIP) process while they plan to restructure their debts, as well as introducing a more streamlined liquidation process.

Key changes

• A new two-tiered process will be adopted, allowing incorporated small businesses with liabilities under $1 million – representing around 76% of businesses currently subject to insolvencies – to continue trading under the control of the directors as they develop a plan to present to creditors. Larger companies will remain subject to the insolvency laws currently in place.
• A requirement for the company to engage a Small Business Restructuring Practitioner (SBRP) to certify the plan, and to oversee disbursements and distributions to creditors. It should be noted that while the plan is being developed, unsecured and some secured creditors will not be able to take enforcement action against the company.
• The company and the SBRP will have 20 business days to prepare and present the plan, following which creditors will have 15 business days to vote on the plan (including voting on the remuneration of the SBRP). The plan must be supported by over 50% of the creditors in value in order to be approved. Notably, any outstanding employee entitlements must be paid out in full before the plan is voted on by creditors.
• Safeguards will be put in place to prevent corporate misconduct, including corporate phoenixing which is currently a key focus of the Australian Securities & Investments Commission (ASIC). Additionally, the same company or same directors will only be able to use the new process once every 7 years.
• If the plan is not approved, the company can either go into voluntary administration or a streamlined liquidation process.
• The new insolvency regime will commence from January 1 2021, replacing the temporary insolvency measures introduced during COVID-19, which are due to end on 31 December 2020.

Further consultation is expected between now and January in order to clarify key elements of the insolvency changes, including; the qualification requirements for the SBRP, the role of the Courts, and the rights of secured creditors.  

The primary intention of the proposed reforms, namely to simplify and streamline insolvency processes for small business, have broadly been welcomed. However, there are a number of elements of the reforms that are yet to be clarified, and we expect the government will engage now with industry stakeholders in the period leading up to January 2021 to ensure that the new regime is workable and that it will provide small businesses with the best opportunity to continue viably.

In the meantime, businesses who are contemplating a restructure during this period should engage early with an appropriately qualified advisor to discuss options and to ensure they are best prepared for a post-COVID environment.

The insolvency changes form part of wider announcements around the Federal Budget, with the Treasurer signalling that structural reforms, like the new insolvency provisions, will be integral to Australia’s economic recovery.