From January 2021, important changes to laws affecting small to medium businesses in Australia who may be suffering financial distress due to COVID-19 are proposed.
Set to be introduced at the Commonwealth level (subject to parliamentary approval), the changes aim to help small business owners and directors whose companies experience financial difficulty to remain in control of their business whilst restructuring their debts.
The centrepiece of the reform involves creation of a new debt restricting process which draws on features of the Chapter 11 bankruptcy model in the United States.
Known as the ‘debtor in possession model’, the process will allow owners and directors of small companies to retain operational control of their business and to continue to trade under the ordinary course of business whilst a debt restructuring plan is developed and voted on by owners.
When developing the plan, owners will work with a new classification of practitioner known as a small business restructuring practitioner. The practitioner will help to determine whether the company is eligible for the scheme, support the company to develop a plan and review its financial affairs, certify the plan to creditors and manage disbursements once the plan is in place.
Whilst business owners will be able to trade in the ordinary course of business whilst the plan is being developed, they will need the approval of the small business restructuring practitioner for any trading outside the ordinary course of business.
The new process is available only to companies with debts of less than $1 million. Above that threshold, existing rules remain unchanged.
Will it Work?
In a statement announcing the reforms last month, Federal Treasurer Josh Frydenberg stated that: “By adopting key aspects of the US Chapter 11 bankruptcy process, it (the new model) will introduce a single, simpler, faster, more cost-effective insolvency process for small businesses. It will see our system move from a rigid, one size fits all “creditor in possession” model…” (as it is now) “to a more flexible “debtor in possession” model.”
He went on to say: “This will enable small business owners to remain in control, provide them with an opportunity to restructure and ultimately increase their chances of surviving this COVID crisis.”
Interesting comments. Will the reforms deliver?
One concern is that the easier you make it for businesses to avoid the consequences of external administration, the more likely the ‘system’ will be subject to abuse. There is a danger that unscrupulous parties will see the reforms as an easy way to avoid paying their debts and set up in business under another name – the old ‘phoenix activity.’
There are also questions around stated aims such as reducing costs for small businesses in financial trouble, faster turnaround times for dealing with insolvent situations, and of course, helping small businesses get to the other side of COVID – whenever that might be.
It is important to note that secured creditors’ rights will not be affected by the changes.
Another concern is that timeframes may be too restrictive. Under the new process, owners and their restructuring practitioners will have 20 business days to prepare and propose a restructuring plan after which creditors will have fifteen days to vote. In the US, the time-period for consideration is 90 days with the possibility of extension. In cases where large numbers of small debts are involved, having creditors vote within these timeframes could be difficult.
Another concern is that consultation on the proposed reforms may be either non-existent or inadequate. As things stand, the legislation is expected to be (and hoped to be) released for consultation in the next few weeks. Even if this happens, the proposed start date of January 1 means that consultation timeframes will be constrained. Whilst few debate the need for reform, consultation should not be rushed.
Next, there are questions about how the law will operate in practice and what its effect will be. As the laws are based on US law, guidance surrounding their likely effect in Australia can be derived by looking to the US. Nevertheless, there are differences between the US and Australia. Compared with their Australian counterparts, business in the US have generally been more heavily impacted by COVID. In the US, the laws apply to any business; here they will only apply to incorporated businesses (i.e. companies). In the US, the eligibility threshold for the model to apply is set at $7.5 million; here that threshold is $1 million or less. For these reasons, the impact of the law in Australia may differ from that in the US.
Finally, whilst the reforms aim to minimise the need for insolvency practitioner involvement, it should be noted that practitioners will still be involved under this scheme. Whilst the small business restructuring practitioners will not be driving the process – which unlike in the US will take place out of court – they still have an umpire-like monitoring role as described above. Whilst detail surrounding the level of practitioner supervision is still being worked out, it is possible that the practitioner’s role could become even more crucial.
In several areas, practitioner oversight will be critical. As mentioned above, restructuring practitioner approval will be needed before any trading outside the ordinary course of business can occur – a welcome and important control. Also important is an ability for the practitioner – in extreme cases – to terminate the scheme. Finally, another welcome control is a requirement for any business operating under the scheme to now include ‘restructuring practitioner appointed’ after its name. This ensures that those who deal with the company are aware of its status.
With many details still being worked through, much about the likely impact of the law remains uncertain.
On what is currently known, however, the above discussion provides ideas about its likely effect.