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The Federal Government has announced new insolvency rules that will allow small businesses to stay afloat whilst restructuring debts. This new insolvency regime is proposed to start from 1 January 2021, following the lifting of temporary insolvency measures introduced in March 2020.
Incorporated businesses with liabilities less than $1 million may retain control of their company and assets without having to go into administration. Large companies remain bound by existing insolvency rules.
“This $1 million threshold will cover about 76 per cent of businesses subject to insolvencies today, 98 per cent of which have less than 20 full-time employees,” said Treasurer Josh Frydenberg.
Insolvent small businesses have 20 days to produce a restructuring plan. Creditors will then vote on whether to accept it within 15 days. There is a moratorium on unsecured and some secured creditors taking action against the company whilst it is restructuring.
This will help small businesses who are in financial distress due to COVID-19 but are still regarded as viable.
“These are the most significant reforms to Australia’s insolvency framework in almost 30 years, and will help to keep more businesses in business and Australians in jobs,” said Frydenberg.
“The reforms are a critical part of our economic recovery plan and will help to boost business confidence and dynamism across the economy by allowing viable businesses to survive as our economy rebuilds.”
These changes will see Australian bankruptcy laws move from a “creditor in possession” model to a “debtor in possession” model, shifting control from administrators to the business owner.
This reflects Chapter 11 of the United States Bankruptcy Code, which describes how businesses can restructure debts whilst continuing to operate. In the past, US companies such as General Motors, United Airlines and K-Mart have filed for chapter 11 bankruptcy whilst running business as usual.
Australian Small Business and Family Enterprise Ombudsman Kate Carnell welcomed the reforms.
“It’s clear the Federal Government has heard our concerns that current insolvency practices do not work for small and family businesses,” Ms Carnell said.
“Our July report found that in many cases, small businesses were not getting the chance to turn their business around and instead finding themselves on an express train to winding up with zero control over the process.
“The changes announced today by Treasurer Josh Frydenberg will go a long way to fixing that problem.”
However there are concerns that these relaxations will lead to a rise in phoenix activity, where companies are deliberately liquidated to avoid paying debts.
A 2018 PwC report found that phoenixing cost the Australian economy up to $5.13 billion in 2015-16. The direct cost to business was estimated to be between $1,162 million and $3,171 million in the same period.
Frydenberg has indicated that there will be “safeguards” against such illegal activity.
“There will also be safeguards in place to prevent corporate misconduct, including phoenix activity, with related creditors prohibited from voting on the restructure plan, and the same company or same directors not being able to use the insolvency process more than once every seven years.”
Relaxed continuous disclosure provisions for companies and officers are also extended until 23 March 2021. Companies can hold back from making forecasts about future earnings or other “forward-looking estimates”, which would limit the amount of information available to investors during this period.
Frydenberg explained that these measures were necessary to protect against “the threat of opportunistic class actions for [companies who are] allegedly falling foul of their continuous obligation disclosures if their forecasts in the middle of a pandemic are found to be inaccurate.”
“So while this temporary measure has not detracted from information being provided to the market, it has made it harder to bring such actions against companies and officers during the coronavirus crisis and while allowing the market to continue to stay informed and function effectively.”
In addition to the reforms, the government is currently providing $314 billion to households and businesses as part of Australia’s economic recovery.