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Why small business owners and Restructuring Practitioners must move quickly before 1 January 2021

Last week, as part of the Australian Government’s ongoing response to the pandemic-induced economic crisis, the Senate passed reforms to insolvency arrangements for small businesses with liabilities less than $1 million. 

From 1 January 2021, these businesses will be able to avail themselves of:

  • A new debtor-in-possession, debt-restructuring process to improve the prospects of business rehabilitation; and
  • A new, lower cost and simplified liquidation pathway.

The reform package provides a user-friendly alternative for small businesses that may have accumulated unmanageable debts through (or before) the COVID-19 crisis. 

In considering the debt restructuring process, there are some important things for Directors to keep in mind.

First, there is strict eligibility criteria to meet before the regime can be utilised. Second, with the assistance and oversight of a Restructuring Practitioner, Directors must prepare a restructuring and debt compromise proposal for creditors that puts the business (and its stakeholders) on a sustainable future path. Finally, selecting the Restructuring Practitioner is critical – the process can only be used once every seven years, so a credible, experienced, and well-known restructuring adviser will substantially improve the prospects of creditor support and a successful restructuring.

Creditors who are asked to compromise their debt in support of a restructuring proposal will also need to carefully consider the merits of the plan, the bona fides of the Restructuring Practitioner and the prospects of the business going forward.

Background to the reforms

A key purpose of the reforms is to provide flexible restructuring options to small businesses, timed to come into effect as certain COVID-19 measures expire at the end of the year, including temporary relief for Directors from insolvent trading and the reversing of minimum statutory demand thresholds. 

However, the regime is intended to be an ongoing formal insolvency option.  The complexity and cost of the existing insolvency regime is often a deterrent to its effectiveness as a restructuring and rehabilitation tool for small businesses.  Simplification of the process and lowering of the cost will provide small business owners with a useable statutory restructuring tool.

Benefits for small businesses

A significant advantage for small businesses in the reforms is that Directors have the opportunity to stay in control of their business while they agree on a restructuring plan with creditors. That said, Directors need to be aware that the process acts as a form of insolvency once a restructuring plan is put to creditors. 

The simplified liquidation process is intended to reduce the cost and time of liquidating a small business and thereby increase returns to creditors.

Restructuring considerations for small businesses

There are several key considerations for Directors and business owners in embarking on the process.

  • The debt restructuring process is a powerful opportunity to rehabilitate their business and avoid Liquidation;
  • Directors need to act early so there is time to salvage the business;
  • Understanding the qualifying criteria is critical.  Only businesses with total liabilities – including related party and secured debts but excluding contingent liabilities – of less than $1 million are eligible. Tax lodgements and employee entitlements must be up to date by the time of finalisation of the restructuring plan;
  • There is only one opportunity to put forward a restructuring plan. If creditors vote the plan down, there is no opportunity to try again;
  • A majority of creditors by value must vote in favour of the plan for it to become binding. Directors will have to balance the level of debt compromise sought with the likelihood of approval by creditors;
  • Avoid overly complicated plans – simple plans will be better understood and more likely to win creditor support;
  • Formulate the restructuring plan based on high quality cashflow forecasts and assumptions.  Make sure the business has sufficient post-restructure liquidity to thrive;
  • Use a Restructuring Practitioner who will be credible to your creditors – businesses only get one opportunity to use this restructuring path every seven years.

Final thoughts

Directors of small businesses yet to deal with pandemic financial hangovers have less than three weeks including Christmas to either demonstrate solvency or consider insolvent options (and rehabilitation) under the small business insolvency reforms. 

The new debt restructuring regime provides a path with improved prospects of business rehabilitation, while Directors remain in control of their business.  This process is subject to specific eligibility criteria, requires a level of advance planning and relies on the guidance of a credible Restructuring Practitioner.

Concerned Directors and business owners must act now by taking specialist advice and putting plans in place to protect themselves and their businesses beyond year-end.

Key features of the debt restructuring reform

  • The existing Directors remain in control of the business and develop the restructuring plan (known as the debtor in possession model, which is a key feature of Chapter 11 in the US);
  • Once initiated there will be a moratorium on collection action applicable to unsecured and some secured creditors, as well as a moratorium on enforcing Director guarantees;
  • The company must appoint a Restructuring Practitioner (RP). A Registered Liquidator is qualified to act as a RP;
  • A restructuring plan is prepared by the company in consultation with the RP, within 20 business days of the RP’s appointment;
  • Creditors must vote on the plan within a further 15 business days. Voting to approve the plan is by a simple majority in value only by submission of a voting form or virtual voting online. Secured creditors will only be bound when voting for any unsecured portion of their debt;
  • There is a pathway to voluntary administration or liquidation if the plan is not approved, but this is not automatic; and
  • The process can only be used once every seven years to counter phoenixing and other possible abuses of the process.

Key features of the simplified liquidation reform

  • The liquidator will still take control of the company and realise the assets to make a distribution to creditors. The rights of secured creditors and the statutory rules as to the payment of priority creditors (including employees) are unchanged.
  • The new process will mirror the current liquidation process but with modifications to reduce time and cost and to reflect the asset base, complexity and risk profile of small business. These changes include:
  • Reducing the circumstances in which unfair preference payments can be clawed back
  • Removing requirements to call creditors’ meetings and form committees of inspection
  • Simplifying the dividend and proof-of-debt processes
  • Maximising technology in voting and other communications
  • Replacing the s533 investigations report with a simplified report
  • Only requiring the liquidator to report to ASIC regarding misconduct where there are reasonable grounds to believe that misconduct has occurred

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