Legislative Update: New Australian Insolvency Law Reforms Enacted for Small Businesses

In response to the emergence of the COVID-19 pandemic in Australia in 2020, the federal government injected an unprecedented level of stimulus into the Australian economy and introduced temporary law reforms aimed at protecting against an anticipated "tidal wave" of insolvencies. These temporary law reforms included a moratorium on civil liability for insolvent trading for directors and increased thresholds and time frames for responding to statutory demands.

The majority of these temporary relief measures came to an end on December 31, 2020, and in an attempt to address the expected resulting rise in insolvencies, the federal government has implemented a number of permanent insolvency law reforms intended to assist small businesses restructure their debts in 2021 and beyond. These reforms, which were analyzed as draft legislation in a Jones Day White Paper in October 2020, have been passed by the government and have come into effect from January 1, 2021. The reforms introduce a new reorganization process, a simplified liquidation process, and some changes to the licensing of liquidators.

The reforms apply to "small businesses," which are companies in Australia with liabilities of less than A$1 million. The federal government has suggested this will capture around 76% of businesses subject to insolvencies today.

The "Debtor in Possession" Reorganization Process for Small Businesses

The centerpiece of the reforms is a new reorganization process, which the federal government has emphasized is similar to a Chapter 11 process under the Bankruptcy Code in the United States, in that it is a "debtor in possession" model. However, unlike a Chapter 11 reorganization, the new reorganization process is an out-of-court process and generally does not allow for secured claims to be compromised.

The new reorganization process is in fact more like a hybrid of a safe harbor for insolvent trading and a streamlined voluntary administration process (which already exists under Part 5.3A of the Corporations Act 2001). It aims to provide small businesses with a quicker and simpler way to restructure their existing debts and maximize their chances of continuing as a business.

The new reorganization process for small businesses involves the following general steps:

1. The small business announces its intention to access the restructuring process. The directors have discretion on whether or not to commence this process, but they must be satisfied that in their opinion the company is insolvent, or is likely to become insolvent at some future time. The company must also have total liabilities of less than A$1 million on the day that the restructuring begins.
2. The directors of the business appoint a small business restructuring practitioner (or "SBRP") who helps the business develop a restructuring plan. A moratorium on enforcement action by certain creditors against the company commences upon appointment of the SBRP. The directors continue to control the business and trade in the ordinary course, while they work alongside the SBRP to develop a restructuring plan over 20 business days. The directors have a safe harbor for civil liability for insolvent trading during the restructuring of the company.
3. After this 20-business-day period, the business sends the plan and supporting documents to creditors, and the SBRP declares that, if the restructuring plan is made, the company is likely to be able to discharge the obligations created by the plan. The company must have lodged any outstanding tax returns and paid any outstanding employee entitlements before the plan is put to creditors.
4. Creditors vote on the proposed plan. If a majority of creditors voting by value approve the plan, the plan is then binding on all unsecured creditors (and secured creditors to the extent that any part of their debt exceeds the value of their security interest).
5. If the plan is approved, the SBRP administers the plan and makes distributions to creditors while the business continues to be run as normal by the directors. If the plan is not approved, the directors may place the company into voluntary administration or liquidation.

Temporary Relief

The new laws also introduce a temporary relief period between January 1, 2021, and March 31, 2021, for businesses that wish to engage an SBRP and enter into a restructuring process, but have been unable to find a practitioner or otherwise enter into the process. This is because there may not be enough SBRPs in the early stages of 2021 to service those companies that wish to restructure.

In order to avail themselves of this temporary relief period, the directors of the business must make a declaration in writing that sets out that there are reasonable grounds to believe the that: (i) company is insolvent and otherwise eligible for a small business restructuring; (ii) the board has resolved that a restructuring practitioner should be appointed; and (iii) there is no SBRP or administrator for the company. This declaration must be provided to the Australian corporate regulator, ASIC, within five business days of being made.

The temporary relief provides eligible businesses with a safe harbor from insolvent trading and protection against statutory demands—statutory demands may be issued against the company only for debts above A$20,000 (instead of the threshold of A$2,000 applicable to all other companies) and the company has six months to respond to a demand (instead of the deadline of 21 days applicable to all other companies).

The Simplified Liquidation Process

From January 1, 2021, small businesses with liabilities of less than A$1 million will also be able to access a new simplified liquidation process. This process will retain the basic structure of existing liquidations in Australia, but with time and cost savings through reduced investigative and reporting requirements, and without the requirement for holding meetings of creditors.

The key features of the simplified liquidation process are:

1. Liquidators have narrower obligations to report on potential misconduct by officers or employees of the company in liquidation (as is typically required by Section 533 of the Corporations Act 2001).
2. Liquidators have reduced requirements to convene meetings of creditors.
3. There are reduced circumstances in which unfair preference payments made by a company are voidable, including if such payments occurred more than three months prior to commencement of a liquidation or the payments involve amounts of less than A$30,000.
4. There are relaxed requirements regarding creditors' proofs of debt and the processes for liquidators to pay out dividends to creditors.

 Relaxed Licensing Requirements

The suite of reforms also includes changes to the Insolvency Practice Rules (Corporations) 2016 to allow for relaxed requirements for the licensing of liquidators if they intend to practice only as SBRPs. In short, the relatively onerous requirements for the licensing of liquidators are relaxed for those who intend to practice only as SBRPs. For example, accountants may be appointed as SBRPs and need not have extensive specialist insolvency or liquidation training.

Key Issues and Takeaways

The small business insolvency law reforms have been met with mixed responses in Australia. Some insolvency practitioners and lawyers have criticized the minimal qualifications, experience, and licensing requirements for the new subcategory of liquidators licensed only to act as SBRPs. Their concern is that those who will qualify for licensing will not have sufficient understanding of Australia's insolvency regime to competently fulfil their duties.

In addition, there are other key issues arising from the reforms, including:

1. Debts incurred after the appointment of the SBRP do not have priority over unsecured debts incurred before the restructuring. This means it may be difficult for small businesses to retain staff and maintain relationships with key suppliers during the restructuring process, as employees and suppliers will have no comfort that their debts will be paid ahead of existing unsecured creditors.
2. The duties and liabilities of SBRPs are not commensurate with the scope of their role, powers, and remuneration. SBRPs are treated as "officers" of the company once appointed, exposing them to directors' duties under the Corporations Act 2001, as well as potentially significant liabilities under workplace or occupational health and safety and environmental laws. In contrast, SBRPs have limited control over the business, which remains in the hands of the directors in a "debtor in possession" style process. This means that SBRPs may be exposed to potential liabilities that are not commensurate with their comparatively limited responsibilities, notwithstanding the introduction of Regulation 5.3B.42 to the Corporations Regulations 2001, which aims to protect SBRPs from liability for conduct "in good faith and without negligence."
3. The restructuring period is defined in Section 453A of the Corporations Act 2001 and Regulation 5.3B.02 of the Corporations Regulations 2001 as being (typically) the period beginning when an SBRP is appointed and ending when the company makes a restructuring plan that is approved by creditors. Notably, it does not include the period in which the restructuring plan is actually implemented. It remains to be seen how effective this will be in ensuring that restructuring plans approved by creditors are implemented properly and efficiently.

It is still not clear whether the anticipated "tidal wave" of insolvencies in Australia will result in the wide-scale adoption of the federal government's new restructuring processes for small businesses. As of January 25, 2021, no businesses have made use of the new reorganization process, and only five businesses have announced their intention to access the temporary restructuring relief period between January 1, 2021, and March 31, 2021.

Financiers, banks, and unsecured creditors should be aware of these new kinds of restructuring and insolvency processes in Australia. The lack of creditor oversight and compressed time frames mean that creditors should be prepared to be proactive if debtors begin to engage in a new reorganization process or simplified liquidation.