Insolvency through the looking glass

Despite the global economy suffering its worst economic shock since the Great Depression and Australia its first recession in a quarter of a century, business failures were abnormally low.

"Although it appears a major change in approach, the reality is this change represents a streamlining of the current administration approach for small businesses.”

Sadly, we know this will not last. As government and funding support unwinds, insolvencies will grow - particularly in the small and micro business sector (even though early signs in 2021 are looking less dire). It is a critical and timely moment for reforms to insolvency law in this sector.

As calendars ticked over to 2021, a new law was launched which aims to establish a cost-effective insolvency alternative to provide the best opportunity for small and micro businesses- those with less than $A1 million in liabilities - to continue under the current owners.

It is estimated many small and micro businesses will be eligible to utilise this new restructuring procedure.

Although it appears a major change in approach, the reality is this change represents a streamlining of the current administration approach for small businesses given the costs, red tape and reporting obligations of the current regime. That complexity can make the process uncommercial for directors and creditors as the costs erode the returns and delays in the process.

A simplified liquidation process will exclude some aspects of the usual process. The major changes are reduced investigation requirements for liquidators, creditors’ meetings will generally not be held (with voting occurring electronically instead), there will be no committees of inspection and technology will be used to produce a more efficient process.

These encompass other Government initiatives including:

• Temporary insolvency relief measures which expired on 31 December 2020
• Encouraging the use of technology in administrations
• Fee waivers for new liquidators and having a new category of practitioner, a “Small Business”

So what happens if creditors do not accept the plan? The directors can then consider options that include Voluntary Administration or the simplified liquidation process.

Of course, there are safeguards designed to protect creditors from abuse of the process including:

• Where the liquidator forms the view the company or a director has engaged in fraud or dishonest conduct that has, or is likely to have, a material adverse effect on the interests of creditors, the simplified liquidation process is taken to have ceased from the day the liquidator forms that view. The liquidation will then proceed in accordance with the usual process;
• related creditors are unable to vote on the restructuring plan;
• businesses are unable to act outside of the ‘ordinary course of business’ during the process, without the approval of the SBRP; and
• the same company or directors cannot use the process more than once within seven years.

 The effectiveness of these safeguards in preventing abuse of the process will be critical to maximising the impact of the change. There is always risk of abuse of any procedure for use for “Phoenix” transactions (transactions that strip assets away and leave creditors in the existing, valueless structure) where independence is not enforced and supervision inadequate.

Other potential issues relating to adequate record keeping, like if a creditor claim is not reported by a director that would have made the entity not eligible (such as liabilities above $A1 million) or is the creditor bound if it is not involved in the process, may arise as the process is used.

Overall, these changes represent a step towards commercial arrangements for small and micro businesses that have been used in overseas jurisdictions and enables directors to consider options available and then put the preferred option to creditors.

There is similarity with the Safe Harbour corporate plans where companies/directors can assess the options and pursue an improved return for creditors compared to liquidation.

Creditors may have to consider more commercial arrangements and implications for their own businesses due to customers using this process.

Effectively, directors with the assistance of an independent, skilled and experienced SBRP are empowered to put a commercial compromise to creditors for consideration to enable the business to continue with the reduced costs (compared with the Voluntary Administration process) enabling further funds to be available for creditors.

If the safeguards protect the interest of creditors, directors and SBRP, then this process may achieve the Federal Government’s aim to enable more businesses to survive the impact of 2020 and continue into the future.

Miles Grant is Senior Lawyer at ANZ

This article was produced with the assistance of HLB Mann Judd accountants