As Insolvency Rates Climb, Are You on Top of the Recent Reforms?

Now that the federal government’s temporary insolvency law measures and JobKeeper have come to an end, practitioners may be starting to see an uptick in insolvency and restructuring work, which is predicted to continue to increase during 2021.

CreditorWatch reported a 61% hike in external administrations in January as compared with February this year and a further increase of 14% in March.

With the increase in insolvency and restructuring work starting to flow through, practitioners should ensure that they are thoroughly across and prepared to work with the new small business insolvency law reforms introduced by the Federal Government on 1 January 2021.

Lifeline or speedy exit?

On 1 January 2021, the Federal Government introduced what it described as the most significant insolvency reforms in 30 years, which are directed at reducing the time and cost involved in restructuring for small businesses. Their intended purpose is to maximise the chances of these businesses surviving the economic impact of COVID-19 and, where this is not possible, to wind up more speedily.

“The reforms reflect a policy shift away from protecting creditors’ rights in favour of seeking to facilitate the continuation of businesses and protecting jobs,” explains Laura Hawes, Head of Dispute Resolution, Insolvency and Restructuring, Practical Law Australia at Thomson Reuters.

“However, the legislation is complex and was passed after only an 8-day consultation period and, consequently, a number of errors and issues have already been identified, which will need to be resolved in due course.”

So, to the regimes …

Two new insolvency processes were introduced on 1 January 2021 for eligible small businesses: a small business restructuring regime and a simplified liquidation framework.

What is the small business restructuring regime?

The small business restructuring regime adopts a “debtor in possession” model which allows eligible small businesses to compromise their debts with their creditors’ agreement and maximise their chances of survival.

To enter the process, the board must resolve that the company is insolvent or likely to be become insolvent and that a restructuring practitioner (who must be a registered liquidator or, alternatively, a registered restructuring practitioner) should be appointed. After the appointment, the restructuring practitioner assists the company to develop a restructuring plan to put to creditors for consideration while the directors remain in control and may trade in the ordinary course of business. If the creditors approve the plan, the restructuring practitioner implements its terms.

The same moratoria against secured and unsecured creditor action (court proceedings and enforcement processes) that apply in voluntary administration generally also apply during the restructuring process.

The purpose of the framework is to strip away the previous “one-size-fits-all” approach to insolvency under the Corporations Act 2001, which imposed the same expensive and lengthy process on all businesses and limited the opportunity for small businesses to restructure.

Drawing on some features of US Chapter 11 bankruptcy, the small business restructuring process is available to incorporated businesses with liabilities of less than $1 million.

Some concerns that have been identified in relation to the new regime include the fact that it will have relatively limited application (few businesses will meet the eligibility criteria); the set fee nature of the restructuring practitioner’s remuneration; and the less onerous qualification requirements for restructuring practitioners (compared with registered liquidators).

What is the simplified liquidation process?

The simplified liquidation process is available to eligible companies for whom restructuring is not possible and can only be commenced within a creditors’ voluntary liquidation. A liquidator can adopt the simplified liquidation process if the company meets similar eligibility criteria that applies under the small business restructuring regime, and provided that certain other qualifying steps are taken.

While much of the process is the same as a standard liquidation, the key differences are that there are no creditors’ meetings or committees of inspection; the liquidator is not required to provide a report on offences to ASIC unless the liquidator has reasonable grounds to believe that misconduct has occurred; there is only one dividend payment to creditors; and the liquidator is limited to clawing back voidable transactions over $30,000 in value (and entered into or act(s) done for the purpose of giving effect to them) within three months prior to before the relation-back day).

One of the major issues identified with the operation of the simplified liquidation process is that creditors have 20 business days within which they may direct the liquidator not to adopt the process but the liquidator also only has 20 business days in which to adopt the process (with the consequence that a liquidator will never be in a position to adopt the process).

Timing now “critical”: Practical Law expert

The small business insolvency law reforms aside, 2020 saw a rush of legislative and regulatory activity, from the temporary insolvency relief measures introduced in response to COVID-19 to a new set of bankruptcy regulations.

And prior to that, in 2017 we saw the introduction of the broader insolvency law reforms, the new safe harbour and ipso facto legislation and creditor-defeating disposition provisions.

“Given the extent of these significant changes over a relatively short period of time – and with more foreshadowed to come (including to address issues with the small business insolvency law reforms) – it has never been more critical for practitioners to be thoroughly up-to-date with their technical knowledge.”

– Laura Hawes, Head of Dispute Resolution, Insolvency and Restructuring, Practical Law.

Are you ready?

Now that the temporary relief measures are over and JobKeeper has ended, and given the extent and significance of recent legislative changes, insolvency lawyers, accounting practitioners and in-house lawyers must ensure that their knowledge of insolvency law and best practice is up-to-date so that they can provide the best possible advice to their clients.

That is particularly so, given the predicted increase in insolvency work in 2021.

“Insolvency practitioners should particularly ensure that they are thoroughly across the small business insolvency reforms, as they will be required to act quickly due to the short timeframes involved.”

– Laura Hawes, Head of Dispute Resolution, Insolvency and Restructuring, Practical Law.

Practical Law’s Insolvency and Restructuring module can assist practitioners to position themselves to win more insolvency work as it starts to flow through and to complete it much more efficiently.

With its extensive range of practical tools, know-how reflect the latest legal developments, the Insolvency & Restructuring module enables practitioners to act with confidence and save time in their day-to-day practice.

If you are looking for a know-how resource with up-to-the-minute practical legal guidance in the new insolvency reforms, contact a Practical Law specialist today.

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