Small business fast track insolvency

By Zilla Efrat

In what it calls the most significant reforms to Australia’s insolvency framework in 30 years, the Federal government has introduced a simplified liquidation process for incorporated small businesses with liabilities of less than $1 million.

The changes make permanent what were previously temporary regulatory measures, first announced in March 2020 to help financially distressed businesses get to the other side of COVID-19.

They became permanent on January 1 2021 and are expected to enable more Australian small businesses to quickly restructure. Where restructure is not possible, businesses will be able to wind up faster, enabling greater returns for creditors and employees.

Treasurer Josh Frydenberg says the reforms move the insolvency process away from a rigid one-size-fits-all “creditor in possession” model, which typically takes control of the company away from the owners and gives it to the creditors after an independent external administrator is appointed.

Instead, the reforms move the insolvency process towards a more flexible “debtor in possession” model, drawing on some key features of the Chapter 11 bankruptcy model in the United States. They allow directors to retain control of their businesses. Directors can undertake transactions that are in the ordinary course of business, but they must seek external support from a small business restructuring practitioner (SBRP), a new class of registered liquidator.

The SBRP has 20 business days to develop a restructuring plan, but can extend this period by up to 10 business days where an extension is reasonable in the circumstances. After this, creditors have 15 business days to vote on the plan.

The debt restructuring plan sets out how a company’s creditors will be repaid and whether this will be a proportion of the debt owed to them or an amount of “cents in the dollar”.

The plan should be accompanied by a restructuring proposal statement, which includes a schedule setting out the company’s creditors and the amount they are owed by the company.

However, thanks to government support such as JobKeeper during COVID-19, the number of insolvencies in Australia is well below the 10-year average.

Indeed, 9,829 companies entered into external administration and controller appointments in 2010-2011, according to the Australian Securities and Investments Commission’s figures. But in 2020-2021, the number had fallen to 4,235.

When announcing the reforms, Frydenberg expected them to cover around 76 percent of businesses subject to insolvencies, 98 per cent of which have less than 20 employees.

But the take-up has been slow with just five small business restructurings in the first quarter of 2021 and seven in the second quarter – an outcome that has widely been blamed on a lack of awareness of the scheme among small business owners.

The requirement to have paid employee entitlements currently due, including superannuation, before the restructuring can go ahead is also seen as a big hurdle for many struggling small businesses to overcome.

“We were and still are fully supportive of a small business restructuring regime that is less costly than the other alternatives,” says Carl Gunther, president of the Turnaround Management Association Australia.

However, he believes the new regime is only useful for very small companies.

“Given debt thresholds it remains to be seen if many companies can qualify and if insolvency professionals can make it pay,” he says.

“We do still have some issues with the way the legislation is drafted. But unless and until there is some significant uptake with this new regime, the chances of amending the legislation to address some of those shortfalls are remote.”

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The government has made insolvency rules for incorporated small businesses with liabilities of less than $1 million permanent. Initially released last year as temporary measures, they make it simpler and cheaper for them to restructure if they are struggling. Where a restructure is not possible, small businesses will be able to wind up faster, providing greater returns to creditors and employees.

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