Small business restructuring reforms

A new 'debtor-in-possession' restructuring regime 12 min read

On 10 December 2020, the Federal Government's insolvency reform package relating to small business was passed by the Parliament.¹ The new laws provide for a debt restructuring process which is intended to give eligible small businesses the flexibility to restructure debts while the directors remain in control of the business, and for a new simplified liquidation process for small business.

Banks and other creditors should expect to see some restructuring proposals start to come across their desks in the new year, and will need to be in a position to act quickly given the relatively short timeframes involved and the informality of the voting process.

Key takeaways

• Eligible small businesses will have access to a 'debtor-in-possession' restructuring process in which a restructuring plan can be proposed to deal with creditor claims.
• A secured creditor will only be bound by a restructuring plan to the extent its claim exceeds the value of its security, or if it votes in favour of the plan.
• A new simplified liquidation process, which disapplies some of the features of a standard liquidation, will also be available for eligible small businesses.

Background and timing

The reforms will commence on 1 January 2021, which will coincide with the end of the temporary insolvent trading 'safe harbour' and statutory demand relief measures introduced in March 2020 in response to COVID-19.

The Treasurer has described these reforms as the most significant changes to Australia's insolvency laws in almost three decades, and has said the reforms are directed to:

• reducing access costs for small business;
• reducing the time small business spends in insolvency processes;
• ensuring greater economic dynamism; and
• helping small businesses to survive and avoid insolvency.²

The changes may well provide a useful opportunity for small businesses to restructure their affairs and reach a binding compromise with creditors without the costs and loss of control which often accompanies voluntary administration. However, the eligibility criteria will limit the use of this process to relatively small businesses with simple affairs. It remains to be seen whether those eligibility criteria will limit the extent to which these new processes have any meaningful impact on small business insolvency once the temporary COVID-19 relief measures end.

The new debt restructuring process

The new debt restructuring process will provide eligible small businesses with an opportunity to work with a small business restructuring practitioner to develop and propose a debt restructuring plan to creditors which, if accepted, will bind the company and most of its creditors. It is a 'debtor-in-possession' model, so the directors of the company will remain in control of the business while the restructuring plan is being developed.

Eligibility for the process

The process is available to companies which meet the eligibility criteria, the most significant of which is that the company's liabilities must be less than $1 million, including secured and related-party debt, but excluding employee entitlements. The Treasurer has said that the $1 million liabilities cap will cover around 76% of businesses subject to insolvencies today.

How does the process commence?

Directors of an eligible small business commence the process by passing a resolution to the effect that the company is insolvent or is likely to become insolvent at some future time, and that a small business restructuring practitioner should be appointed, and then appointing the practitioner. The restructuring practitioner must be a registered liquidator, but there will be some changes to the Insolvency Practice Rules which will introduce a new class of registered liquidator for small business restructuring.

What happens during the process?

The directors and the restructuring practitioner will work together to develop a plan for the company's creditors. The restructuring practitioner is required to give advice and assistance to the directors, and has powers to investigate the company's business, property and affairs, and to require the assistance of the directors in exercising those powers.

The company has 20 business days to prepare and propose the restructuring plan to its creditors (although that period can be extended). During that period, the company will have the benefit of moratoria on security enforcement which broadly reflect the moratoria that apply under the existing voluntary administration regime (including the ability of substantial secured creditors to enforce security interests within the 'decision period').

While the directors will remain in control of the company, there are some protections for creditors during the process. In particular, the company cannot enter into any transaction affecting the property of the company unless the transaction was in the ordinary course of the company's business, or the restructuring practitioner consents to the transaction, or the transaction was entered into under a court order. The Regulations³ provide that payment of admissible debts (that is, generally, debts or claims the circumstances giving rise to which occurred before the commencement of the debt restructuring process ) is not to be treated as being in the ordinary course of business which, in practice, means the directors will need the consent of the restructuring practitioner (which can only be given if the relevant transaction is in the best interests of the company's creditors) before paying any pre-restructuring process debts.

Proposing a restructuring plan

Before the company can propose a restructuring plan to its creditors, it must ensure it has paid all employee entitlements that are payable, and that all of its tax lodgements are up to date. If it meets those requirements, it can execute a plan and propose the plan to its creditors. By proposing a restructuring plan, the company is taken to be insolvent.

The plan must identify the company's property that is to be dealt with by the plan and how that property is going to be dealt with; provide for the restructuring practitioner's remuneration; and specify the date on which it was executed. The plan must be accompanied by a proposal statement setting out a schedule of the debts and claims which are to be dealt with under the plan, and a declaration signed by the restructuring practitioner stating that the practitioner believes on reasonable grounds that the company meets the eligibility criteria for the process and that the company will be able to discharge the obligations created under the plan as and when they become due and payable (or, if the practitioner does not have that belief, the reasons for that conclusion). In this context, the restructuring practitioner is required to make reasonable enquiries into the company's affairs and to take reasonable steps to verify information provided by the directors, which provides some degree of protection for the company's creditors.

A restructuring plan can be conditional upon the occurrence of a future event, provided it specifies what that event is and when it needs to occur by, (which cannot be more than ten business days after the plan is accepted). As secured creditors will only be bound by a restructuring plan to the extent their claims exceed the value of their security interests, or otherwise if they vote in favour of the plan, we expect that many plans will be conditional upon securing the support of a lender or other secured creditor.

Voting on the restructuring plan

The restructuring practitioner is required to provide the proposed plan, proposal statement and declaration to as many of the company's creditors as is reasonably practicable, and invite all creditors except for those who are related to the company or the practitioner, to indicate in writing whether or not the plan should be accepted.

The period for accepting a plan is 15 business days, although that period can be extended where a creditor disputes the assessment of its claim in the proposal statement and a varied schedule is provided to creditors as a result.

The plan will be accepted if a majority in value of the company's creditors who vote on the proposal, vote to accept it. Related creditors are ineligible to vote, and creditors who have acquired a debt are only permitted to vote to the value of the price paid for the debt and not its face value.

Making the restructuring plan

If creditors vote to accept the plan, the company is taken to have made the plan and it will bind the company, the restructuring practitioner and creditors with admissible debts or claims under the plan (including contingent debts), but a secured creditor will only be bound to the extent its claim exceeds the value of its security, or otherwise if it voted in favour of the plan. 

Once the plan is made, the directors and the restructuring practitioner implement it, and the practitioner will be responsible for receiving money and holding it on trust, and then distributing it to creditors. The restructuring practitioner can also be involved in selling property of the company for the benefit of creditors, but only if the directors request that assistance and the plan provides for it, and the practitioner cannot sell any company property that is subject to a security interest, other than in the ordinary course of business, with the consent of the secured party or with leave of the court.

Effect on secured creditors

As noted above, a secured creditor will only be bound to the extent its claim exceeds the value of its security, or otherwise if it voted in favour of the plan. The Regulations are silent about how the determination of the value of a security is to be made in this context.

As with voluntary administration, a secured creditor will be free to realise or otherwise deal with its security interest unless it voted in favour of a plan which restricts it from doing so or if the court so orders.

Ending the restructuring process

If a restructuring plan is accepted by creditors, the debt restructuring process will be at an end. However, the process can also be ended at any time, and for any reason, by a resolution of the company's directors, and by the restructuring practitioner if the practitioner believes the company doesn't meet the eligibility criteria, or that it would be in the interests of the creditors for the restructuring to end.

The process will also be at an end if:

• the company fails to propose a plan to its creditors;
• the creditors vote against the plan;
• the restructuring practitioner cancels a proposal to make a plan after becoming aware that relevant information has been omitted or was incorrect or there has been a material change in the company's circumstances;
• an administrator or liquidator is appointed to the company; or
• the court orders that the process should end.

Once a plan is made, it can end prematurely if:

• the plan is conditional, and the condition(s) are not satisfied;
• an administrator or liquidator is appointed to the company, or if there has been a contravention of the plan which has not been rectified; or
• the court orders that the plan should be terminated.

There is no automatic transition into any other form of insolvency administration if a restructuring process ends, or a plan terminates, prematurely. However, the company's directors will need to deal with creditors without the benefits of the moratoria and safe harbours provided by the process and, if a plan has been proposed, in circumstances where the company will be deemed to be insolvent. In this context, if a plan terminates prematurely, any debts which haven't been dealt with in accordance with the plan are taken to be due and payable on the following day.

Temporary relief

The new laws also provide for temporary relief for company directors who wish to enter into a debt restructuring process but are unable to do so in the early part of 2021. This is in recognition that there may well be a large number of companies wanting to access the new debt restructuring process and not enough restructuring practitioners available to service them immediately after 1 January 2021.

The temporary relief effectively provides for an extension to the two safe harbours that were introduced in response to COVID-19: that is, relief from insolvent trading for debts incurred in the ordinary course of business, and changes to the monetary threshold and the time for responding to creditors' statutory demands.

To qualify for temporary relief, the directors of the company must make and publish on ASIC's insolvency notices website a declaration in writing after 1 January 2021 but before 31 March 2021 to the effect that:

• there are reasonable grounds to believe that the company is insolvent or likely to become insolvent and that the eligibility criteria for small business restructuring would be satisfied;
• the board has resolved that a restructuring practitioner should be appointed; and
• no restructuring practitioner or other insolvency practitioner has been appointed.

Once the declaration is made, the company is entitled to temporary relief for a period of three months, or for a fourth month where the criteria continue to apply and the directors have taken all reasonable steps to appoint a restructuring practitioner but have been unable to do so, and publish a further notice to that effect. The temporary relief ends when a restructuring practitioner or other insolvency practitioner is appointed, or where the three- or four-month period expires.

Simplified liquidation

The new laws also introduce a simplified liquidation process for small business which is intended to be a more appropriate pathway for small businesses with simple affairs.

The process is available in any creditors' voluntary winding up where the company meets the eligibility criteria, which are broadly the same as for debt restructuring (including the $1 million liabilities cap) but include an additional requirement that the company has all tax lodgements up to date. It is not necessary for the company to have been through a debt restructuring process before winding up for the simplified process to apply.

Where a company is wound up and the directors believe the company meets the eligibility criteria for simplified liquidation, the directors can give the liquidator a declaration to that effect within five business days of the winding up commencing. If the liquidator agrees that the criteria are met, a notice must be given to creditors explaining how the simplified liquidation process works.

The company's creditors may give notice to the liquidator that the simplified process should not be adopted. If 25% of creditors by value (excluding related creditors) oppose the process, the liquidator cannot adopt it. If that 25% threshold is not met, the liquidator can adopt the simplified process.

Features of simplified liquidation

The simplified liquidation process operates by disapplying certain provisions of the existing creditors' voluntary winding up process. In particular:

• there are reduced obligations on the liquidator to investigate the company's affairs and make reports to ASIC;
• creditors' meetings will generally not be held – information and voting will be handled electronically;
• there will be no committees of inspection or reviewing liquidators (although the court will retain its supervisory powers); and
• there are some limitations on the liquidator's ability to recover voidable transactions.

There are some safeguards for creditors in a simplified liquidation process. In particular, where the liquidator forms the view that the company or a director has engaged in fraud or dishonest conduct that has, or is likely to have had, a material adverse effect on the interests of creditors, the simplified process is taken to have ceased from the day the liquidator forms that view and the liquidation will proceed in accordance with the standard process.

Next steps

As noted above, the new laws will commence on 1 January 2021, which will coincide with the end of the COVID-19 temporary relief measures. Whether that means we will see a flood of small businesses taking advantage of the new debt restructuring process remains to be seen.

The $1 million liabilities cap, and the inclusion of secured and related party debt in that cap, means this is a process which is limited to relatively small businesses with simple affairs. For eligible small businesses, the new process provides a useful and more flexible framework for restructuring debts which avoids some of the loss of control which is occasioned by the appointment of voluntary administrators.

Banks and other creditors should expect to see some restructuring proposals start to come across their desks in the new year, and will need to be in a position to act quickly given the relatively short timeframes involved and the informality of the voting process.