Restructuring reforms – will the proposed two tier system avert the zombie apocalypse?

Articles Written by Pravin Aathreya (Partner), Aidan Douglas (Special Counsel), Rebecca Proudman (Associate)

The Treasurer has announced major proposed reforms to Australia’s insolvency framework aimed at facilitating the restructuring of small to medium businesses (MSMEs) and streamlining their liquidation if rescue is not achievable (Reforms). The Reforms are intended to come into effect from 1 January 2021, after the suite of current insolvency protections introduced to address the economic impact of COVID-19, expire on 31 December 2020. This article focuses on the restructuring aspects of the Reforms and particularly their impact on creditors and insolvency practitioners.

The Reforms  

MSMEs have been severely impacted by COVID-19. The Reforms are designed to provide these businesses with a cost-effective and efficient mechanism to agree a restructuring plan with their creditors, without the directors relinquishing managerial control. This new restructuring process draws on the US Chapter 11 debtor-in-possession model and appears to be modelled on similar measures introduced in the UK in July 2020. The key aspects of the Reforms include:

  • companies with total liabilities of less than $1 million can appoint a small business restructuring practitioner (SBRP) to develop a restructuring plan for the company
  • upon the appointment of the SBRP, a 20 business day moratorium is imposed on all unsecured creditors as well as some secured creditors and the directors remain in control of the business
  • the SBRP certifies that they consider the business can meet the proposed repayments and has properly disclosed its affairs
  • the company must discharge all employee entitlements and tax returns before putting the restructuring plan to creditors
  • creditors have 15 business days to vote on the plan – it is binding on unsecured creditors if approved by more than 50 per cent of creditors in value (excluding related party creditors)
  • if the plan is not accepted, the company can opt to appoint a voluntary administrator or use the simplified liquidation process.

Better outcome for creditors?

A key objective of the Reforms is to facilitate the achievement of a better outcome for creditors than in a voluntary administration. However, there are at least several obstacles to realisation of this objective. 

First, the company is able to continue to trade while the restructuring plan is developed and voted on by creditors. Whereas in a VA, creditors have the benefit of the administrator’s personal liability for debts incurred, this will not be the case in respect of an SBRP and there is no indication that directors will be liable for these debts. Consequently, it is difficult to see how many creditors would be prepared to extend any credit in the 35 day business period between the appointment of the SBRP and the creditors’ vote on the proposed restructuring plan, other than transacting on a “cash on delivery” basis.

Secondly, once a restructuring plan has been developed, the SBRP must certify the plan based on their assessment of the financial affairs of the company. The detail of this certification process is yet to be confirmed, but currently available information suggests that it is similar to the process involved in preparation of the second report to creditors. Accordingly, the associated cost may result in an equivalent depletion of the assets available to creditors. 

Thirdly, the Reforms contemplate the company being put into VA (as an alternative to using the simplified liquidation process) if the restructuring plan is rejected by creditors. If creditors have rejected the restructuring plan under this mechanism, it appears unlikely that they would then approve a deed of company arrangement under a traditional VA, noting the similarity of the voting thresholds. Any administrator that is appointed following a restructuring plan being rejected would still have the same reporting obligations and would still be required to prepare a report to creditors. Consequently, rather than removing a layer of costs, this framework may in some cases be adding one.   

Fourthly, the requirement that all employee entitlements be discharged and all outstanding tax returns be lodged prior to voting means that a majority of MSMEs (in the absence of rescue financing which funds those liabilities) will be ineligible for the SBRP process and should therefore swiftly proceed to liquidation. To this extent, the Reform’s proposed simplified liquidation process should avoid the perpetuation of a continued existence in a post-COVID19 environment of “zombie companies” previously kept out of external administration by a combination of government assistance and moratoriums on insolvent trading liability and the issue of statutory demands. The simplified liquidation process may in turn result in higher returns to creditors than currently available external administration pathways.

Finally, the impact of the Reforms on secured creditors remains uncertain. The Government’s fact sheet is inconsistent on this point, in that it indicates both that there will be no change to the rights of secured creditors and that some creditors will be prohibited from taking action against the company. Greater clarity on this point is required. In the interim, until draft legislation is released, we recommend that creditors assess their debtors and consider entering into bilateral arrangements for debt reduction, or otherwise taking steps to protect their positions. This may include reliance on contractual remedies which are independent of the occurrence of an insolvency event.

How do the Reforms impact insolvency practitioners?

There are a number of aspects of the Reforms that may make accepting an appointment as an SBRP unattractive for specialist insolvency practitioners. 

First, SBRPs are required to agree a flat fee for their appointment upfront. Given the limited information regarding the company’s financial affairs that the practitioner will have at this stage of the process, it is inevitable that not all time costs will be recoverable, particularly while experience of preparing and certifying a restructuring plan is developed. This may provide a valuable cost saving to companies in financial distress, but may also disincentivise specialist insolvency practitioners from accepting appointments as an SBRP. Secondly, the less stringent requirements for an individual to be registered as an SBRP may well broaden the pool of potential advisors, but may also lead to inferior advice and standards of conduct, including a potential increase in phoenix activity. Thirdly, while the Government has indicated that practitioners will not have personal liability for debts incurred by the company during the appointment period, there is no guidance at present as to the risk exposure for the practitioners in managing the implementation of a restructuring plan.

While there is certainly merit in establishing a statutory framework specifically for the restructuring of MSMEs, the proposed Reforms carry the risk of some unintended consequences. We expect the detail of the proposed Reforms to be further refined to ensure that any such consequences are minimised.

See the official media release and fact sheet for further information.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).

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