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The Small Business Insolvency Reforms:? what is proposed, and what will it mean for business and the profession?The Corporations Amendment (Corporate Insolvency Reforms) Bill 2020 (“The Bill”) Presentation to the CPA Insolvency & Reconstruction Discussion GroupMonday, 9 November 2020Presented by Mark McKillop, Barrister at Lawof Castan Chambers Level 14.Foley’s List Victorian BarTelephone 9225 7592Email mark.mckillop@.auMobile 0402 891 370Introduction and ResourcesOn 24 September 2020 Treasury announced corporate law reforms introducing a new system for administering insolvent small and medium enterprises (SMEs). The primary reform is to provide businesses that have less than $1 million in liabilities an opportunity to restructure their debts whilst staying under the control of directors, and enjoying protections comparable to those afforded under voluntary administration. It is a type of “Debtor in Possession” model of insolvent administration that adopts aspects of the US Chapter 11 bankruptcy process.The introduction of the reforms, slated to commence on 1 January 2020, are intended to coincide with temporary protections for directors and companies ending on 31 December 2020, and the Job Keeper subsidy ending on 28 March 2021. The reforms are designed in anticipation of an expected wave of SME insolvencies projected to occur when the current moratoria and restrictions on insolvencies end. The proposed amendments giving effect to the new system are intended to be passed before the end of the year so that they can take effect from 1 January 2021.A copy of the Treasurer’s initial media release can be found?here. ?The release also includes a link to a “Insolvency Reforms Fact Sheet”?here.? The draft legislation has been rushed out, being only about two thirds finished. The unfinished parts are to be filled by regulations to be made later. Presumably the idea is to permit more time for the Commonwealth to consult with the professions, industry and other SME stakeholders, which may be the only practical way to get the changes made so they can commence by 1 January 2021. This approach, whilst unorthodox for insolvency reform, is welcome at least to the extent that there was little or no consultation before the package was announced. My comments on the draft legislation can be found here and I prepared a submission to Treasury on the draft legislation, which can be found here. The draft legislation can be found here and the accompanying explanatory memorandum here. My comments on the initial proposal can be found here. Somewhat extraordinarily, Treasury allowed only 6 days before comments on the draft closed. Evidence recently given to the Senate Economics Legislation Committee by Treasury shows the degree to which the process of making these reforms has been rushed. No small business stakeholders, industries or their associations were consulted on the reforms before their announcement, even privately. The exposure draft of the bill was open for a week, and the reason “was the desire to have this legislation in place for commencement on 1 January”. Some 51 submissions were received in that week.The Philosophy behind the ReformsThe Federal Government has promoted this mechanism as a cheaper and more flexible insolvent administration for small businesses, one of its core constituencies. Many small businesses avoid voluntary administration process due to perceptions of high cost and delays.Small businesses are prone to having their assets depleted during the liquidation process through high administrative costs. The changes are intended to provide a form of insolvent administration that small businesses are more likely to use, and in the event the business fails, allow the business owners to walk away with fewer losses.The explanatory memorandum contains summary of the context for the reforms as the government sees it:The current insolvency system is a one-size-fits-all system that imposes the same duties and obligations, regardless of the size and complexity of the administration. In this way, the current system lacks the flexibility to provide for small businesses for which complex, lengthy and rigid procedures can be unsuitable. The barriers of high cost and lengthy processes can prevent distressed small businesses from engaging with the insolvency system early, reducing their opportunity to restructure and survive. The costs incurred under external administration are borne out of the assets of the distressed company and can be greater than the value of the assets of the company. This places undue pressure on the company, potentially forcing it into liquidation at the end of voluntary administration, leaving less returns for creditors and employees. These challenges are particularly evident in light of the economic consequences of Coronavirus and the increase in numbers of businesses facing financial distress. The significant economic consequences have highlighted the need for an efficient external administration process that allows small incorporated businesses to remain viable, and where that is not possible, for a process that encourages a better deal for creditors and employees.According to the treasurer’s press release, the reforms will cover around 76 per cent of businesses subject to insolvencies, 98 per cent of whom who have less than 20 employees.A Brief Summary of the Proposed ReformsRestructuring a CompanyRather than adapting the existing processes for voluntary administration, the drafters have inserted an entirely new part, Part 5.3B of the Corporations Act 2001 (Cth) (CA) entitled “Part 5.3B – Restructuring a Company”, dealing with restructuring of a company. A new type of “debtor in possession” insolvency process is created, called the “restructuring” process. Under that process, Incorporated businesses with liabilities of less than $1 million are permitted to stay in control of the business while restructuring their existing debts. Whilst the company will stay under director control, the director/s will be required to appoint a “restructuring practitioner”. The practitioner will have to be a registered liquidator.The office of “restructuring practitioner” is created to be retained to assist in restructuring, and in dealing with creditors. The term for the appointee used in the part is “restructuring practitioner”. The term is used for an appointee both during the restructuring period and after the restructuring plan is accepted: there is no term akin to “deed administrator”. Once the director/s have approved the appointment of a restructuring practitioner, the company is protected from all unsecured creditors, and there is limited protection from secured creditors. These creditors cannot enforce personal guarantees against the directors from this time. A company who proposes a restructuring plan is taken to be insolvent.The company has 20 days to develop a restructuring plan, in which time the director/s are still in control of the business.Creditors then have 15 days to vote on the restructuring plan, and if accepted the practitioner will oversee the distributions of funds to creditors. Employee entitlements that are due and payable will be required to be paid in full before the plan is voted on by creditors, and outstanding tax filings (but not due payments) will need to be up to date. The restructuring plan will require a vote of more than 50% of creditors by value to be approved. Related party creditors will be prohibited from voting on the plan.The restructuring practitioner has power to terminate a restructuring on certain grounds: see s453J. The grounds include (subject to further regulations) if the company does not meet the eligibility criteria for restructuring, if it would not be in the interests of creditors to make a restructuring plan, or continue with a plan, or it would be in the interests of creditors for the company to be wound up.Many of the mechanical sections of the part are copied over from part 5.3A. An example: a person appointed as a restructuring practitioner must make a declaration of relevant relationships. The DIRRI provision, section 60, has been amended accordingly. Similarly, there are parallel restrictions on third party property and secured creditor action during the period of the restructuring process. Others include, effects of an appointment on a winding up (which are akin to a VA appointment) and secured creditor assets and leave to proceed.A lot of basic mechanics dealt with in the new Part 5.3B are copies of similar provisions from 5.3A. Simplified LiquidationIf the restructuring plan is rejected, the company will go into a new, simplified version of liquidation. The simplified process is to be achieved in the CA by the simple expedient of carving out certain processes that apply at present. The main carve outs include:reducing the circumstances in which a liquidator can clawback unfair preferences from a creditor that is not related to the company;requiring the liquidator to report to ASIC (under section 533 of the Corporations Act 2001 (Cth)) only on potential misconduct where there are reasonable grounds to believe that misconduct has occurred;removing requirements to call creditor meetings and the ability to form committees of inspection;streamlining the process of dealing with proofs of debt and distributing dividends; maximising the use of modern technology in communications and creditor voting. These changes include using electronic communication to reduce the delay in communicating with creditors, permitting electronic voting by creditors and eliminating the paper-based costs if distributing documents, including creditor reports; andfeatures of the liquidation process otherwise continue to apply, including safe harbour. There are amendments to the safe harbour provisions, and a new safe harbour for companies under restructuring in 588GAA(B). There is a carve out for insolvent trading in relation to transactions entered into during the restructuring period which are in the ordinary course of the company’s business or with the consent of the restructuring practitioner. Comments on the Bill What is the best threshold for the reforms to cut in? Are the total amount of debts really the best criteria to apply?The amount of the debt threshold is a real issue. Careful thought needs to be given to the basket of companies the government is really looking to protect. If the government is really looking to carve out those companies which make up (by number) the bulk of insolvencies, which typically do not (or should not) involve much work by the insolvency practitioner due to low levels of assets, then the debt threshold ought to be lower. The objective for these companies may be to “speed” through the process of getting in and distributing assets and to turn over a new leaf so the business transforms into a debt free existence. Likewise, the types of and what sort of debts that are to count is an issue. If future debts are included, then any company with long lease obligations for land or equipment may qualify for the debt threshold if future lease payments are counted. Likewise, if contingent debts are counted then operating contracts (eg a construction subcontract) may also reach the threshold with such claims.The prejudice to creditors of a very simplified process is not unwarranted since, for such companies, there would normally be little or no return to creditors anyway. Such a policy objective would be aided by a low threshold of say $250,000 not including future or contingent claims, if a debt threshold is to be the only criteria applied. There is a lot of sense in using a broader criterion than debt alone. Similar reforms in Singapore have introduced thresholds that take into account other factors. Companies are eligible to participate in the Simplified Insolvency Programme in Singapore only if they satisfy all of the following criteria:Sales turnover not exceeding SGP 10m;No more than 30 employees;No more than 50 creditors;Liabilities of no more than SGD 2m;For winding up, the value of realisable assets is not in excess of SGD50,000.In my view a combination of similar factors should be used in Australia to better target the reforms, even with a higher liability threshold. The legislation is undercookedAbout two thirds of the changes to be introduced are not yet in the legislation but are to be provided later by regulation. In summary, the exposure draft leaves a lot of work to be done by the drafters to get the legislation finalised. A lot of the meat in terms of substantive changes to the existing law is left to regulation, probably sensibly the only way to get this process done with consultation within the industry in time. It seems to me that the exposure draft has been rushed out by using this device and that a lot of the hard yards will be done in the process of sifting through submissions already made and in further consultation, hopefully with industry bodies and the legal profession.Some notable examples include:The eligibility of a company to participate in a restructuring based on its liabilities, and the degree to which a director can have previously been involved in another restructuring – see 435C. The whole question of what liabilities count toward the threshold debt ceiling for eligibility, and even what the ceiling is to be, are not yet in the legislation;Surprisingly, nearly all of the functions, duties and powers of the restructuring practitioner. There is a generic provision for basic functions like providing advice to the company on restructuring matters, assisting and preparing a restructuring plan, making a declaration to creditors “in accordance with the regulations” in relation to the plan and any other functions given to the practitioner under the Act. Apart from that, the regulations are to provide;The form, content, making, implementation, varying, lapsing, voiding, contravention and termination of restructuring plans. Regulations are also to provide for the role of the restructuring practitioner in relation to the plan. There are all very important issues for the success of the reforms;The role of the Court is, in many respects, to be provided: there is division 6, which provides for the powers of the court in relation to restructuring plans to be subject to regulation. Section 458A does provide that the powers of the Court will include at least a power to vary or terminate a restructuring plan and to declare a restructuring plan void.the eligibility criteria for the simplified liquidation process, simplified methods of dealing with proofs of debt and distribution of dividends, ASIC reporting, dealing with contributories, payment of dividends, and more limited basis of circumstances in which unfair preferences can be recovered. One would think that regulations are being used in order to allow consultation with the industry before the legislation is finalised, or perhaps allowing it to be easily tweaked after 1 January 2021. It will be interesting to see whether substantive text is used in the final draft of Part 5.3B rather than in regulations.The role of the Court The role of the Court is a work in progress. There is a balancing act in any insolvency regime. On one hand it is desirable to allow creditors or other stakeholders to go to court to protect themselves from abuse of process. On the other hand, too much judicial oversight can make the process too expensive to use. Cost is a key complaint that has led to the reform package. The fact that the role of the Court is to be finalised in the Exposure Draft reflects, I think, a lot of thinking going on at government level and probably a desire to further consult on this issue with the profession. Practical Operation IssuesIt will be interesting to see on what basis the power of a restructuring practitioner to terminate the restructuring of a company will be exercised in practice. One would imagine the type of situations in which a VA might recommend liquidation would be a basis - where businesses are dead and buried with no potential of saving, so that the appointment is misconceived, or cases involving substantial fraud or criminality.There is provision for transition to a voluntary administration or liquidation in the event that a restructuring plan is rejected. It is not clear to me exactly how this is to occur: it is to be provided for in regulations (s453A(b)). Amendments to the small business guide in Part 1.5 of the Act do provide that if creditors do not agree to the restructuring plan the company may be placed in voluntary administration or winding up. It appears that the rejection of the restructuring plan will amount to a resolution by creditors that the company be wound up unless alternative arrangements are made to transition to a voluntary administration. Logically it would be similar to the rejection of a DOCA proposal.The Bill does not make clear whether the appointment of a restructuring practitioner will trigger vesting under section 267 of the Personal Property Securities Act 2009 (Cth) (PPSA). ?Or will vesting not occur if and until a subsequent administration or liquidation occurs.?A security interest which is unperfected vests in corporations which are wound up or enter into a voluntary administration by s267(1). ?The underlying policy principle behind vesting is to aid unsecured creditors in the insolvent administration left unaware of the unperfected security ments on the Proposed Reforms Generally Scrap the entitlements and tax lodgement requirements The Bill requires all employee entitlements to be paid before it can be used. In my view this requirement ought to be scrapped. If the Bill is intended to deal with victims of the pandemic, how many of them will be in a position to make these payments? Some sure, but many will not. Anecdotally, insolvency practitioners inform me that entitlements and tax lodgements are rarely if ever up to date fulfilled in SME insolvencies. It seems to me to be a device to prefer the entitlements guarantee fund. Similarly, the requirement to have ATO lodgements up to date ought also be scrapped - it is a unnecessary barrier. If the government wishes to protect the revenue, then there are other methods available which are more efficient. What may end up happening is that truly destitute companies that need to access the process, but cannot meet these requirements, will be forced into voluntary administration or liquidation instead. Draft more of the Bill, and use less regulationsLarge parts of the Bill leave substantive issues to be made by regulation. It is preferable to have much of the law once passed contained in one place for ease of reference, not just for lawyers, but for businesses using or exposed to the law as debtors or creditors. No draft regulations have been issued yet. Much of the legislation is accordingly yet to be revealed. Whilst it is understandable that such an approach be taken to prepare the exposure draft to save time, the final draft of the Bill incorporates as much of the amendments in the text of the Act as possible. In particular:Powers of the Court;The rights, obligations and liabilities of the restructuring practitioner;Debt criteria for determining companies that can participate in a restructuring and in simplified liquidation;Form, content, making, implementation, varying, lapsing, voiding, contravention and termination of restructuring plans. Limitations on Voidable Transactions in Debt Restructuring.Hasten more slowly The rush to get the legislation in place is understandable, but in my view is not really necessary. Perhaps when the idea was hatched within Treasury, in mid-year, the possibility of an avalanche of insolvencies was a real prospect. But I think that danger has receded:first, the existing restrictions/moratoria on statutory demands, bankruptcy and insolvent trading have driven down new appointments to very low levels. There is, ironically, probably a greater danger of insolvency firms being driven into the wall than some SMEs. The consequence is that there is a great deal of unused capacity in the industry to deal with new appointments after 1 January 2021; second, the covid recession in Australia looks to be shorter than expected. Jobkeeper and Jobseeker look to have been effective in avoiding a collapse in expenditure. It may be that the damage to small business will be isolated to particular industries, like international tourism, education, hospitality and arts, leisure and events. Widespread damage to swathes of the economy look avoidable;third, there will be a gradual build up in insolvency work, like other recessions in the past. All of these factors suggest that the 1 January 2021 start date is not essential. The commencement of the Bill ought to be delayed in my view, to 1 March 2021. The time is necessary to allow proper development of the Bill and the policy behind it. It would still be possible to allow Companies to indicate an intention to activate the process from 1 January 2021 as is currently intended. As I understand it elements of the Bill have been borrowed from ARITA who is largely supportive of the overall policy idea. Consultation with ARITA in particular, and others, should be made as to the practical need for some elements of the Bill and refinement of the drafting. Only a minority of SMEs are covered, and those that are may not be assistedA real concern, given that the reforms are aimed at making insolvent administration of SMEs quicker and cheaper, is that they fail to include personal insolvency or incorporated associations. A significant proportion of SMEs are unincorporated. According to figures cited by Michael Murray and sourced from the Small Business Ombudsman, corporations make up less than 40% of SMEs. The reforms will not cover sole traders, partnerships, incorporated associations or trusts where the trustee is not incorporated.So 60% of SMEs are not covered or assisted by the reforms which do not touch bankruptcy law, the state incorporated associations legislation nor partnership legislation.Further, when one drills into the statistics of corporate insolvencies in Australia, it is apparent that the vast majority of insolvent companies that qualify for restructuring are unlikely to be in a position to successfully implement a restructuring plan. In order for a turnaround plan to work, there must be assets available to pay creditors some better return than liquidation and to pay the restructuring practitioner. The following numbers in relation to corporate insolvencies subject to external administration are sourced from ASIC and compiled by Professor Jason Harris, a leading insolvency academic:75% had annual turnover of under $200,00078% had remaining assets or funds of $50,000 or less, and a majority $10,000 or less92% were estimated to provide nil dividends to creditors;in a significant proportion, the practitioner was unpaid or underpaid.The reforms will thus not assist a significant share of eligible companies to restructure. The profession and small business impacts I suspect that the impact of the reforms will be more limited than both treasury and the profession think. I suspect that the threshold for application of restructuring as presently proposed, in particular the requirement for up to date entitlements and tax lodgements, will prevent many companies from qualifying. Assuming that issue is fixed in the drafting and the requirements scrapped, I suspect that most of the companies using the process will not have had sufficient assets to generate much of a return to creditors nor fees to liquidators. In that respect, I don’t think liquidators ought be concerned about losing otherwise paying work in VA or liquidation appointments. As the treasury has noted, they expect to catch the vast bulk of company liquidations that have little or no assets, relatively few creditors and not much prospect of succeeding through formal VA process. It is type of “one percenter” issue. The vast bulk of liquidations produce little or no returns to creditors: in that sense the profile of the corporate population is the same as individuals. If the reforms succeed in reducing the bulk of ordinary liquidations or voluntary administrations, that will not be a bad thing. They will be directed by the process, if invoked, into simplified liquidation. To the extent the reforms make the administration and renewal (or liquidation) of SMEs quicker, cheaper and more flexible, they ought to be good for both business and the profession. Date: 9 November 2020Mark McKillopCastan ChambersMelbourne Victoria ................
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