Winding-up: Simplifying small business insolvency

On 1 January 2021, new laws came into effect that introduce a new, simplified debt restructuring and liquidation framework for small business.

 Drawing on key features of the Chapter 11 bankruptcy model in the United States, the new system aims to speed up the insolvency process, reduce costs and where possible, restructure to help the business survive. Where survival is not possible, it’s hoped that the quicker insolvency process will deliver greater returns for creditors and employees.

Under previous insolvency laws, the insolvency process treated all businesses the same regardless of size. The new laws step away from the ‘one size fits all’ model. The simplified debt restructuring and liquidation framework is available to incorporated entities with liabilities of less than $1 million (around 76% of insolvencies are businesses with less than 20 employees) with non-complex debt. The liquidation framework also requires that a company is up to date with its entitlements and tax obligations.

The new laws are intended to help manage the tide of insolvencies expected now that the temporary insolvency related relief for financially distressed businesses has ended (the COVID-19 relief measures which protected directors from insolvent trading and raised the threshold for action by creditors, ended on 31 December 2020.) There is no question that the temporary measures in tandem with the stimulus measures such as JobKeeper have kept some ‘zombie’ businesses afloat. In November 2020, 306 businesses entered external administration compared to 748 in November 2019. In general, the number of insolvencies has dropped by around 200 to 300 each month since March 2020 compared to 2019 figures.

Debt restructuring

For financially distressed but viable companies, simplified debt restructuring is available. Under this process, the directors resolve 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. Once a practitioner has been appointed, the directors generally have 20 days to develop a plan that sets out an approach to repay the company’s existing debts. Only the company directors can propose a debt restructuring plan to the company’s creditors and the creditors have the opportunity to vote on the plan electronically or virtually (previously creditors had to be physically present or appoint a proxy).

During this time, the company directors retain control of the business – which is very different to the previous laws where the administrator took control of the company during voluntary administration.

To prevent the new laws being abused by phoenixing, a company is not eligible to use the debt restructuring process if a director of the company or the company itself has previously been through this process or the simplified liquidation process. The new laws are also not available where the company has already entered into an external administration process.

Streamlined insolvency

If a company is not viable (the company will not be able to pay its debts in full within 12 months), the directors can resolve to voluntarily wind up the company and access the streamlined insolvency process. Once the resolution has been passed, the directors have five business days to provide the appointed liquidator with a report on the company’s business affairs and a declaration that the company meets the eligibility criteria to access the simplified liquidation process.

If the liquidator agrees that the company qualifies for the simplified liquidation process, the creditors are advised of the process that will be adopted. The creditors can reject the approach if 25% or more by value, oppose the process.

Streamlined insolvency is designed for companies with relatively simple affairs and is limited to those that have liabilities under $1 million and are up to date with their taxation obligations. It uses the existing insolvency framework but simplifies the interaction with creditors and ASIC. For example, outside of the simplified system, the liquidator may convene a creditor’s meeting at any time to keep creditors up to date, find out the creditor’s wishes, or to approve the liquidator’s fees. The simplified system removes the obligation for a liquidator to convene these meetings with communication managed electronically. And, under the simplified systems the oversight of creditors is limited, creditors for example cannot appoint a committee of inspection to monitor the conduct of the liquidation.

There are strict timings that apply to the insolvency process. If you are concerned that your business will not be able to meet its obligations, please contact us as soon as possible and we will review the situation for you. Where assistance is required, we can refer you to a qualified insolvency or small business restructuring practitioner.