Insolvency law reform for small businesses

by Mia Formichella

The proposed insolvency reform introduced by the Federal Government in October 2020 will provide a streamlined restructuring and liquidation process to support small businesses, with a focus on restructuring rather than deregistering.  This reform has largely come about due to the increasing number of small businesses in financial distress as a result of the COVID-19 pandemic.


The insolvency relief measures introduced as a result of the pandemic are due to expire on 31 December 2020, being previously extended from 25 September 2020.  Therefore, on 31 December 2020, the temporary measures relating to relief for directors with respect to insolvent trading and the statutory demand regime will cease.  Subject to the passing of the proposed legislation, it is intended that the new insolvency regime will come into effect on 1 January 2021, thereby providing continued relief to eligible businesses impacted as a result of the pandemic.


Insolvency reform


The consultation period for the draft bill entitled the Corporations Amendment (Corporate Insolvency Reforms) Bill 2020 has now ended.  It is intended that when enacted, this legislation will amend both the Corporations Act 2001 and the Corporations Regulations 2001.


The draft bill includes a legislative framework for the measures that will be introduced as a result of the insolvency reform.  The draft bill provides for certain matters to be governed by regulations that will be introduced in support of the legislation.  As the regulations have not yet been made available, the details of how the new processes will operate in practice is open to speculation.


The draft bill introduces two new insolvency processes to support small incorporated businesses (hereinafter referred to as both ‘company’ and ‘business’ where the context requires):


  • A new debt restructuring process; and
  • A new simplified liquidation process.

Whether or not a business may engage in either process will turn on whether that business meets the eligibility requirements imposed by the regulations.  Prior to engaging in either process an eligible business must:


  • Have a liability to its creditors with a cap to be set by the regulations, proposed to be $1 million but subject to flexibility;
  • Have up to date tax lodgements; and
  • For the restructuring process, the business must have paid out all employee entitlements prior to putting forward a restructuring plan.

Furthermore, an eligible business may not enter into either process if a director of that company has previously engaged in either process during a time period to be established by the regulations.  The intention of this measure is to safeguard against illegal phoenix activity.


The new regime differs from other measures currently available to businesses in financial distress, such as voluntary administration or creditor’s voluntary liquidation.  The intention of the insolvency reform is to provide a process for small businesses, where the existing insolvency processes would be inappropriate for many reasons, largely due to the cost.


Restructuring process


The new restructuring process is modelled on the “debtor in possession” model where the directors of the company remain in control of the business throughout the restructuring process.


The new regime includes the introduction of a small business restructuring practitioner (SBRP) appointed by the directors of the company.  The SBRP must be a registered liquidator, and therefore subject to regulation by ASIC.  Whether there will be ancillary requirements or qualifications required of a liquidator appointed to this role is yet to be determined.


The SBRP is to provide advice to the business under restructuring, to assist the business prepare the restructuring plan and any other functions given to the SBRP under the legislation.  The draft bill provides that the regulations may determine further functions, duties, powers, rights and liabilities of the SBRP.


From the date of appointment of the SBRP, and for a period of 20 business days thereafter, the SBRP is to assist the directors of the company to develop a restructuring plan for the business.  What must be included in the plan will be determined by the terms of the regulations.  The creditors of the business then have 15 business days to consider the plan and vote whether to accept it or not.  If more than 50% of the creditors (by value) do not accept the plan, the directors may choose to engage in another insolvency process.


It is important to note, that by putting a restructuring plan to its creditors, a company is taken to be insolvent.


During the 20-business day period and the further 15-business day voting period, the directors may continue to trade in the ordinary course of business.  If the director seeks to trade outside of the ordinary course of business, the SBRP must provide its consent if it considers on reasonable grounds that such transactions would be in the interests of the creditors of the company.


A key difference with this regime compared to others, is that during the entire restructuring period, the directors remain in control of the company.  Although there are certain actions that the SBRP must consent to, the SBRP is appointed as an agent of the company, rather than as an officer.


The significant difference between the existing safe harbour regime and the new restructuring process is that the latter requires a formal appointment of a SBRP.  Although, similar to voluntary administration, the directors are the persons to instigate this process.


Simplified liquidation process


Where a restructuring plan is not appropriate, an eligible business may engage in a simplified liquidation process.  The intention of the refined process is to streamline the regulatory obligations ordinarily required in a liquidation, with a view to saving time and costs.


The simplified liquidation process preserves most of the existing framework for liquidation but differs as follows (amongst other things):


  • Reducing investigation and reporting requirements;
  • Reducing meetings;
  • Removing the requirement for a committee of inspection;
  • Simplifying the dividend process;
  • Increasing the use of technology; and
  • Other matters to be detailed in the regulations, which will include:
    • Reducing the circumstances in which a liquidator can pursue unfair preferences and voidable transactions;
    • Reducing reporting requirements for reports made to ASIC; and
    • Improving the process for proving debts in the liquidation.

Two noteworthy points in the reformed insolvency regime is that in both instances tax lodgements are required to be up to date, and for the restructuring process, employment entitlements must be paid out prior to implementing the restructuring plan.  Although the policy consideration driving each of these requirements is evident, it is likely that these conditions may also pose a barrier to businesses seeking to engage in either process.  It is also uncertain how trade creditors will respond to a business trading during a restructuring period.  These issues, and others, may be addressed pending the outcome of the consultation period, noting submissions in response to the draft bill closed on 12 October 2020.

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