How will the new Insolvency reforms impact your business?

In what will be the biggest shake up to insolvencies in 30 years, new legislation is set to take effect from January 1, 2021 that will impact on all businesses. Gone will be the “one-size-fits-all” model of the past, instead giving smaller companies more control of the restructure process through less costly systems, thereby improving the prospects for businesses to survive whilst leaving more money for creditors. So how will it work, and what will the impact be on not only insolvent businesses, but sustainable players too?

Why is the process changing?

The current process for handling end of life businesses is designed for large and complicated business failures, and is therefore very costly and time consuming, usually leaving creditors with little or no repayments. It therefore means that many companies don’t face the issues until it is too late, with many going straight to liquidation instead, and a high portion (about 60%) of those trying voluntary administrations not able to return to a viable position. Whilst many businesses were failing prior to Covid19, there is now going to be a tsunami of businesses in this position, and the simplified process is intended to allow more businesses to continue to trade and keep people employed, whilst trying to soften the blow to the insolvency industry and creditors so they can cope with the fallout. In 2018-2019, 76% of companies that entered external administration had liabilities of less than $1 million, of which 98% of these businesses had less than 20 employees.

How does it work?

Note that this is still draft legislation, but the overall concept is unlikely to be modified:

  1. Rather than have to use costly Voluntary Administration processes requiring handing over control to external advisors (a “creditor in possession” model), incorporated businesses with less than $1 million in liabilities will be able to use a “Debtor in Possession” model drawing on key features from the United States “Chapter 11” bankruptcy model.
  2. During a 20 business day restructure period, the business owner/s can remain in control of the day to day running of the business whilst developing a restructuring plan with assistance and sign off by a “small business restructuring practitioner” (SBRP).
  3. Creditors then get 15 days to vote on the debt restructure plan, including advisor remuneration. A minimum of 50% of the voting creditors by value must approve the plan. There is also a requirement for employee entitlements to be paid out in full before the plan is put to a vote.
  4. If either the SBRP or the creditors vote doesn’t pass, the business can either go into traditional Voluntary administration, or more likely into a simplified Liquidation pathway, designed to reduce cost to leave more money for all creditors.

There will be rules in place to reduce rorting and potential illegal Phoenix activity, including a proposed bar on the same company or directors being able to use the process more than once in a 7 year period, and that related creditors can’t have a vote in the restructure plan.

What is the impact on businesses?

Hopefully businesses in strife will stick their hands up early enough that they can be resurrected. It is likely that the restructure plans will involve creditors agreeing to accept less than the amount they are owed, and potentially that the payments are made over a period of time. Whilst that is not good for creditors, some payments in a shorter period of time is better than no payments after a costly drawn out process.

A carry over issue from the current insolvency laws is that Secured Creditors still get paid first. This rule is in place to protect banks at the expense of business creditors (who are highly unlikely to be able to get their debtors to sign a legally enforcing General Security arrangement). It appears that secured creditors will have an equal vote to unsecured creditors, even though the approved scheme will give secured creditors preference whilst binding all unsecured creditors to the plan. The issue of course is that the banks and ATO combined are probably owed the majority of funds and will continue to get paid first as opposed to in proportion to the total debts owed, meaning unsecured creditors will most likely still come out receiving crumbs or empty handed.

SBRP’s will be required to propose a flat fee (potentially as a fixed percentage fee of disbursements), which should limit the potential for milking the company dry. In return, the SBRP’s have less reporting and investigative requirements and can use simplified voting and communication processes. Limiting the SBRP’s ability to undertake costly (and usually fruitless) unfair preferential payment claims will also help give some certainty to well run creditors who simply managed their debt collection processes only to still find themselves on the receiving end of nasty surprises.

Other than having good debt collection practices in place, including possibly using General Security Agreements, there is not really anything further that businesses can do to protect themselves from the fallout of companies going down than they currently do.

Will the system work?

In my experience, nearly every company that fails doesn’t acknowledge the issues until it’s too late to do anything about it, frequently because they know handing the company over to administrators will be the final nail in the coffin and leave them with less than they feel they can get by struggling on. Voluntary administration and the usually ensuing Liquidation sucks out any remaining funds. So, based on that the current system nearly always fails, whilst the new process has flaws, the new system will lead to better outcomes faster and at lower costs in more instances. Whilst the new system leaves the control of the company with the original owner, in many cases that leaves the reason for the business failure still in charge. However, they will be working at a lower cost than administrators and probably much harder to try to make it work because they have more skin in the game. It is also proposed that SBRP’s need to be registered liquidators. The new legislation therefore still leaves the high cost fox in the hen house, but the difference is that the possibly headless chook has now been put in charge to lead the company to a new pen.

What is lacking is that this scheme needs for the businesses to have access to low-cost-hands-on experienced business managers and a pool of specialised service providers (from people who know how to actually make the business more efficient and productive). That is, if the business doesn’t know how to handle employment issues/debt collection or whatever, they need access to get in an experienced person to undertake the required actions whilst the owner concentrates on their area of expertise.

At the end of the day, it’s a reality that not all businesses are viable. The new system should enable these businesses to fail at less cost. This system will allow more businesses to emerge from tough times, but it will also continue kicking the “zombie company” can down the road by allowing some businesses to clean out debts at reduced amounts, thereby continuing to impact on market price levels required for sustainable businesses. One positive is that this should shine a light on the “illegal phoenix operators/advisers” by hopefully increasing the use of “pre-insolvency advisors”, that is the genuine business advisers who work to actually improve the profitability of businesses as opposed to asset shufflers.

The proposed system has more benefits than drawbacks and needs to be given a go. My prediction is that there needs to be a review after about 12 months to address unintended consequences, including some of the potential issues highlight above. There will still be a lot of failed businesses and unpaid creditors, but a higher portion of businesses will survive and more bills will be paid (with less going to the insolvency vultures) than without these changes.

As always, onwards and upwards!

Fred Carlsson

General Manager

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