The Government has made changes to our insolvency framework to better serve Australian small businesses, their creditors and their employees. The changes introduce new processes suitable for small businesses from 1 January 2021, reducing complexity, time and costs for small businesses.
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The changes will enable more Australian small businesses to quickly restructure and to survive the economic impact of COVID-19. Where restructure is not possible, businesses will be able to wind up faster, enabling greater returns for creditors and employees.
These reforms are the most significant changes to the Australian insolvency framework in almost 30 years. They form part of the Government’s JobMaker plan to ensure Australia emerges from the pandemic with a stronger, more resilient and more competitive economy. The need to give businesses and their creditors certainty is crucial to kick-starting confidence and activity as the economy transitions to the recovery phase.
Need for reform of insolvency rules
An efficient and effective insolvency system is important in generating business dynamism which is needed to underpin our economic recovery. The system helps the movement of capital and jobs to more productive from less productive firms. It allows the efficient winding up of businesses, ensuring creditors and employees are paid fairly.
The insolvency system is facing a number of challenges:
- An increase in the number of businesses in financial distress because of COVID-19.
- A ‘one-size-fits-all’ system, which imposes the same duties and obligations, regardless of the size and complexity of the administration.
- Barriers of high cost and lengthy processes that can prevent distressed small businesses from engaging with the insolvency system early, reducing their opportunity to restructure and survive.
Last year, the Government announced temporary measures to support businesses to get through the Coronavirus outbreak. These measures have had a positive impact on allowing businesses to survive, with a 46 per cent decrease in the number of companies that have gone into external administration over the period from March to July 2020 compared with the same period last year. However, as the temporary relief expires at the end of December, the number of companies being put into external administration is expected to increase significantly, putting additional stress on the system. These reforms will help more businesses to successfully get to the other side of the crisis.
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The package of reforms features three key elements:
- A new formal debt restructuring process for small businesses to provide a faster and less complex mechanism for financially distressed but viable firms to restructure their existing debts, maximising the chance of them surviving and contributing to economic and jobs growth.
- A new, simplified liquidation pathway for small businesses to allow faster and lower-cost liquidation, increasing returns for creditors and employees.
- Complementary measures to ensure the insolvency sector can respond effectively both in the short and long term to increased demand and to the needs of small business.
Together, these measures will reposition Australia's insolvency system to reduce access costs for small business, to reduce the time they spend during insolvency processes, to ensure greater economic dynamism, and ultimately help more small businesses to survive.
These measures commenced on 1 January 2021, subject to the passing of legislation.
Small and medium enterprises may warrant a different treatment from other firms in a debt restructuring strategy as complex, lengthy and rigid procedures, as well as required expertise and high costs of insolvency can fail to adequately meet the needs of SMEs
Why this is needed
Many small businesses will have significantly increased their level of debt in order to remain in business during the Coronavirus outbreak. To support small businesses facing financial distress to recover, it will be important that they can access a simple, cheap and faster means to restructure their debt. This will allow more businesses to go on trading, meaning better outcomes for the businesses, their creditors and their employees.
Currently, requirements around voluntary administration in Australia are more suited to large, complex company insolvencies. The high costs of voluntary administration can also consume most or all of the value of a small business’s assets, making it harder for the business to restructure and reducing the business’s willingness to engage with the system. Voluntary administration also involves placing the business under the control of an administrator, which may deter many small and family businesses from accessing the process.
A new, simplified restructuring process drawing on key features of the US Chapter 11 bankruptcy process will be introduced for eligible small businesses so that they can restructure their debts, maximising their opportunity for survival. The process will allow small businesses to access a single, streamlined process while allowing the owners to remain in control of their business.
The Productivity Commission reported in 2015 that almost 60 per cent of companies that enter voluntary administration are deregistered within three years. The new restructuring process is not only aimed at enhancing the rate of successful restructuring outcomes, but also providing a pathway for distressed small businesses that historically would never have entered voluntary administration due to the costs and the loss of control associated with that process.
The process will be available to incorporated businesses with liabilities of less than $1 million.
Around 76 per cent of companies entering into external administration in 2018-19 had less than $1 million in liabilities. Of these, around 98 per cent are estimated to be businesses with less than 20 full-time equivalent employees. Larger and more complex businesses, as well as small businesses seeking more flexibility in how they may restructure, can continue to use voluntary administration.
A ‘debtor in possession’ model
The proposal adopts a ‘debtor in possession’ model. That means that the business can keep trading under the control of its owners, who know the business best, while a debt restructuring plan is developed and voted on by creditors.
Business owners will be able to trade in the ordinary course of business when a plan is being developed; prior approval of the small business restructuring practitioner (the practitioner) will be required for trading that is outside the ordinary course of business.
The business owners will be required to work with the practitioner to develop and put forward a restructuring plan and to provide information about the business’s financial affairs to the practitioner to assist with identifying creditors and to assist creditors in making an informed decision on the restructuring plan.
The change to SME insolvency rules is expected to create higher demand for turn-around specialist firms, where the focus is on saving the company and its jobs, rather than liquidating its assets.
More information can be found at: