Small business restructuring: what does it mean for financiers?

On 1 January 2021, amendments to the Corporations Act 2001 (Cth) introduced a new regime for the restructuring of small businesses. The procedure shares many of the features of administration under Pt 5.3A of the Corporations Act. The focus of this article is the differences between the new small business restructuring regime and administration, and the different approach financiers and creditors may adopt in light of those differences.

Background

The new legislation followed the Insolvency Inquiry Report by the Australian Small Business and Family Enterprise Ombudsman, which investigated the experience of small and family companies that had undergone external administration.[1] The legislation has introduced a restructuring regime for eligible companies and provides temporary protection from statutory demands and insolvent trading claims for companies seeking restructuring. The stated intention of introducing these provisions was reducing the costs of the prior one-size-fits-all insolvency system for smaller and less complex external administrations, assisting more businesses to remain viable and improving the returns to creditors and employees for unviable businesses.[2]

Under the new legislation, a company becomes eligible for restructuring when the liabilities of the company are less than $1 million and the directors have not sought restructuring within the last 7 years. If the board believes the company is insolvent or insolvency is impending, a restructuring practitioner may then be appointed by resolution of the board. In the financial year ending June 2019, almost 76% of companies entering liquidation had liabilities of less than $1 million. The new restructuring regime has, therefore, the potential to become the dominant form of pre-liquidation external administration.

Protections for companies seeking to restructure

Restructuring comes with similar or equivalent protections to administration offered under ss 440A–440JA of the Corporations Act and offers similar rights to secured parties, owners and lessors.

The legislation also introduced temporary protection provisions as a response to the financial pressures created by the COVID-19 pandemic. Companies eligible for restructuring that make the required declaration between 1 January 2021 and 31 March 2021 are granted a 3-month relief period (which may be extended to 4 months). During this relief period, the statutory minimum for a statutory demand is increased to $20,000 and the statutory period for repayment of a demand is increased to 6 months. Also during this relief period, a safe harbour from s 588G(2) applies to companies that incur debts in the ordinary course of business after taking all reasonable steps to appoint a restructuring practitioner. This provision effectively builds upon the temporary safe harbour provision introduced in March 2020 by the Coronavirus Economic Response Package Omnibus Act 2020 (Cth).

Dealing with creditors’ claims

The restructuring plan deals with “admissible debts or claims”, being debts incurred by the company before restructuring commenced. Debts incurred once restructuring commences, including employee entitlements and related entity creditors, are excluded. So as to be able to propose a restructuring plan, a company must have paid employee entitlements and have up-to-date tax lodgements. Further, a restructuring plan is void to the extent it is inconsistent with the standard terms that all admissible debts and claims rank equally and will be paid proportionately if there is insufficient property.

The legislation creates fixed terms for the period of any conditional commencement, the full release of the company from admissible debts and claims, a 3-year maximum duration, and the requirement to provide for the restructuring practitioner’s remuneration. The terms of a restructuring plan are, in essence, a much more rigid and simplified approach when compared to a deed of company arrangement (DOCA), which has a great deal more flexibility.

A restructuring plan is also a little less negotiable (being either accepted or not) when considered in light of the ability of creditors under s 439C to agree to execute a DOCA that differs from the proposed deed. However, the simplicity of the approach is likely appropriate for the companies opting for a cheaper restructuring over administration.

The central difference between restructuring and administration is the party with control of the company. Restructuring utilises a debtor-in-possession approach, leaving the directors in control of the company and its transactions that are in the “ordinary course of business”.[3] The approach is an attempt to encourage engagement with the insolvency regime, as directors of small companies wish to retain control based on the notion[4] that they are (or at least they perceive they are) the best person to trade the business during external administration. As developed below, the debtor-in-possession model is likely to have a profound impact on dealings between a company and its creditors and financiers during a restructuring.

The proposal period for a restructuring plan is equivalent to a DOCA (ie, 20 business days). The acceptance period for the plan (15 days) is tight considering that voting is reliant on the post. There are also tight timeframes for creditors to dispute the amount of their admissible debts or claims as set out in the proposal statement. A creditor may dispute the debt within 5 business days of receiving the proposal. If their dispute is not accepted by the restructuring practitioner, they will need to obtain an order of the court prior to the restructuring plan being accepted (ie, within 15 days of the proposed plan being given). It is unclear whether a later application to the court to vary the admissible debt would fall under the court’s power to vary the restructuring plan as the schedule of debts is not contained in the plan itself but the accompanying proposal statement.

The benefits of the new small business restructuring regime for creditors is really the reduced costs of the process, no doubt attempting to address findings that external administration is too expensive for small companies and discouraged them from engaging with the insolvency regime.[5] Costs are saved in a variety of ways — meeting of creditors are not required, there is no committee of inspection, no reports to creditors, little in terms of investigations and the restructuring practitioner is not responsible for the continued trading of the company. Changes have also been made to remuneration — fixing the rate in the plan as a percentage of payments to creditors[6] — in an apparent hope to address concerns that external administrators’ fees are too high.[7]

The reduced costs may be advantageous to creditors as it increases any return, but it comes hand in hand with a lesser degree of oversight and control. The lack of creditor meetings and reports means creditors are provided with less information. Nor can creditors vary a restructuring plan by resolution (as they can with a DOCA); only the court has the power to do so.

Consequences of debtor-in-possession model

A flow on effect of the retention of control by the company’s directors is the exclusion of liability on the part of the restructuring practitioner for actions during the restructuring. This is likely to have a serious impact on the approach of creditors and financiers to its dealings with a company in the process of restructuring and will, in turn, impact upon the efficacy of the regime.

In an administration, the administrator bears personal liability for costs incurred during the administration. This personal liability gives those dealing with the company confidence that it can continue its dealings with the company more or less as before, in turn permitting the company to continue trading and maximising the chances of recovery, or a retention of value (and therefore better return to creditors) if the company cannot be rescued.

Stripped of those protections, creditors and financiers would be well advised not to advance further credit to a company proposing to restructure under the new regime, and instead insist (for example) on “cash on delivery terms” or the securing of further debt against assets held by the directors personally. Actions such as these, at a time when a small business is already in straitened financial circumstances, will very likely result in the kind of value destruction for which the existing insolvency procedures have been criticised in the past.

Conclusion

The restructuring regime is responsive to the finding in the Insolvency Inquiry Report that the existing regime was focused on maximising the return to creditors, irrespective of the cost of the process or the effect on the business. No doubt this consideration informed many aspects of the new small business restructuring regime. This premise does not, however, adequately acknowledge that where a business is in distress, the interests of the company and its creditors are mostly aligned. Both are interested in rescuing the business (thus retaining a customer for the creditor) and if that is not possible, retaining as much value in the business as possible by having it continue as a going concern so as to generate the best possible return for creditors, many of whom may also be small businesses. The limited extent to which the new process has been taken up by small businesses in the short time since its enactment may be due to a number of factors, and the success (or otherwise) of the new regime will become clearer in the months and years to come.