Lacunae in the Legislation: Small Business Restructuring and the Restructuring Practitioner

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By Ariel Borland, Partner and Nik Angelakis, Lawyer

Introduction

On 7 October 2020, the Federal Government released the Exposure Draft Bill and Exposure Draft Explanatory Materials for the Corporations Amendment (Corporate Insolvency Reforms) Bill 2020 (respectively, the Bill and EM). The Bill amends the Corporations Act 2001 (Cth) (Act) to establish the framework for a new formal debt restructuring process, known as Restructuring, and a simplified liquidation procedure for small to medium enterprise companies (SMEs). SMEs are set to have access to the reforms from 1 January 2021.

The reforms are ostensibly geared towards SMEs facing liquidity issues as a result of the COVID-19 pandemic. These are companies relying on temporary moratorium and stimulus measures (such as the JobKeeper Scheme) in order to keep afloat. The Restructuring regime seeks to bridge the gap by creating a permanent solution that will come into force when the temporary measures cease to have effect.

Given the time pressures, the Federal Government has only announced the bare bones of the Restructuring regime. The remainder will be prescribed through amendments to the Corporations Regulations 2001 (Cth) (Regulations) following consultation with industry bodies and the legal profession.

SME insolvency is an area in dire need of reform. However, these reforms have been developed ‘on the fly’ and we hope that the Government pays close attention to the concerns of key stakeholders. This article proceeds in two parts: Part 1 will discuss the key features of, and issues with, the Restructuring regime generally and Part 2 will discuss the lack of clarity surrounding the new office created by the Bill – the small business restructuring practitioner (Restructuring Practitioner).

Part 1 – Key Features

Objective of the Procedure

In contrast to the ‘creditor in possession’ model of insolvency presently used in Australia, Restructuring adopts a ‘debtor in possession’ model which contemplates that the company (and by extension, its directors) will retain control of the company’s affairs, but with the assistance of a Restructuring Practitioner.

The objective of Restructuring is to allow SMEs with viable businesses to trade out of insolvency, with the hope of securing a better outcome for creditors than would result from the immediate appointment of a liquidator or voluntary administrator (the costs of which are generally disproportionate to the complexity of an SME’s affairs, and the quantum of its assets and liabilities).

Overview of the Procedure

In summary, a Restructure will follow a three-stage process.

Firstly, the directors of an eligible SME in financial distress resolve to appoint the Restructuring Practitioner.[1] While the eligibility criteria have not been legislated, the Government has indicated that Restructuring is available only to SMEs with liabilities of less than $1 million.[2] During the period of the Restructure:

  • creditors are restrained from enforcing security interests, taking possession of land or personal property used by the SME, enforcing personal guarantees, terminating contracts due to the SME’s insolvency, or enforcing their debts and claims by virtue of provisions which adapt key concepts from the voluntary administration process; and
  • management of the company are only permitted to enter into transactions which are in the ordinary course of the company’s business or with consent of the Restructuring Practitioner.[3]

Secondly, over a period of twenty business days the company will formulate a proposal for a restructuring plan (Plan) with the assistance of the Restructuring Practitioner.[4] The company is taken to be insolvent if it proposes a Plan. The Plan:

  • can only be offered to creditors if the SME has liabilities under the threshold prescribed by the Regulations (anticipated to be $1 million), is up to date with its tax lodgements, and has paid any employee entitlements which are due and payable;[5] and
  • will specify the debts that are included within and/or compromised by the Plan, the ranking of any distributions made in respect of those debts, and the property available to make those distributions.

Thirdly, creditors will have fifteen business days to submit a proof of debt and vote by electronic means on the proposal. We anticipate that the Regulations will specify that fifty per cent of creditors in value will need to vote in favour of the Plan for it to be adopted by the SME.[6]  If the Plan:

  • is approved, the business of the SME will continue under the directors, but there will be provision for the Plan to be varied or terminated (and we anticipate the operative provisions will be similar to those in place for deeds of company arrangement);[7] and
  • is not approved, the SME may utilise alternative insolvency procedures (such as voluntary administration).[8] Unlike voluntary administration, the creditors of the SME cannot pass a resolution for its winding up, and the SME is returned to the control of its directors – but outside of the Restructure process.

Commentary

We welcome the reforms as a step towards providing tailored and cost-effective insolvency relief to SMEs. However, there are several issues that we hope are either revised on the face of the Bill or clarified in the Regulations which are yet to come.

Eligibility Criteria

As noted, the Government has indicated that Restructuring is available only to SMEs with ‘non-complex’ liabilities with a value of less than $1 million.[9] The Government has not indicated how contingent or prospective liabilities (such as rent under a shopfront lease) or unliquidated claims (such as a claim for damages relating to the sale of defective goods) are to be assessed for that purpose.

In our view, the test ought to factor in the probability that the SME will be required to satisfy the liabilities that are assessed. This test may assess values on a discounted present value basis, or according to whether liabilities are ‘due and payable’ (being, the traditional test of assessing insolvency under the Act). If probabilities are not factored in, then it is likely that the $1 million cap may exclude many SMEs which have long-term or uncertain liabilities (such as leases, or unfounded legal claims made against them). An alternative to this may be to exclude such contingent or uncertain liabilities from the liabilities compromised under the Plan, however such an approach may leave entities with substantial long-term liabilities that could undermine the effectiveness of any restructure. In these cases, it is likely to be cleaner for any restructure to proceed through a voluntary administration.

We also note that in order to propose a Plan to creditors, the SME must ensure that all tax lodgements are up to date,[10] and that employee entitlements have been paid in full.[11] It is not clear whether all tax liabilities must have been remitted (or merely lodged) and whether superannuation contributions must have been paid in full. Each of these is rare in our experience with SMEs (and particularly so in the COVID-19 environment). This is likely to exclude many SMEs from the regime.

Personal Liability & Extension of Credit to SME in Restructure

Unlike a voluntary administrator, the Restructuring Practitioner is not personally liable for debts incurred whilst the SME is in Restructure. This reflects a traditional debtor in possession model.

However, there is no provision in the Bill to make the SME’s directors or officers personally liable for debts incurred in the ordinary course or a super priority for these debts.

. This may undermine the effectiveness of the Restructure regime. Debts incurred by the SME during Restructure are provable debts (and are not paid in priority) in a winding up. Creditors (and in particular, suppliers of goods or services) may be hesitant to extend credit to companies in Restructure, and may instead demand cash on delivery, given the risk of non-payment. The SME may not have cash on hand to do business on that basis. On the other hand, it is likely that directors and officers would be hesitant to enter a Restructure if they assumed personal liability for all debts incurred in the period of Restructure. This is likely to be a major commercial impediment to many Restructures.

Director Penalty Notices

It is unclear how the Restructuring reforms will interact with the director penalty notice (DPN) regime by which the Commissioner of Taxation (Commissioner) can issue a notice on directors requiring them to personally remit PAYG or SGC liabilities. Presently, the recipient of a DPN has 21 days to pay the debt, come to a payment arrangement, or place the company in liquidation or voluntary administration.

Consequential amendments have not been proposed that permit the recipient to place the SME into Restructuring within 21 days, or that stay the Commissioner from issuing a DPN during a Restructure. It is possible that the DPN regime will effectively provide the Commissioner with a power to ‘veto’ any proposed Restructure. In our view, such amendments are necessary so that the Commissioner is not provided with disproportionate power over the process compared with other creditors.

Moreover, the Bill provides that a Restructuring Practitioner may terminate a Restructure,[12] but does not specify whether directors can resolve to terminate the Restructure without the consent of the Restructuring Practitioner. This should be clarified in the Regulations, particularly if the DPN regime is not affected by these reforms.

Court Oversight

Finally, the Bill provides the Court with an oversight role. This role extends to authorising or validating transactions outside of the ordinary course of the SME’s business,[13] authorising a dealing in the shares of the SME,[14] granting leave for a creditor to proceed with a claim against the company or enforce their security interest,[15] to restrain a secured party or receiver from undertaking certain acts,[16] or to vary or terminate a Plan.[17]

However, the reforms are geared specifically at low-asset, low-liability SMEs. We doubt whether it will be commercial to apply to the Court in most, if not all, Restructurings or Plans. This is an issue wider than the scope of these reforms, however, there may well be merit in considering a US-style ‘Bankruptcy Court’ system which deals only with insolvency-centric issues in an expedient, streamlined and cost-effective manner.

Conclusion

As the Australian economy begins to recover from COVID-19, it is important that mechanisms are in place to deal with the swathe of ‘zombie companies’ presently staying afloat due to temporary stimulus measures. The Restructure and Plan processes may be an effective form of rescue for distressed SMEs with viable businesses that could not otherwise bear the cost of the voluntary administration process. Yet as 1 January 2021 fast approaches, there is still much to be done.

Part 2 – The Restructuring Practitioner

Introduction

Part 2 of this article discusses the nature of the Restructuring Practitioner who oversees the process, and specific concerns that we have with the draft legislation.

The Act clearly sets out the powers, functions, and duties of the receiver,[18] voluntary administrator,[19] and liquidator.[20] The result is that practitioners are generally aware of what they can and cannot do. If there is doubt, or a risk of exposure to personal liability, then the practitioner can obtain directions from the Court under the section 90-15 of the Insolvency Practice Schedule (Corporations) 2016.

Unfortunately, the Bill and EM fall short of providing practitioners with the clarity they need to take an appointment as a Restructuring Practitioner come 1 January 2021. Section 453E of the Bill sets out the functions of the Restructuring Practitioner in broad descriptive terms, however, the draft legislation does not clearly specify the tasks required of them, or the powers and potential liabilities associated with that office.

Summary of the Functions, Powers, and Duties of the Restructuring Practitioner

From our review of the Bill, the following functions, powers, or duties form part of the role of the Restructuring Practitioner:

Function, Power or Duty of Restructuring Practitioner Section
Advising the SME on matters relating to the Restructure. 453E
Assisting the SME to prepare a Plan. 453E
Making a declaration in relation to a Plan which has been proposed to creditors of the SME. 453E
Powers to obtain and review the SME’s books and records. 453F, 453G
The Restructuring Practitioner is an agent of the SME. 453H
Assessing whether the SME meets the eligibility criteria. 453J
Power to terminate the Restructure if the eligibility criteria is not met, or if it is not in the interests of creditors. 453J
Giving consent to transactions outside of the ordinary course of business, if it is in the interests of creditors. 453L
Giving consent to a dealing in the SME’s shares, if it is in the interests of creditors 453N
Giving consent to a secured creditor or lessor exercising their security or entering possession of leased premises. 453Q
Giving consent to permit a creditor to proceed with a court proceeding against the SME. 453R
Receiving the surplus from the sale proceeds of any collateral subject to a possessory security interest. 454H
May apply to the Court to restrain a receiver or secured party from performing a function or exercising a power. 454F, 454M
Must consent to appointment as Restructuring Practitioner. 456A
Restructuring Practitioner must be a registered liquidator. 456B
Making a declaration of relevant relationships (DIRRI) and lodging that DIRRI with ASIC. 456F
Not liable for decisions to terminate, or not terminate, a Restructuring, or a decision to give, or not give consent. 456H
Administers the Plan in accordance with its terms. EM
Power to sell property on the SME’s behalf. EM

Commentary

The EM and Bill provide little detail on the nature of an appointment as a Restructuring Practitioner. We discuss specific areas of concern below.

Advising the Company

It is the SME, rather than the Restructuring Practitioner, who prepares and proposes the Plan to the SME’s creditors.[21] The function of the Restructuring Practitioner is “to provide advice to the company on matters relating to restructuring”.[22]

Practitioners will need to take care as not to become a ‘shadow director’ of the SME. The engagement involves providing advice directly to directors, with the intention that they will follow it. This is consistent with the indicia relied on to show that a person is a shadow director. While the Restructuring Practitioner is not liable for a claim in insolvent trading,[23] it would be desirable for the Government to amend the definitions of ‘director’ and ‘officer’ in the Act to specify whether the Restructuring Practitioner is included within them (and by extension, whether the directors’ duties regime applies to Restructuring Practitioners).

Section 453H provides that: “When performing a function or duty, or exercising a power, as restructuring practitioner for a company under restructuring, the restructuring practitioner is taken to be acting as the company’s agent.” The EM expands upon this by way of example: “the practitioner acts as an agent of the company where they sell company property to raise funds to pay debts or make an application to the Court on behalf of the company.”[24]

While the Bill stipulates that the Restructuring Practitioner is an agent of the company, it does not specify what the Restructuring Practitioner has authority to do, and what they cannot do, on behalf of the SME. Without further clarity there is a risk that practitioners may unknowingly act in excess of that authority.

Moreover, a Restructure will generally involve a trade-on during the period that a Plan is being formulated. Section 453K of the Bill provides that the company retains control of its business, property and affairs for the duration of the Restructure. Management of the SME retain authority to enter into transactions on behalf of the company in the ordinary course of business but require the consent of the Restructuring Practitioner for any transaction outside of that.[25]

The extract from the EM above indicates that the Restructuring Practitioner will be permitted to deal with the property of the SME. The legislation does not provide that the Restructuring Practitioner has a duty of care in exercising its power of sale (such as to achieve market value or the best price reasonably obtainable, like the duty imposed on a receiver).[26] This should be clarified. It also is not clear whether the Restructuring Practitioner may enter into transactions or sell property on the company’s behalf without the consent of management (whether or not it is in the ordinary course of business), or whether their role is solely to advise and give consent to management where appropriate.

Assessment of Eligibility Criteria

In order to enter into the simplified liquidation procedure, the liquidator must assess whether the eligibility criteria are satisfied.[27] By contrast, there is no express obligation on a Restructuring Practitioner to do this. The Restructuring Practitioner has power to, and “may” terminate the Restructure by written notice to the SME.[28] They also are not liable for any loss occasioned by a decision to terminate or not to terminate a Restructure.[29]

While that immunity is welcome, we consider that clarity is needed in two respects. Namely, whether the Restructuring Practitioner has a duty to investigate whether the criteria are satisfied, and whether they must terminate the Restructure in circumstances where they doubt that the criteria are satisfied.

The EM indicates that it is the directors of an SME who “are responsible for ensuring that they comply with the legislative requirements of the debt restructuring process”.[30] However, the Restructuring Practitioner is only immune from liability if they make a “decision” to terminate or not to terminate. That would not seem to encompass a scenario where the Restructuring Practitioner does not turn their mind to, or investigate, the eligibility criteria. If the Government intends that practitioners will audit the decision of the directors in relation to the eligibility criteria, then this should be clearly expressed in the legislation.

Declaration to Creditors

Section 453E of the Bill provides that another function of the Restructuring Practitioner is to “make a declaration to creditors in accordance with the regulations in relation to the restructuring plan proposed to the creditors”. As indicated, the form of the declaration will be prescribed by the Regulations.

It is likely that the declaration will incorporate aspects of the report provided by voluntary administrators ahead of the second meeting of creditors held pursuant to section 439A of the Act. The EM suggests that the declaration will require an “opinion on [the] feasibility of a proposed plan” to restructure the SME.[31] Government commentary has also suggested that the Restructuring Practitioner must certify whether “the business can meet the proposed repayments and has properly disclosed its affairs.”[32]

We note, however, that the regime contemplates that the Restructuring Practitioner will undertake very limited investigations during the period of the Restructure. As a result, they are not likely to have as great of an understanding of the voidable transaction claims, or other claims, available to the SME compared with a voluntary administrator in their same position. Likewise, Restructuring Practitioners must rely on the information provided by the SME and material misstatements in the Plan or SME’s disclosures are not likely to be readily apparent.

In those circumstances, we consider that it would be difficult for a Restructuring Practitioner to express a wide-ranging opinion as to whether it would be in the interests of creditors to either adopt a Plan or enter into liquidation. To overcome this, we recommend that the immunity in section 456H of the Bill be extended to encompass opinions expressed in the declaration.

Conclusion

In our view, clarity is sorely needed, and we hope this is provided in the Regulations. Given that the Restructure regime deals with low-asset SMEs, it is unlikely that assets will be available to fund applications to the Court for directions on questions or controversies that arise in the Restructure.

[1]  Bill, s 453B.

[2] EM, [1.20]

[3] Bill, s 453L.

[4] Bill, s 455A(1).

[5] See EM, [1.120].

[6] Bill, s 455B(c).

[7] Bill, s 455B(2). See e.g. Corporations Act 2001 (Cth) s 445D.

[8] See Bill, Schedule 1, Part 2, Item 19.

[9] EM, [1.20]

[10] See Bill, s 500AA.

[11] See Bill, s 500AA.

[12] Bill, s 453J.

[13] Bill, s 453L.

[14] Bill, s 453N.

[15] Bill, ss 453Q(2), 453R and 453S.

[16] Bill s 454F, s 454M

[17] Bill, s 458A.

[18] Corporations Act 2001 (Cth) s 420.

[19] Corporations Act 2001 (Cth) s 437A.

[20] Corporations Act 2001 (Cth) s 477.

[21] EM, [1.48] and Bill, s 455A(1).

[22] Bill, s 453E.

[23] Bill, s 588GAAB.

[24] EM, [1.138].

[25] Bill, s 453L.

[26] Corporations Act 2001 (Cth) s 420A.

[27] Bill, s 500A.

[28] Bill, s 453J.

[29] Bill, s 456H.

[30] EM, [1.47].

[31] EM, [1.50].

[32] See Government Fact Sheet.

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