Australia: A guide to small business restructuring

The opposite of complex is simple, not easy

Introduction
The draft regulations and rules for the new small business restructuring and simplified liquidation processes will shortly go before parliament and, in the likely event they are passed, the laws should commence 1 January 2021.

Based on a debtor-in-possession model, restructuring is a significant step forward in our corporate insolvency's evolution. The debtor-in-possession concept has intuitive appeal because it eliminates the cost to an external administrator of taking possession of the debtor's assets and trading its business, which is a major impediment to small business restructuring. I would hope the debtor-in-possession model is retained, although it will likely take time to optimise the restructuring process.

It will be a major undertaking for the insolvency industry to carry restructuring into effect, not only because it is a completely new system, but because it should become operational in just one month's time. However, unless you're an insolvency practitioner, your interest will be in the benefits for small business. In short, restructuring is "designed to meet the needs of small businesses by reducing the complexity and costs in insolvency processes"¹. While it might be less complex than a voluntary administration (the only other existing option for corporate restructuring), the opposite of complex is simple, not easy, therefore restructuring will not be without its challenges. Some of those are addressed in this article as part of a summary of several key features of the process.

A reminder that this article is based on draft legislation, which may be subject to change.

Scope
Companies are expected to be the primary user of restructuring, however it's available to other incorporated entities.² Sole traders do not have an equivalent option under the personal insolvency regime (although Part IX of the Bankruptcy Act 1966 may produce a similar outcome in some cases).

Is restructuring the best option?
Restructuring a small business can be a gruelling and emotionally taxing process on directors and their families. Therefore, before appointing a small business restructuring practitioner ("restructuring practitioner"), which is a new category of insolvency practitioner comprised only of registered liquidators for the time being, the directors must consider if they want to commit to the process.

Why the company is in financial difficulty must be considered to determine whether the business is a good candidate for restructuring. For example, if the core business is not viable because of industry changes, the directors might need to consider other options (e.g. liquidation). That said, right now it's likely that many struggling businesses will be able to use restructuring to repair the wounds inflicted by the coronavirus pandemic.

Why early intervention is so important
Successful restructuring depends, to a large extent, on early intervention. A director who seeks appropriate advice when faced with the early indicators of financial difficulty will almost certainly have more pathways than those who wait until the situation is dire. In fact, by seeking appropriate advice early, a company may be able to address its financial problems without formal intervention.

From a practical perspective, a business in the late stages of insolvency usually has insufficient working capital or lack customer/supplier support to continue trading, which eliminates restructuring as a viable option.

Is my company eligible? ³
A company is eligible for restructuring system if:

• Its total liabilities do not exceed $1 million,⁴ and
• Within the previous seven years:
  • The company had not undergone restructuring or been through simplified liquidation, or
  • None of the company's directors (including former directors who resigned within the previous 12 months) was a director of another company that went through restructuring or was subject to simplified liquidation.

The director must also resolve that the company is insolvent or is likely to become insolvent at some future time and that a restructuring practitioner should be appointed.

Liabilities for the purposes of restructuring includes debts to related parties, however contingent liabilities are excluded. The exclusion of contingent liabilities might make restructuring unsuitable in some cases.⁵

Director's declaration⁶
Within five business days after the restructuring begins (or longer if approved by the restructuring practitioner), the director must provide the restructuring practitioner with a declaration stating that:

• The company has not entered into a voidable transaction under section 588FE of the Corporations Act 2001, excluding unfair preferences, in the event the company is wound up, and
• The director believes on reasonable grounds that the company meets the eligibility criteria, and why.

Transactions outside the ordinary course of business, such as material asset transfers and forgiving related party debts, are the sorts of transactions that might be voidable in a liquidation. If in doubt, a director may require appropriate advice before making the declaration.

Temporary relief period
A company can seek "temporary restructuring relief" from 1 January 2021 to 31 March 2021.⁷ The purpose for relief is to protect the company from being wound up while the directors make reasonable efforts to appoint a restructuring practitioner. It presupposes that there will be a shortage of restructuring practitioners when the system kicks off on 1 January 2021.

The 3 phases of restructuring
Restructuring has 3 phases:

• The planning phase: During this period, which lasts up to 20 business days,⁸ the company prepares a restructuring plan and a restructuring proposal statement.⁹ The plan includes details of how the company's property will be dealt with and what will distributed to creditors. The statement must include, among other things, a schedule of debts and claims to be addressed through the restructuring plan.
• The voting phase: Following the planning phase' conclusion, the proposed restructuring plan is sent to creditors along with several other documents. Creditors have 15 business days to approve/reject the plan.¹⁰ The plan is approved when a majority in value of voting creditors are in favour.¹¹
• The administration phase: If the restructuring plan is approved, it is then administered by the restructuring practitioner in accordance with its terms.

During restructuring there is a moratorium on enforcement action by creditors similar to the moratorium available during a voluntary administration.

What is the restructuring practitioner's role during the planning phase?
According to the explanatory statement to the draft regulations, the restructuring practitioner's role during planning phase is "a largely supportive role in advising and assisting the company directors".¹² Depending on what's involved with the plan, input from the company's accountant, solicitor, other advisors, employees, suppliers and other stakeholders might be required.

Prescribed terms
All restructuring plans must include several prescribed terms and conditions. For example, admissible debts and claims must rank equally and receive a pro-rata share of the funds available for distribution (including related creditors). Additionally, a creditor cannot receive a transfer of property other than money and the plan is limited to five years.

Termination during the planning phase
The restructuring practitioner has wide-ranging powers to end a restructuring during the planning phase.¹³ For example, they have the discretion to terminate if they determine the company is ineligible or believe it would not be in the creditors' best interests to consider a restructuring plan. There are currently no guidelines for when a restructuring practitioner should exercise the discretion to terminate.¹⁴

The directors and the court can also end a restructuring during the planning phase. Termination is automatic if:

• The directors do not complete the declaration, or
• The company does not make a plan within the prescribed timeframe.

Certifying the proposed restructuring plan¹⁵
One of the restructuring practitioner's most important roles is to certify a proposed restructuring plan according to the criteria stipulated in the regulations. Certification provides creditors assurance that the proposed restructuring plan contains all relevant information to enable them to make an informed decision on whether to accept or reject the proposal.

Currently, there is no guidance on the scope of the inquiry required to certify a proposal. To some extent, restructuring practitioners with the relevant experience may be able to work by analogy from some aspects of the voluntary administration process.¹⁶

A different ethical standard?
Referral fees are prohibited in all other types of formal insolvency; however they are impliedly permitted by regulation 5.3B.16.

Transitioning from the planning to the voting phase
A proposed restructuring plan cannot go to creditors unless the company has paid all due and payable employee entitlements and has given any returns, notices, statements, applications or other documents as required by taxation laws (within the meaning of the Income Tax Assessment Act 1997).¹⁷ According to regulation 5.3B.22, "substantial compliance" with these obligations will suffice. It is unknown what constitutes "substantial compliance". From a practical perspective, it is common for a small business in the later stages of financial difficulty to have arrears in superannuation and outstanding tax lodgements, which is another reason why early intervention matters.

Some observations about voting on a proposed restructuring plan
Related creditors do not get to vote on the plan.

The Australian Taxation Office (ATO) and other statutory creditors are often the largest unsecured creditors of a small business; therefore, the fate of many restructuring plans will be in their hands. The ATO typically has guidelines on how they vote in external administrations, although it has not indicated how it will approach restructuring proposals.¹⁸

Offering or giving valuable consideration to a creditor to influence their vote on a restructuring plan is an offence.¹⁹

Deemed insolvency
A company will be deemed insolvent when a restructuring plan is sent to creditors.²⁰ Presumably a creditor could use this as grounds for a winding up application if the restructuring ends for any reason other than an approved restructuring plan being completed in accordance with its terms.

The deeming provision needs further clarification, however it could deter early intervention, especially for a company that is not yet insolvent but is well down the road.

Secured creditors
Secured creditors are subject to similar moratorium provisions as applies in a voluntary administration and will only be bound by a restructuring plan to the extent they agree to be bound.²¹

I cannot comment on how banks and other secured lenders will deal with companies undergoing restructuring. Whatever the case, it remains good advice for a small business to invest in the relationships with their bank and other lenders, as they should with all major stakeholders in their business.

Terminating a restructuring plan²²
When an approved restructuring plan is fully effectuated in accordance with its terms, it terminates and the company is freed from the debts covered by the plan.

A plan also terminates:

• By court order,
• If the plan is conditional on a particular event occurring within 10 business days after the plan is made, and the event does not occur within that period (i.e. a condition precedent),
• If there is a breach that goes unremedied for 30 days, and
• If an administrator, liquidator or provisional liquidator is appointed to the company.

Varying a plan
Varying an approved restructuring plan might not be commercially viable in many cases as a court order is required.²³

What happens if a new liability is identified after a restructuring plan is made?
A new liability identified after a restructuring plan is made is admissible under Regulation 5.3B.29. Put simply, provided the creditor is unrelated and its debt substantiated, it is entitled to participate in the plan. New liabilities owing to related creditors are excluded from participation.

If a new liability results in a breach of the $1 million limit, the restructuring plan does not automatically terminate. A creditor's only recourse may be to apply to court for appropriate orders.

The restructuring practitioner's remuneration²⁴
A restructuring practitioner is remunerated as follows:

• For work during the planning and voting phases, a fixed fee as agreed with the directors prior to the appointment.
• For work during the administration phase, a fixed percentage of the recoveries under the plan, subject to creditor approval.

The remuneration structure naturally lends itself to price competition between practitioners. That being said, at Worrells we believe the quality of our service and ability to deliver a win/win outcome for the company and its creditors will be as much a point of distinction from our competitors as will be our price point.

Closing
While opinions on the debtor-in-possession model may differ, provided it is reviewed, refined, and updated over time, it should prove a valuable addition to our insolvency framework. Like any new technology, it may take some time before the system is "run in" and fully fit for purpose.

As a firm we are well on our way up a steep learning curve. This article is the tip of the iceberg in terms of understanding the mechanics driving this new system. Nevertheless, we are ready to go on 1 January 2021 and are already answering queries. Please do not hesitate to contact your local Worrells office for assistance or in-house training through our Worrells Workshops.

Footnotes

¹ Explanatory statement to the Corporations Amendment (Corporate Insolvency Reforms) Regulations 2020 ("CIR Regulations), page 1. Unless otherwise indicated, all references to regulations in this article refer to the CIR Regulations.

²  As companies will be the primary beneficiary of the system in the remainder of this article I use company-centric references.

³  See section 453C of the Insolvency Reform Bill and Regulation 5.3B.03

⁴  Whether or not the $1 million cap too high is a policy argument that will inevitably be resolved once the system is in operation.

⁵  By comparison, a deed of company arrangement can encompass contingent liabilities.

⁶  See regulation 5.3B .44

⁷  See Sections 458D and 458E of the Insolvency Reform Bill 2020.

⁸  If requested by the company, the small business restructuring practitioner may extend the period by 10 business days, provided they are satisfied that it would not be reasonable in the circumstances to require the company to provide a restructuring plan within the proposal period.

⁹  There are supposed to be prescribed forms for the plan and statement, they are yet to be released.

¹⁰  See regulation 5.3B.19

¹¹  See regulation 5.3B.23

¹²  Above n 1, p29

¹³  See section 453J of the Insolvency Reform Bill.

¹⁴  As someone who qualifies as a restructuring practitioner, I would deem the discovery of an attempt to conceal assets, liabilities or other pertinent information as grounds to terminate (in some cases summarily or maybe after a brief enquiry into any extenuating circumstances).

¹⁵  See regulation 5.3B.16

¹⁶  That said, there is no suggestion that a restructuring practitioner is required to assess the potential return to creditors in a hypothetical liquidation as would be the case in a voluntary administration.

¹⁷  See regulation 5.3B.12 of the Corporations Amendment (Corporate Insolvency Reforms) Regulations 2020 ("CIR Regulations). Unless otherwise indicated, all references to regulations in this article refer to the CIR Regulations.

¹⁸  If the voluntary administration process is any guide, then the ATO may judge a plan on the quality of the debtor's compliance history as much, if not more, than the financial return on offer.

¹⁹  See regulation 5.3B.23

²⁰  See Section 455A of the Insolvency Reform Bill

²¹  See regulation 5.3B.27

²²  See regulation 5.3B.02

²³  This is one of the more onerous and rigid provisions.

²⁴  See regulation 5.3B.13

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.