To help small businesses continue to operate despite the fallout of COVID-19, the government has introduced new insolvency rules which will take effect in 2021. The changes follow temporary rules put in place throughout 2020 to prevent a slew of insolvencies. 

What has changed? 

The new rules will give viable small businesses time to restructure debts and turn their businesses around before needing to commence insolvency proceedings and appoint an administrator. This is known as a ‘debtor in possession’ model, rather than the previous ‘creditor in possession’ model, and mirrors Chapter 11 of the United States Bankruptcy Code. It is hoped the changes will prevent an influx of insolvencies and keep people in jobs. 

Incorporated businesses with less than $1 million in liabilities will be able to continue to operate without having to immediately commence insolvency proceedings. The government anticipates this will capture 76% of businesses currently subject to insolvency, with the vast majority having less than 20 full-time employees. The changes won’t apply to large companies. 

Insolvent small businesses will have 20 days to produce a plan for how they will restructure debt. The company will be required to lodge any outstanding tax returns and pay any employee entitlements before establishing the plan. Creditors will vote on whether to accept the plan within 15 days. Half of the creditors by value will need to approve the plan. If the plan is not approved, the company will proceed to a simplified liquidation process. 

Unsecured and some secured creditors will not be able to take legal action against the company while it is restructuring. 

When will the changes take effect?

Subject to parliament passing the Corporations Amendment (Corporate Insolvency Reforms) Bill 2020, the changes will commence on 1 January 2021 following the expiry of the current COVID-19 insolvency relief measures on 31 December 2020.

What implications will the changes have?

For many small businesses under financial pressure, the changes will be a welcome reprieve. Critics of the current rules have long said the Australian system favours creditors over debtors, and makes it impossible for insolvent companies to return to profitability. The new rules will change that. 

On the other hand, the new system could make creditors more vulnerable. The new system will make it more difficult for creditors to have their debt repaid and could deter investment in Australian companies. 

For unsecured creditors looking to protect themselves, becoming a secured creditor may help. In 2009 the Commonwealth Government’s Personal Property Securities Register (PPSR) was introduced. With the PPSR, businesses can register their security interests in personal property other than land. This ensures the business becomes a secured creditor if the company is liquidated down the track and ensures their debt is a higher priority. Note, this only helps once the company commences insolvency proceedings. Until that point, there isn’t much protection for creditors under the new rules. 

What’s next?

The proposed changes will be the most significant changes to insolvency in Australia for almost 30 years. In the short-term, the hope is that the rules will be a reprieve for small businesses in the COVID-19 environment. However, it remains to be seen how the new rules will play out in the mid to long-term.