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Government throws small business an insolvency lifeline

The government has scrapped it’s one-size-fits-all insolvency regime. What does this offer for small businesses in trouble?

Gary Anders | October 2020

The full economic flow-on effects from COVID-19 are yet to be felt, but it’s widely expected that hundreds of thousands of Australian small business enterprises will not survive the pandemic.

That’s set to place unprecedented strain on our insolvency regime, and accounting practitioners will be on the frontline as many clients are forced to wind up their businesses to repay lenders and other creditors.

One-size-fits-all regime scrapped

In late September the federal government announced its intention to scrap the current “one-size fits all” insolvency system from 1 January 2021 and introduce a package of reforms aimed at helping more small businesses in financial distress to survive.

Chief among them would be a measure allowing the owners of financially distressed but viable small businesses that have less than $1 million in liabilities to retain control and continue trading while they restructure their debts.

New role: registered small business restructuring practitioner

This “debtor in possession” model would involve these businesses working with a registered small business restructuring practitioner (SBRP) to develop and put forward a restructuring plan. 

This would include identifying creditors and assisting them in making informed decisions around recouping their funds.

“The new process would streamline the role for, and powers of, the practitioner compared with the role played by an administrator in a voluntary administration,” the government says. “This reflects the reduced complexity of the new process and the businesses eligible to use it.”

The role of practitioners would be to determine if a business is eligible, support the business to develop a plan and review its financial affairs, certify the plan to creditors, and then manage disbursements once the plan is in place.

Personal liability not at stake

A practitioner would not be required to take on personal liability for a business or manage its day-to-day affairs.

The government has also outlined its rule for who will be eligible to become a restructuring practitioner.

“To support more practitioners being available to work with small business, they will be able to choose to register as a small business restructuring practitioner only,” it states.

“Their practice will be limited to the new simplified restructuring process. Qualifications required to register as a small business restructuring practitioner only will be in line with the streamlined requirements of the role.

“Registered liquidators will also be able to manage the new process.” 

Protections in place

Safeguards will be included in the government’s legislation to prevent companies from using the process to undertake corporate misconduct, including firms seeking to carry out illegal phoenix activity.

This includes allowing creditors to convert the liquidation back to a “full” process and preventing directors from using the process more than once within a prescribed period (proposed at seven years).

Experts assess the changes

The new insolvency framework follows an extensive inquiry earlier this year by the Australian Small Business and Family Enterprise Ombudsman, which in July released a 46-page report containing a series of recommendations to overhaul the existing system governing small businesses.

Ombudsman Kate Carnell says the proposed changes will spare distressed businesses from “unnecessary insolvency pain”.

“Unfortunately, small businesses with cash flow issues, compounded by falling revenue, may not seek out professional advice because it’s deemed to be unaffordable,” she says.

Carnell notes that the sooner a small business owner experiencing financial stress seeks assistance from an accredited professional, the better the outcome.

“My office continues to recommend the establishment of a small business viability voucher program, where small business owners facing financial stress can obtain a voucher valued up to $5,000 to access tailored advice on the state of their business.”

ASBFEO has also proposed capping the cost of insolvency for SMEs, with the majority entering liquidation having assets of less than $10,000.

Challenges and concerns

The government has set a very tight schedule to get its insolvency reforms legislation passed by both houses of federal parliament before the end of this year.

CPA Australia’s policy adviser, environmental, social and governance, Dr John Purcell, says that within this time frame there are critical questions to be answered around the exact powers of small business restructuring practitioners versus those of registered company liquidators.

These include the applicable regulatory and licencing regimes for both, how they interact with industry bodies in terms of matters such as training, reporting misconduct, and the application of ethical and professional standards. 

“The ‘devil’ will be in the detail given the very specific characteristics of the SBRP’s role and the likelihood, it would seem, that the regulatory regime will be built into Corporations Act’s Insolvency Practice Schedule and associated rules,” Purcell says.

“There’s also a query in the design of matters such as qualifications and experience, such as the extent to which the SBRP will need a high level of familiarity with external administration and corporate law more generally.”

He adds that the issue of practitioner independence in the insolvency process may be more problematic than initially meets the eye, with SBRPs contracted to work alongside business owners.

“What objective standard of independence is to be applied? And does the debtor in possession emphasis create conflicting interests which may cloud assessments of independence?”

Worrells Solvency & Forensic Accountants partner, Scott Andersen, adds that it’s important to recognise small businesses can get into financial trouble for a whole range of reasons.

“Usually there are factors that have contributed, such as debt, but it’s more often the case than not that there are other circumstances which underpin the failure that’s contributed to ongoing losses being incurred.

“Even if they can strike a deal with creditors and the business is able to restructure its debt, it’s not actually going to alter the ongoing loss position of the business. In a larger sense, it’s not dealing with that broader financial issue,” Andersen says.

At the time of writing, the enabling Bill including draft consequential amendments is expected to be released sometime in the week commencing 5 October. A future edition of INPRACTICE will provide details.