Debtor in Possession – Thoughts on Frydenburg’s Insolvency Law reform to commence 1 January 2021

The outline of the Federal Government’s small business insolvency reform package, to introduce a debtor in possession model for incorporated businesses with less than $1 m in debt, have been covered elsewhere. This package was announced just after 4pm yesterday.  A copy of the Treasurer’s media release can be found here.  The lease also includes a link to a “Insolvency Reforms Fact Sheet” here.  A useful summary of the proposed changes, by my colleague at the Victorian Bar, Carrie Rome-Sievers, can be found here.

Some thoughts that immediately spring to mind, from a PPSA perspective and generally follow.

Is the appointment of a “Small business restructuring practitioner” (SBRP) also going to trigger vesting under section 267 of the PPSA?  Or will vesting not occur if and until an administration or liquidation occurs. A security interest which is unperfected vests in corporations which are wound up or enter into a voluntary administration or DOCA (s267(1)).  The underlying policy principle behind vesting is to aid unsecured creditors in the insolvent administration left unaware of the unperfected security interest.

Josh and Scomo

Presumably voidable transactions will continue to be recoverable only in liquidation.  When will the relation back period commence for a subsequent liquidation?  Will it be from the appointment of the SBRP, or will it be the date on which the voluntary administration is taken to commence?  If it is the latter, the appointment of a SBRP will be a tool that can be used to manipulate the relation back period to protect voidable transactions. See the discussion in my article on this issue, relating to the manipulation of the  relation back period by VA appointments.

The proposal requires all employee entitlements to be paid before a SBRP can be appointed. What entitlements? Arrears of wages and superannuation? What about unpaid accrued leave entitlements? Presumably contingent claims like amounts due on retrenchment are not included. Are such payments protected from preference claims in future liquidation?

Whilst the debtor is in possession, the business continues to trade for 20 business days whilst devising a turnaround plan.  What is the status of debts incurred in this period?  Is the owner/director personally liable, because the SBRP is not.  This seems to be a serious flaw compared to the personal liability of administrators in the same position.  It would seem to me that trade creditors would be reluctant to extend any credit once a SBRP was appointed without some security.

The new regime is set to apply from 1 January 2021, yet as others have noted today, there has been little or no industry consultation with respect to devising the proposal.  Presumably that will follow in coming months, however the process of baking the pie seems somewhat arse end around (apology for the mixed metaphor).

The regime includes a transitional period from 1 January 2021 to 31 March 2020, anticipating that there will not be enough trained SBRPs to meet the demand at the start. In this period businesses will be able to declare an intention to access the new process and thereby extend statutory demand and insolvent trading relief for the same period, as long as they appoint someone before 31 March. It seems to me the transition will introduce an added layer of uncertainty. I would imagine many business owners will choose the transition option to buy another 3 months of trading time.

It has been suggested, but I have not verified, that the proposal is a lift from a similar reform brought into law in the UK in June. See the attached link to a summary of the Corporate Insolvency and Governance Act 2020) (UK) prepared by Norton Rose Fulbright. It certainly looks very similar. That may explain how this proposal has been put together inside Treasury without much external input.

SBRPs appear to be paid a fee bargained with the debtor as a percentage of the “disbursements under the plan”, presumably a percentage of the payments made to creditors. What happens if the SBRP is not content with the fee offered?

The process is said to be available only to incorporated businesses.  Sole traders are not mentioned.  Yet sole traders make up a sizeable proportion of small businesses in Australia.  Are parallel changes going to be made in bankruptcy? Part X arrangements going to be harmonized for example?

Only incorporated businesses with liabilities less than $1 million can use the process.  How is the debt under the cap calculated?  Is it limited to actual debts of that amount, or are contingent debts included?  Will uncrystallised claims count, say under a premises lease or equipment lease?  What about liquidated damages  or penalties accruing in default under operational contracts, such as in construction?

The role of SBRP can be filled by persons other than a registered liquidator:  who in practice is going to take on the role other than registered liquidators?  Remembering that at law, if not in practice, voluntary administrators are not limited to registered liquidators, yet the latter are nearly always used.

Interesting times ahead.


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