Many businesses and industry groups are currently advocating for the Treasurer to extend the temporary six month exemption from insolvent trading liability for directors – due to expire on 25 September 2020 – and to also adopt other interim relief measures such as a prohibition on liquidators recovering unfair preference payments to creditors. It had been anticipated that the Treasurer would do so as part of the Australian Government's Economic Update on 23 July, but an announcement was not forthcoming.

While these measures are argued to relieve the pressure on directors continuing to struggle to navigate the economic impact of the pandemic, and to enable companies to trade on, the risk is that they perpetuate the existence of 'zombie companies' notwithstanding the scaling back of JobKeeper announced as part of the Economic Update – and also divert attention from the more substantive, structural insolvency law reforms required to support sustained economic recovery.

The Limits of Interim Measures

Interim relief from insolvent trading in effect allows directors to cause a company to continue to trade, knowing they will not become personally liable for its debts. This is a compelling incentive. Yet, if a company has no realistic prospect of profitability without ongoing Government fiscal support, refraining from immediate liquidation while debts continue to be incurred unfairly places the risk of loss squarely onto creditors – including small suppliers and sole traders – that can least afford it. Indeed, with a limited chance of ever being able to recover their debts, those creditors may not be able to withstand the financial shock to their own businesses and livelihoods. It is a case of robbing Peter to pay Paul.

Any interim suspension of liquidators' ability to recover unfair preferences is also problematic. While designed as an incentive for key suppliers to continue to support a financially distressed (and probably insolvent) company during the pandemic – without fear prepayments of new debts can be clawed back by a liquidator later appointed to the company if it is unable to resume profitable trade – this leaves little, if anything, available for existing creditors that supported a business prior to the pandemic. Again, many of those creditors may suffer from an insolvency 'ripple effect' that may compromise their own businesses – this time, robbing Paul to pay Peter.

So What Would Deeper Insolvency Law Reforms Look Like?

First, it is important to incentivise informal workouts for viable businesses wherever possible, not only to bypass the cost of formal insolvency proceedings but also to minimise the risk of major secured creditors enforcing their rights in a manner that may lead to premature liquidation.

The safe harbour from insolvent trading under section 588GA of the Corporations Act, available to directors who pursue an informal restructuring attempt, with expert advice, reasonably likely to result in corporate or business rescue, has gone some way to building a stronger informal rescue culture in Australia since it was introduced in September 2017. However, a key limitation of the existing insolvency regime is that there is no moratorium preventing creditors from enforcing their rights during an informal workout attempt. That includes the enforcement of ipso facto contractual termination rights, with the prohibition on ipso facto enforcement introduced in the Corporations Act with effect from 1 July 2018 only applying when a company is subject to a formal insolvency process.

A viable alternative would be to provide for an enforcement moratorium for a limited period to enable an insolvent company to pursue an informal restructuring attempt. A moratorium of that kind was introduced in the United Kingdom as part of the Corporate Insolvency and Governance Act 2020 (UK) (CIGA) reforms which came into force on 26 June 2020. The moratorium applies for an initial period of 20 business days under the supervision of an independent monitor, in circumstances where the monitor certifies that the company has a reasonable likelihood of being revived as a going concern.

Secondly, a more 'debtor friendly' formal rescue process would enhance the prospect of viable entities being revived in circumstances where informal rescue negotiations are not fruitful during the period of an initial informal enforcement moratorium.

In that regard, the voluntary administration process in Part 5.3A of the Corporations Act would benefit from:

  • The inclusion of all creditors – secured and unsecured – within the scope of the formal insolvency moratorium commencing upon the appointment of an administrator, as currently occurs in the comparative Chapter 11 process in the United States; and
  • A broader 'cram down' process to enable a deed of company arrangement to be binding on dissenting secured creditors.

Alternatively, a cram down could be included as an adjunct to the creditors' scheme of arrangement process under Part 5.1 of the Corporations Act. Currently, a scheme cannot come into effect unless it is approved by 75% in value and a majority in number of each class of voting creditors.

Again, Australia can look to the United Kingdom for an alternative model. The CIGA reforms now provide for a new 'restructuring plan', with the court permitted to order that the plan comes into effect even if one or more classes of creditors does not approve it by the requisite 75% in value/majority in number threshold. Already, this new procedure is being resorted to, with Virgin Atlantic Airways launching the first restructuring plan under the new laws on 14 July in what will become an important model in other large-scale restructurings during the economic recovery period.

Further, provision ought to be made for debtor in possession 'super priority' financing during a period of voluntary administration. Working capital is the lifeblood of any business and without incentives for new lending – with court-ordered first-priority enforcement rights – additional funding is unlikely to be forthcoming, especially in circumstances of tighter liquidity in the financial system as a whole during the pandemic.

Other reforms, such as the scaling back of administrators' personal liability for lease payments and new debts incurred during voluntary administration – as the standard legislative position rather than relying on the ad hoc orders that courts have been prepared to make during the pandemic (most notably in the Virgin Australia restructuring) – would also enhance the prospect of viable entities being able to trade out of their difficulties in a manner that would boost jobs and broader economic growth.

For entities that do not have any realistic chance of continued trade without Government support, reforms are also needed to provide for a quick and cheap dedicated liquidation process for small businesses. With the 'tsunami' of liquidations expected in the final quarter of 2020 and leading into 2021, the expense and delays involved in the current 'one size fits all' liquidation process in the Corporations Act leaves little prospect of any return at all to unsecured creditors, and indeed may risk liquidators refusing to act at all given their fees and expenses cannot be paid.

Looking Ahead

The time has come for substantive, enduring insolvency law reform measures to be adopted. The speed at which the interim pandemic-related measures have been introduced in 2020 – backed by cooperative Commonwealth, state and territory engagement – shows that the law reform impasse of previous years, bogged down by rounds of consultations with no end result, can be overcome.

Reforms to the informal and formal rescue process in Australia to incentivise the restructuring of viable businesses will help to save jobs and secure the future of important businesses as a key pillar of sustained economic recovery in the years ahead.

A new dedicated liquidation process for small businesses – potentially backed by increased Government funding in a revamped Assetless Administration Regime – will also ensure the efficient recycling of 'dead capital' and an end to the 'zombie company' trend that has been a hallmark of the last six months.

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