Small businesses in financial distress due to the Covid recession but still considered viable could be left in the hands of their owners rather than placed into administration under a new debt restructuring process to be unveiled by the Morrison government.
The Coalition will introduce the new process for incorporated businesses with liabilities of less than $1m as part of an overhaul of the insolvency framework intended to ensure more businesses survive the economic shock of the pandemic.
The treasurer, Josh Frydenberg, will unveil the proposal on Thursday ahead of a speech outlining the government’s fiscal strategy before the budget’s release on 6 October.
Frydenberg in March adjusted the insolvency framework in an attempt to ensure businesses hit by the lockdowns could enter a period of hibernation without carrying liabilities so substantial they would sink the business.
The reforms included temporary relief from any personal liability for trading while insolvent for directors. The government increased the threshold at which creditors can issue a statutory demand on a company and the time companies have to respond.
The government is concerned there could be a rush of companies being put into external administration once those measures expire in December and the Coalition has been lobbied by business groups to make the reforms permanent.
Briefing materials distributed ahead of Thursday’s announcement say the proposed reforms draw on some features of the Chapter 11 bankruptcy model in the United States.
The government says it wants to create a new debt restructuring process for small businesses that are in financial distress – but regarded as still viable.
If the business is in that category, the Coalition is proposing to move from a “creditor in possession” model to a “debtor in possession” model, which leaves the owner in control of their business rather than in the hand of administrators.
Eligible businesses will have 20 business days to come up with a restructuring plan with a small business restructuring practitioner, and creditors will have a 15-day period to vote on it. If at least 50% of creditors by value endorse the plan, it will be approved and will bind unsecured creditors.
During that process, unsecured and some secured creditors will be prohibited from taking actions against the company, including the enforcement of personal guarantees against directors or their families. If the proposal is voted down, then the company can proceed to voluntary administration or use a simplified liquidation process.
The obvious risk associated with simplifying the insolvency framework is providing a green light to phoenixing – a practice where under-capitalised companies intentionally go into liquidation to avoid paying creditors and workers’ entitlements.
A report in 2018 by accounting firm PwC estimated that phoenixing cost the Australian economy at least $5bn in 2016-17, including $3.2bn in unpaid bills, $300m in unpaid employee entitlements and $1.7bn in unpaid taxes and compliance costs.
The government says it will propose safeguards to avoid creating perverse incentives. The proposed safeguards will include a prohibition on related creditors voting on a restructuring plan, and companies and directors will be prevented from using the new procedures more than once within a defined timeframe, envisaged to be seven years.
The government says there will be a capacity within the new framework to stop the process if deliberate misconduct is identified.
In a statement ahead of Thursday’s announcement, Frydenberg said the overhaul was necessary to try and save jobs.
“The reforms are a critical part of our economic recovery plan and will help to boost business confidence and dynamism across the economy by allowing viable businesses to survive as our economy rebuilds,” he said.