by Paul Gidley16.12.20

We currently live and operate in unprecedented social and economic times. COVID-19 is the catalyst for enduring economic challenges as well as opportunities, both globally and domestically, for years to come. 

The Federal Government legislated a raft of measures designed to delay mass formal corporate liquidations and personal bankruptcies. These measures have been a successful delay tactic by the Government. 

Personally however, I have cancelled all my leave for 2021, as I expect the insolvency profession will be extremely busy, playing “catch-up” on 2020, dealing with the normal case load for 2021, as well as any COVID fallout. 

The Government in their own words, note:

“as the temporary relief expires at the end of December, the number of companies being put into external administration is expected to increase significantly, putting additional stress on the system”, have reformed Australia’s insolvency legislation to help more businesses to “successfully get to the other side of the crisis” (did they say crisis! ☹)

The reforms are a statutory mechanism designed to enable the small business sector to navigate the global economic storm which is brewing as a consequence of the costs associated with controlling the COVID-19 pandemic and the shutdown of trade and business worldwide. 

Small businesses for the purpose of the reforms are those companies with liabilities of less than $1 million. The reforms enable a director to retain control of their company, avoid insolvent trading and work their way out of trouble. The reforms are said to be (but are not) akin to the United States Chapter 11 model. 

As there will be no administrative infrastructure (or registered restructuring practitioners for that matter) in place as of 1 January 2021, in order to enable the legislation transition, the Government will allow Director(s) a three (3) month period to register a “declaration to restructure” with the company creditors, during which the insolvent trading moratorium continues. 

Registration commences as of 1 January 2021, concluding 31 March 2021. 

The 3-month declaration period will hopefully allow: - 

  • the insolvency profession to get up to speed with the new legislation; 
  • allow the registration of restructuring practitioners, an essential requirement to the restructuring plan; and 
  • allow the necessary administrative tools and precedents to be created in order to properly manage the restructuring processes and the plan effectively, efficiently, and transparently.    

The new insolvency reforms and legislative amendments are to be found in Part 5.3B of the Corporations Act, aptly named “Restructuring of a Company”.  

The draft legislation states the objectives of Part 5.3B are to provide for a restructuring process for eligible companies that allows the Director(s) to retain control of the business, property and affairs while developing a plan to restructure, with the assistance of a small business restructuring practitioner, with the view to enter a restructuring plan with the company’s creditors. 

Sounds simple enough but unfortunately it is not. Company restructuring is a very complex affair. 

It requires access to various scarce resources, across a broad range of core business disciplines and more importantly, something I believe is missing from the equation, the existence of a turnaround “culture” (in the true sense of the meaning) within the broader business sector. 

Unfortunately, you just cannot legislate a “culture”. Culture creates laws, not the other way around.

From my years of experience, I am aware that corporate reconstruction is a tough gig at the big end of town, so double if not triple down when attempting corporate rescue in the under resourced dog eat dog underworld of small business.

So, what else is missing from the turnaround equation?

I argue that for any type of workout to have a chance of success, the environment in which the process is taking place must be capable of being controlled. To have a controlled turnaround environment I am of the opinion the following minimum conditions must exist:

  1. Access to relevant scarce resources.
  2. Adequate protection for Directors & their Advisers from liability.
  3. Effective but fair moratoriums on all forms of creditor’s claims.
  4. Effective and educated corporate governance and management.
  5. Timely, complete, and correct financial recording and reporting.
  6. Access to appropriately qualified advisers. 
  7. Problems that can be identified, controlled, and quarantined. 
  8. Goodwill from mission critical stakeholders and the market. 

I’d further argue that any legislation developed to facilitate corporate reconstruction should focus in the first instance on creating the correct environment, after all, critical patients are not placed in the general ward, they are taken to intensive care, a highly regulated, sterile and controlled environment.

Which takes us back to the other missing ingredient, if we had a turnaround culture, we would be able to develop laws that enact a controlled restructuring environment (or is this one of those chicken and the egg conundrums?).

Conceptually, reconstruction and insolvency laws exist to maintain value in our corporate marketplace, be it through continued trade and/or by maintaining asset market values, and subsequently mitigating or avoiding any losses to stakeholders. 

If these outcomes are not achievable, the laws bring to account the reasons for a company’s failure and subsequent losses to its stakeholders.

More broadly speaking reconstruction and insolvency legislation is also integral to maintaining an accountable and competitive marketplace, be it domestically or internationally. 

Unfortunately, and for a variety of commercial reasons, the conceptual objectives of maintaining value are rarely achieved by our insolvency laws, resulting in Corporate Australia’s landscape littered with the carcasses of failed and valueless companies. 

I attribute the significant levels of liquidations relevant to restructuring to the absence of turnaround culture in Australia, which if present, would see Directors acting far earlier in the solvency curve. I also believe it is in part our legislator’s failure to create laws that accommodate the commercial complexities and nuances associated with conducting even the simplest forms of business restructuring. 

Australia currently has two (2) statutory mechanisms to which small business can avail themselves for restructuring and turnaround purposes. The Corporations Act currently provides for:

  1. Part 5.3A - Voluntary administration/Deed of Company Arrangement (or liquidation); and
  2. The Safe Harbour provisions (found in Part 5.7B, Subdivision C).

Most commentators within our profession believe the voluntary administration has failed to adequately achieve the purposes for which it was enacted, be it small or large business, or anywhere in between. 

Part 5.3A fails to create the controlled environment required for corporate reconstruction resulting in a process that is cumbersome, expensive, subject to misguided regulation and open to abuse and misuse. 

The Safe Harbour provisions are yet to be fully tested by the market, and any physical data on take up and successful outcomes is difficult to obtain, due to Safe Harbour’s non-disclosure nature. 

From my experience however, the insolvent trading relief and requirements for entry into Safe Harbour are an effective catalyst for directors to take recovery and reconstruction seriously and methodically, therefore in my opinion making s588GA a useful pre-insolvency option for certain small businesses. 

S588GA is cost-efficient and can provide a level of protection and control to enable a company to restructure, through consensus amongst mission critical stakeholders, who adopt commercial common sense. 

Further, Safe Harbour does not require disclosure to the market place for most SMEs, and if put to work early in the solvency curve, can succeed as the SME still has some access to relevant scarce resources and is yet to do any irreversible damage to the goodwill it may have with mission critical stakeholders. 

I do feel the government missed a prime opportunity to revisit the safe harbour legislation (noting they said they would so when Safe Harbour was first legislated) to tune and enhance these laws to be the most effective tool for COVID affected small businesses.

So, what can be said about Part 5.3B, “Restructuring of a Company” and is it the real turnaround deal? 

Most current commentary appears to conclude it is not the “real deal” and like its big sister Part 5.3A, will prove to be deficient for most small business restructuring. 

The other concerns I have about the utility of Part 5.3B are: -

  • It falls well short in creating the controlled environment small businesses require to design and implement an effective recovery plan.
  • Capital is amongst the scarcest of resources for small business, most small businesses commence their lives seriously undercapitalised, that is as a $1 dollar company. To enter Part 5.3B the company must be insolvent or likely to become insolvent, a point on the solvency curve where access to additional capital is virtually non-existent, making any workout extremely difficult.
  • The infancy of turnaround, reconstruction, and recovery culture in Australia’s small business sector. The Federal Government are working on developing such a culture within corporate Australia, but it will take many years to change our current culture.

Whilst I am hoping to be proven wrong, the experience I have gained over the last thirty (30) years of practicing in insolvency law and reconstruction, leads me to give short odds that the legislation will not achieve its desired objectives across the broad spectrum of small businesses in financial strife. 

I do see some opportunity for Part 5.3B to prove useful, for healthy pre-COVID-19 economy businesses, who have endured the recessionary times of recent and come out the other side trading profitably and cash flow positive, although carrying more core debt than they can service relative to current turnover, and only in need of some breathing space to get their balance sheet back in manageable order. 

What I do know is that we are all in for interesting times ahead. 

A final word, if you believe Part 5.3B is the solution for you or your clients, don’t hesitate to contact one of the seasoned Shaw Gidley Directors for assistance with the declaration to restructure or for any other matter associated with this new reforms, liquidations  or insolvency related matters. 

Shaw Gidley are experts in restructuring, turnaround and insolvency and provide free initial advice on these matters. Please contact our offices on (02) 4908 4444 or (02) 6580 0400.