Budget Review 2020–21 Index
Ian Zhou
Introduction
The Government’s JobMaker package
contains proposals to change Australia’s insolvency laws (p. 48). The proposed
changes, which don’t have any associated spending measures, are set out in a Treasury
factsheet for small business operators and include:
- a new debt restructuring process for businesses with liabilities
of less than $1 million
-
transition from a ‘creditor in possession’ model to more of a
‘debtor in possession’ model which will allow company directors to remain in
control of their business and continue to trade while they restructure their
existing business debts. The Government says this means that small business
owners can retain control of their companies and plan for recovery without
their businesses being handed over to external administrators and
-
a series of complementary measures, including use of technology
and relaxing registration requirements for insolvency practitioners involved in
small business restructuring and liquidations.
The Budget announcements follow the temporary loosening of
insolvency laws in March 2020, as explained in the next section.
The proposed changes to insolvency laws relate closely to
JobMaker measure, ‘Removing barriers to credit’ (p. 47) aiming to loosen
consumer credit lending laws (described in a Treasury
factsheet). The proposals are interrelated
because many small business owners use their family home as security for
business loans. A loosening of credit lending regulation means business owners
have the potential to obtain additional bank loans to support their businesses
in response to the economic challenges posed by the COVID-19 pandemic, while the
changes to the insolvency laws may offer business owners more opportunities to
restructure their business debt, continue trading while insolvent, and avoid
foreclosure of their family home.
Temporary relief measures—March
2020 and September 2020
The Government’s proposed changes to insolvency laws are designed
to provide a longer term solution to the issues addressed by the temporary
insolvency relief measures introduced in March 2020.
The temporary measures, which are detailed in a Treasury
factsheet and a Parliamentary
Library FlagPost blog article, include:
- insolvent trading—temporary relief for company directors
from personal liability for trading while insolvent, in relation to debts
incurred in the ordinary course of business. Ordinarily, company directors may
be personally liable for debts incurred by the company if it trades while
insolvent and
- statutory demand regime—temporary increase in the
threshold (from $2,000 to $20,000) at which creditors can issue a statutory
demand, and a temporary increase in the time (from 21 days to six months)
companies have to respond to a statutory demand.
Ordinarily, a company that has become insolvent (where the
company cannot pay its debts when they fall due for payment) may enter into
voluntary administration by handing control of the company over to external
administrators. These administrators investigate the company’s affairs to see
if it is possible for the company to restructure and continue trading before
deciding whether to liquidate the company. Nevertheless, once the
administrators are appointed, the company directors lose control of the company
and cannot trade while insolvent.
Intended to complement the JobKeeper program, these
temporary changes to insolvency laws were introduced to provide relief to
businesses by easing the burden of cash flow restrictions and reducing the
immediate risk associated with incurring a debt in this time of crisis.
The temporary measures were legislated initially in the Coronavirus
Economic Response Package Omnibus Act 2020. These measures were intended
to last for six months but were extended to 31 December 2020 by the Corporations and
Bankruptcy Legislation Amendment (Extending Temporary Relief for Financially
Distressed Businesses and Individuals) Regulations 2020 made in September 2020.
Subject to the enabling legislation being passed, the
announced insolvency law changes are due to commence on 1 January 2021
following expiry of the current COVID-19 insolvency relief measures on 31 December 2020
(see Table 1 below).
Table 1: timeline of insolvency law
changes
Policy debate on the insolvency law
changes
The Government’s proposed insolvency law changes, if
enacted, would commence on 1 January 2021 following expiry of the
current COVID-19 insolvency relief measures on 31 December 2020.
The timing of the proposed insolvency law changes and the Treasurer’s
media statement indicate that the Government recognises that as the economy
starts to recover, it will be critical for distressed businesses to have the
necessary flexibility to restructure or wind down their operations in an
orderly manner.
The full economic impact of COVID-19 will be felt by
businesses when government relief measures, such as the JobKeeper program,
cease and an increase in demand for insolvency processes is expected to follow.
The timing of the insolvency law changes aligns with this higher demand.
Business groups, such as the Victorian
Chamber of Commerce and Industry and the Chartered
Accountants Australia and New Zealand, welcomed the Government’s proposal
to change the insolvency laws. This is because the proposed changes draw key
features from the Chapter
11 provisions of the US Bankruptcy Code, which place a greater emphasis on rescuing
corporations instead of liquidating them.
Prior to the temporary relief measures, voluntary
administration was the main formal statutory procedure available to Australian
companies looking to restructure or reorganise their debts. As explained in a Treasury
factsheet, the Government considers voluntary administration to be a
‘one-size-fits-all’ approach that is not well-suited to smaller businesses
because:
Barriers of high cost and lengthy processes that can prevent
distressed small businesses from engaging with the insolvency system early,
reducing their opportunity to restructure and survive.
Furthermore, the Government argues small business owners are
often reluctant to place control of their business into the hands of an
external administrator. A 2015
Productivity Commission report found (p. 24) that almost 60 per cent
of Australian companies that entered voluntary administration were deregistered
within three years.
Australia’s current ‘creditor in possession’ insolvency
model is widely
perceived to protect the interests of creditors over debtors. The Chief
Justice of Western Australia, Wayne
Martin, argued in 2009 that Australia has some of the strictest insolvent
trading prohibitions in the developed world. This limits the possibility that,
through some restructuring or assistance, insolvent companies could return to
profitability and preserve the interests of both creditors and debtors.
On the other hand, stakeholders, such as the Australian
Restructuring Insolvency and Turnaround Association, have expressed concern
that the new ‘debtor in possession’ insolvency model could risk Australia’s
credibility as a destination for investors and creditors.
The shift from a ‘creditor in possession’ to a ‘debtor in
possession’ insolvency model means there will be significant complexities to be
addressed. Details of the legislative changes have been released in the
Government’s Exposure
Draft Bill.
‘Zombie firms’
While economists
from the OECD propose that it is important to prevent otherwise healthy
businesses from going into liquidation during the COVID-19 pandemic, many have
expressed concern that the relief measures and insolvency law changes will only
delay the inevitable collapse of ‘zombie firms’. Zombie firms has become a
popular term to refer to indebted businesses that are being kept on ‘life-support’
by the Government’s relief measures rather than being allowed to die naturally
as part of the ‘creative
destruction’ process.
Insolvency
statistics from the Australian Securities and Investments Commission (ASIC)
indicate that since the Government’s temporary relief measures were introduced in
March 2020, the number of companies entering into external administration has dropped
drastically (see Figure 1 below). This implies that insolvent firms that would
normally enter into external administration have been ‘propped up’ by
government support.
Figure 1: number of companies
that entered into external administration—comparing March, April, May and June,
2017–2020
Source: ASIC, Insolvency statistics, ‘Series 1 Companies entering external administration’.
This analysis is supported by Deloitte’s
modelling, which estimates that 240,000
Australian businesses are at a high risk of failure when the Government winds
back its relief measures. Furthermore, the Australian Bureau of Statistics’ Business
Indicators survey, published in June 2020, observed that nearly 30 per cent
of small businesses reported that they only have enough cash on hand to support
operations for a period of less than three months.
As the Government phases out its temporary relief measures,
according to the Reserve Bank Governor Philip Lowe, there will be an increase
in business insolvencies (dubbed an ‘insolvency
tsunami’ in some media). Mr
Lowe told the House of Representatives Standing Committee on Economics in
August 2020 that Australia will have to:
... confront the reality that there are firms in Australia that
are no longer viable because of the pandemic and they will need to be wound up.
We’re going to be better off if that’s a managed process that takes place over
time rather than occurs because we go over a cliff because of some change in
regulation. So there will be insolvencies. There will be bankruptcies. There
will be some businesses that will not recover. That’s the harsh reality of an
economic downturn that's the worst in 100 years.
All online articles accessed October 2020
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