The Australian Government’s temporary insolvency relief measures were implemented to allow distressed businesses the opportunity to recover from the impact of restrictions which were imposed to curb the spread of COVID-19. Without those measures we risked an immediate wave of insolvencies during the middle of the health crisis. However, as we look to next year and the winding back of the temporary measures, the onus is now on businesses and directors to proactively take steps to address distress and potential insolvency. This is an opportunity to forward plan and future-proof businesses as the economy begins to recover.
It should be noted that the statutory and common law duties of directors and other officers, including the obligation to act in good faith in the best interests of the company as a whole (which can include the obligation to take into account the interests of creditors), have not been altered by the temporary measures; nor has the definition of insolvency. To be clear, a company that has debts that are due and payable, and which it cannot pay, is insolvent now. Once the temporary measures end on 1 January 2021, there is a very real risk that many companies will find themselves technically insolvent. From which point, directors will be at risk for debts incurred by the company and ordinary day-to-day creditors can take enforcement measures. It is incumbent on management and directors to act now to minimise the impact or search for a solution.
When do the relief measures come to an end?
The temporary insolvency relief measures are scheduled to end on 31 December 2020, and while extensions have occurred to date, it is unlikely an additional extension of all of the measures will be granted.
As a result, from 1 January 2021:
1. directors will no longer have relief from personal liability for trading whilst insolvent. Directors will be personally on risk for debts incurred by an insolvent company; and
2. the statutory demand temporary measures will end. While the government has mooted a review of the thresholds and timeframes for serving statutory demands, it is currently expected that creditors will again be able to take steps to recover outstanding debts of as little as $2,000 through the statutory demand regime on a 21-day timeframe. Failure to pay a creditor following receipt of a statutory demand leads to a presumption of insolvency and may lead to liquidation following a court order.
The temporary measures, amongst other things, have resulted in a significant backlog of unpaid debts. It is expected the market will see an influx in statutory demands from as early as January 2021 as frustrated creditors, who are likely under pressure themselves, seek payment.
In addition to the January 2021 changes, JobKeeper 2.0 is slated to end completely on 28 March 2021, as will the bank loan deferrals program. This will see the unemployment figures crystallise and potentially impact consumer confidence.
Businesses who suspect distress or insolvency should act now, before it is too late. A restructure or recapitalisation will take time to plan and directors need to be cautious of the personal risk they will be exposed to come 1 January 2021. In particular, businesses that face uncertainty when JobKeeper payments end, and those with outstanding tax obligations, should be canvassing their options. Companies that have not planned or engaged with stakeholders will likely be the worst impacted.
What should directors be doing now?
For directors to put their company in the best position going forward, and to protect themselves from personal liability, it is time to begin preparing contingency plans and contemplating how to mitigate or manage the worst-case scenario. If there is a chance a company will be trading while insolvent when the temporary measures end, it is critical that steps be taken as soon as possible to afford protection.
There is still an opportunity for companies in distress to plan a restructure, be it informally or through a formal insolvency process (i.e. planned administration and deed of company arrangement). The key is considering what will achieve a better outcome for all stakeholders. Companies who forecast liabilities beyond December 2020 they cannot meet should:
1. engage qualified advisors and begin contingency planning. This does not necessitate immediate action but rather is aimed at developing an understanding of options available and likely outcomes (including legal consequences);
2. engage with key creditors (including the ATO) with a view to negotiating a way forward, such as extensions or forbearance, and to seek to document any revised arrangements. Caution should be taken with regards to informal arrangements. If an agreement cannot be made with all key creditors, the risk of a recalcitrant creditor may loom large and can undo any productive work;
3. consider refinancing options for existing debts. Debt refinancing can be beneficial by offering better terms or terms that preserve cash reserves, such as capitalisation of interest options, providing additional working capital and streamlining reporting requirements if multiple debts are consolidated. At Hamilton Locke we have a wide network of lenders and advisers who may be able to assist with this process;
4. enter (or re-enter) the formal safe harbour if the company satisfies the statutory criteria, particularly that all employee entitlements are paid when they fall due and all tax reporting obligations are complied with. The safe harbour regime is designed to encourage directors in distressed or near insolvent situations to formulate a plan (or plans) that is reasonably likely to deliver a better outcome for the company than an immediate administration or liquidation. The provisions offer directors protection from personal liability for debts incurred directly or indirectly in connection with a course of action or plan developed to achieve a better outcome. As a result, if a company enters safe harbour prior to 1 January 2021 the risk of insolvent trading claims against the directors is neutralised to the extent the company remains eligible for safe harbour. Further details on the safe harbour process can be found here.
5. consider whether the ‘debtor in possession’ model under the new small business regime applies, to assist with the possibility of a quick restructure from 1 January 2021. To be eligible, a distressed business must have liabilities of less than $1 million. Under the new model, the board of a company appoints a small business restructuring practitioner to assist it with developing a restructuring plan, which is then voted on by creditors. The business must pay any employee entitlements which are due and payable before a plan can be put to creditors. The new model allows directors and owners of a distressed small business to maintain control of their business while restructuring the company’s debts with the support of creditors. Further details on these measures can be found here and
6. in appropriate circumstances, the board should consider appointing a voluntary administrator. A strategic voluntary administration enables a distressed business to be restructured or recapitalised and maximises the chances of the business, or as much as possible of the business, continuing, as well as providing a better return for creditors than an immediate winding up of the company.
As well as protecting their company through the above steps, directors also need to be aware of the following, which were not amended or affected by the temporary insolvency relief measures:
1. ongoing directors’ duties of good faith, care and due diligence found in both various statutes and at law;
2. the continuing definition of insolvency, which asks whether a company “cannot meet debts when due and payable”; and
3. the expanded Director Penalty Notice (DPN) regime. The DPN regime imposes personal liability on directors to ensure certain tax liabilities incurred by the company are met. A director can now be made personally liable for unpaid PAYG withholding, goods and services tax (GST), superannuation guarantee charge obligations (SGC), luxury car tax (LCT) and wine equalisation tax liabilities (WET). If the Australian Tax Office (ATO) issues a DPN to a director, the director has 21 days to remit any director penalties stated on the DPN or the ATO may commence legal proceedings.
We recommend reaching out for expert advice should you have a query, or wish to consider your options, either as a company looking to understand its options or as a creditor. The Hamilton Locke restructuring and insolvency team have a broad range of top-tier experience acting for a variety of stakeholders in distressed scenarios. For more information please contact Nicholas Edwards, Zina Edwards or Brit Ibanez.