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Government announces changes to insolvency rules

Government announces changes to insolvency rules

The Federal Government announced details of its second stimulus package in response to COVID-19 (coronavirus), including several material measures relevant to the insolvency industry.

Read: Federal Government announces second COVID-19 economic stimulus plan

The economic impacts of the coronavirus and health measures to prevent spread will see many otherwise profitable and viable businesses temporarily face financial distress.

In broad terms, the government seeks to create a safety net for these businesses to ensure they can sustain the current crisis and resume normal business operations once the crisis passes. The safety net provisions are heavily concentrated on lessening the immediate threat of recovery action against those businesses.

Whilst increased insolvency numbers in the near future appears almost certain, the measures seek to support those business owners and company directors who consider that they have a profitable and viable underlying business, but need temporary assistance to make it past the current crisis.

The measures include the following:

1. Temporary higher threshold, and more time to respond to demand from creditors.

Companies: A creditor issuing a statutory demand on a company is the precursor step to that creditor placing the company into liquidation. The present minimum amount a creditor must be owed in order to commence such an action is $2,000. This amount will be temporarily (for the next 6 months) increased from $2,000 to $20,000.

At present a company has a period of 21 days to respond to that statutory demand, after which time the company is deemed to be insolvent. As a temporary measure, and for the next 6 months, that 21-day compliance period is extended to 6 months.

Individuals: Similar provisions have been implemented with respect to the insolvency of individuals governed by the Bankruptcy Act 1966.

The current minimum threshold amount that a creditor is required to be owed for a bankruptcy to be commenced is $5,000. As a temporary measure for the next 6 months this amount is also increased to $20,000.

The issuing of a bankruptcy notice against an individual is akin to a statutory demand issued against a company. The time for individuals to comply with a bankruptcy notice has also been increased from 21 days to 6 months.

Our view

These announcements will have a significant impact on the number of insolvencies in the medium term, particularly having regard to:

  1. There is already a significant lead time in a creditor compulsory winding-up a company or bankrupting an individual, and
  2. The impact of the coronavirus has already led to significantly modified Court operations, further lengthening that recovery action time in any event.

Nonetheless, the measures are sensible given the current environment.

2. Temporary relief for directors’ personal liability for insolvent trading while insolvent

A company is insolvent if it is unable to pay its debt as and when they fell due. Directors of a company are personally liable for any debts incurred by the company after the time at which it becomes insolvent. This is often a critical factor in the decision of company directors in entering into a formal insolvency.

In order to assist company directors and provide them with confidence to continue to trade (with the aim of returning to long-term viability) the government has announced that directors will be temporarily relieved of their duty to prevent insolvent trading in respect of any debts incurred in the ordinary course of the company’s business. The exemption will apply for the next 6 months.

The government has reminded directors that “egregious cases of dishonesty and fraud” will still be subject to criminal penalties, which already exist.

The company incurring the debt will remain liable for the amount incurred.

The existing personal guarantees that have been given will continue to exist.

Our view

This is the most significant of the temporary relief measures for financially distressed businesses. The measures encourage directors to continue to “have a crack” and not simply give up, where they think they have an underlying profitable and viable business.

Interestingly, the wide-sweeping relief from personal liability under this measure represents a significantly stronger and broader measure than the “safe harbour provisions” recently announced. Those provisions have, by and large, been generally found to be most useful to larger businesses. This announcement has far more wide-sweeping implications, particularly to small and medium enterprises.

3. Providing the treasurer an instrument-making power under the Corporations Act

The government has acknowledged that the coronavirus has created unprecedented issues for businesses and their ability to comply with specific provisions of the Corporations Act. Presently the Australian Securities and Investments Commission (ASIC) has the power to offer relief from some provisions (or to not take action for non-compliance). Presently that relief must be made on an individual case basis to ASIC, which is time consuming. Moreover, companies remain potentially open to legal action from others such as shareholders or creditors. Whilst the specifics of the provisions are minimal at this point, the announcements would appear to foreshadow a significant softening of the government’s approach. Examples of situations which may come under this announcement might include:

  • The deadline for completing audits for public and large entities with ASIC September and October filing obligations
  • The provisions relating to holding of annual meetings of shareholders (particularly in person)
  • The holdings of meeting of creditors under the Corporations Act

Our view

In our view this measure is common sense and necessary. It is pleasing to see that the government has foreshadowed such a sensible approach.

4. ATO recovery action

In addition to the above, the government has also flagged a likely softening of the ATO approach with respect to enforcement proceedings.

The ATO presently has a suite of weapons at its disposal, including traditional winding-up and bankruptcy proceedings, but also garnishee notices (the ability to directly garnishee a tax payers bank account and remove monies from it) and directors penalty notices (the ability to issue a notice to individual directors which has the ultimate effect of making them personally liable for certain taxation obligations).  That basket of potential personal liability taxes was recently expanded to include GST.

Whilst there are no details, clients should indeed expect that such a proposed approach will be honoured. Such a modified course of action was last exhibited during the GFC over a decade ago. During that period the amount outstanding to the ATO, particularly by the SME sector, ballooned massively.

Our view

We again support the announcement, albeit the devil will be in the detail.

It is important to understand that even if the ATO does make concessions on a case by case basis, the underlying tax will still remain payable at some point.

For more information about the recent changes, contact your Pitcher Partners representative.

This content is general commentary only and does not constitute advice. Before making any decision or taking any action in relation to the content, you should consult your professional advisor. To the maximum extent permitted by law, neither Pitcher Partners or its affiliated entities, nor any of our employees will be liable for any loss, damage, liability or claim whatsoever suffered or incurred arising directly or indirectly out of the use or reliance on the material contained in this content. Pitcher Partners is an association of independent firms. Pitcher Partners is a member of the global network of Baker Tilly International Limited, the members of which are separate and independent legal entities. Liability limited by a scheme approved under professional standards legislation.

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