US-style Chapter 11 bankruptcy protection bid for business

The coming wave of corporate insolvencies from the pandemic recession is expected to be massive.
The coming wave of corporate insolvencies from the pandemic recession is expected to be massive.

The Morrison government is examining major reforms to the insolvency industry ahead of an expected surge in company collapses once COVID-19 assistance packages are wound down, including bankruptcy protection measures for small and mid-sized business.

While details of the reforms remain under tight wraps, sources have told The Australian there are plans to incorporate some elements of the Chapter 11 bankruptcy regime in the US with the aim of simplifying and expediting the insolvency process for businesses aside from big corporates.

One of the elements is understood to be a “debtor in possession” approach, where the keys to the company would remain where they are instead of being handed over to an external administrator.

Owners would still have “skin in the game”, but would be subject to strict reporting requirements.

Treasurer Josh Frydenberg’s office declined to comment on any insolvency reform package.

A spokeswoman said the government was evaluating the future of COVID-19 regulatory measures, such as the “safe harbour” protection against insolvent trading.

READ MORE:‘Spend more on regions to lift economy’|COVID shows risks of concentration in cities|Business, government must engage on trade|ASIC draws up ‘phoenix’ hitlist

Australian Small Business and Family Enterprise Ombudsman Kate Carnell, who recommended a range of reforms in a 46-page insolvency inquiry report released last month, said she had not been consulted by the government on any package.

“But (ASBFEO is) really keen to see some changes, and it would be tragic if any changes didn’t focus on the SME sector because most insolvencies will occur there,” Ms Carnell told The Australian.

“Chapter 11 could provide some companies with the capacity to survive COVID-19.”

The coming wave of corporate insolvencies from the pandemic recession is expected to be massive, with Deloitte Access Economics estimating last month that about 240,000 firms — nearly 10 per cent of the nation’s companies — were at high risk of failure after September when they receive their last JobKeeper payments.

Some rental and loan deferral agreements expire around the same time.

The hardest-hit industries, according to Deloitte, are likely to be hospitality, professional services and transport, where 40 per cent of businesses say their cash reserves cover less than three months of operations.

Another factor driving the reforms is the expiry, again in September, of the protection against insolvent trading for debts incurred in the normal course of business. The closest thing Australia has to Chapter 11 restructuring is voluntary administration, although the former is debtor-led while the latter is creditor-led.

The scheme of arrangement that emerges from a voluntary administration has had local success with big company restructures including Centro, Nine Entertainment and Alinta.

However, one practitioner described the process as a “lawyer’s feast” — highly complex, expensive and completely inappropriate for the SME sector.

There are also mixed views about Chapter 11, with the 2014 interim report of the Financial System Inquiry saying it would be costly to adopt and “could leave control in the hands of those who are often the cause of a company’s financial distress”.

The FSI softened its tone in its final report, recommending consultation on possible amendments to the external administration regime to provide more flexibility for businesses in financial difficulty.

Ms Carnell said she liked the idea of business owners staying involved in the process.

“In the SME sector, the directors are the owners and they have serious skin in the game,” she said.

“The role of the administrator would be to look after the creditors, so you get the best of both worlds.”

The ASBFEO report found SME owners regarded the insolvency system as “opaque” — decisions were taken out of their hands, they felt pushed into outcomes they were not looking for, and their expertise or knowledge of the business was discounted or ignored.

Stock was sold at a low point in the market, assets were put up for sale in publications that were not particularly relevant to their industry, and thousands of dollars were spent by registered liquidators to chase down payments worth less than one tenth of the amount spent.

Unsecured creditors — most often small businesses themselves — saw very little return from an insolvency process.

The report said small businesses needed a mechanism, such as a 90-day minimum hibernation period, which enabled them to take stock of their situation in a crisis like COVID-19.

Owners would then be able to engage with creditors so that payment of loans, rent and tax could be deferred.

When the business returned to trading, extended repayment terms could be negotiated.

There would also be a moratorium on personal liability for insolvent trading.