Legal Insights

The long road back: extension to the temporary changes made for directors and debtors

By Sam Kingston & Mathew Gashi

• 08 September 2020 • 5 min read

The Federal Government has announced that it will be extending the operation of the following temporary measures for financially distressed businesses to 31 December 2020:

  • increasing the minimum amount for a creditor to issue a statutory demand to a company from $2,000 to $20,000;
  • increasing the threshold at which a creditor can initiate bankruptcy proceedings from $5,000 to $20,000;
  • increasing the time both companies and individual debtors have to respond to statutory demands or bankruptcy notices from 21 days to 6 months; and
  • relieving directors from their duty to prevent insolvent trading with respect to any debts incurred in the ordinary course of the company’s business. In effect, absent some “egregious dishonest or fraud”, directors may avoid personal liability for insolvent trading regardless of whether they have been taking ‘Safe Harbour’ steps.

These measures were due to expire on 30 September 2020, but as widely anticipated have been extended following the imposition of Stage 4 Restrictions in Victoria, and particularly the Victorian Government’s announcement of its proposed roadmap for leading Victoria out of lockdown.

Rather than a more targeted approach, the Government has simply extended the existing measures. The measures are described as temporary, but now represent a nine month and significant departure from the existing law. Although not part of the Government’s announcement, there is also some discussion about the potential move to US or UK debtor driven restructuring processes, which would be a further significant shift in Australia.

What does this all mean?

Directors are the winners but should still proceed with caution

The clear winners from the further extension are directors and their debtor companies that continue to trade. Absent dishonesty or fraud, directors will have blanket relief from their duty to ensure a company does not trade whilst insolvent under the ‘Safe Harbour’ protections set out in the Corporations Act 2001 (Cth) (Act). Directors should be aware that their ordinary duties remain unchanged and they will still need to consider whether debts are being incurred in the “ordinary course of business”.

Creditors remain at risk

The insolvent trading moratorium, and other stimulus measures such as the Jobkeeper payment and implementation of rent relief guidelines, have seen a stark drop in winding up applications (down almost 90%) and the number of companies entering into voluntary administration (down around 60%). Commentators have pointed out that the ATO, normally one of the more active creditors, did not file a winding up application in July or August 2020. Although banks are now asking customers to resume payments if possible, it is generally accepted that further assistance is available at least for the time being.

Debtor companies are being given significant latitude in paying creditors, which arguably must be at creditor’s expense. Any further shift to a debtor based system would also further improve the position for companies experiencing difficulties, and conversely diminish creditor’s rights. It is unclear if further steps like this will be taken, but regardless the current environment already provides an ideal opportunity to consider restructuring businesses to ensure that they are viable once the current artificial environment comes to an end.

It is widely expected that a significant number of companies will not survive once the stimulus and moratoriums are removed. Because of this, creditors need to be mindful about the significant increase in “zombie” companies that are now continuing to trade (albeit in a limited capacity given the current restrictions) whilst insolvent. Businesses will need to proactively consider risk management steps such as:

  • Reviewing contracts and agreements, including any security agreements, to ensure they are aware of their rights and obligations and aligned with the government stimulus measures;[1]
  • Where necessary, seeking advice on whether any agreement needs to be amended as a result of the pandemic;
  • Considering whether their position may be better protected by, for example, taking out further security; and
  • Carefully considering their dealings with potentially insolvent counterparties and the potential implications if those counterparties were to become externally administered.

It is worth mentioning that no similar changes have been made to the voidable transaction regimes in respect of insolvent companies and bankrupt individuals. Those regimes allow the insolvency practitioner to unwind certain transactions and demand that creditors repay monies they received. This is of particular note in circumstances where many businesses are forced to close their doors and it is likely to be difficult for a creditor to argue that they have not received an unfair preference payment and have no grounds to suspect that the debtor was insolvent. Creditors need to be mindful of this risk and consider taking steps such as receiving payment from a third party (see Maddocks’ recent alert: Third-party payments and unfair preference claims- effective shield or not?).

Maddocks has produced guides to a range of legal issues raised by the coronavirus (COVID-19). You can access these guides here.

[1] See for example Kailis Brothers Pty Ltd v Clarke [2020] NSWSC 1150 where a creditor has recently been able to exercise rights under a Trading Agreement to lodge a caveat over a property.

Need more information on what this means for your business?

Please contact a member of our Restructuring and Insolvency Team.

By Sam Kingston & Mathew Gashi

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