The COVID-19 global pandemic has presented corporations with unique and unexpected financial challenges. Lockdown policies at both State and Federal levels will have a profound economic impact on a substantial number of Australian businesses, many of which were otherwise viable and successful prior to the outbreak.
In response to this unprecedented crisis, the Australian Federal Government has introduced urgent temporary changes to Australia's insolvency laws. These changes are intended to provide a safety net to enable businesses to continue trading and manage their cash flow during the course of the pandemic, in circumstances where Australia's insolvency regime may previously have left directors with little option but to consider appointing administrators or liquidators to protect themselves from personal liability.
The measures will be welcomed by boards of companies that are facing uncertain futures as a result of the ongoing crisis. Whilst there are some uncertainties in the legislation, perhaps inevitably given the speed of enactment, it is expected that boards will feel more assured of their ability to trade through the crisis in reliance on the new laws.
The changes only apply with effect from 25 March 2020. They will not provide relief for company directors where the company incurred debts when trading whilst insolvent prior to that date, and they will not apply to statutory demands issued before that date.
The changes take effect for an initial period of six months, with the ability for that period to be extended in need.
Temporary insolvent trading relief
Directors will be given relief from personal liability for debts incurred by the company when trading whilst insolvent, if the debt is incurred:
- "in the ordinary course of business"; and
- during the six month period starting on 25 March 2020.
The relief is intended to give directors greater confidence to trade on during the course of the pandemic, with the aim of returning to viability once the pandemic passes and business returns to normal.
Effectively, the temporary relief operates as an additional safe harbour regime, alongside the existing safe harbour regime that provides protection for debts incurred directly or indirectly with a course of action likely to lead to a better outcome for the company.
Directors need to be aware that:
- "In the ordinary course of business" is not defined in the new legislation. The Explanatory Memorandum states that a debt is incurred "in the ordinary course of business" if it is necessary to facilitate the continuation of the business during the six month period. This includes new borrowings. Examples given in the Explanatory Memorandum include taking out a loan to move some business operations online and debts incurred through continuing to pay employees throughout the pandemic. There may be some uncertainty around whether certain debts incurred during the pandemic meet this test.
- The relief does not apply to directors' other statutory duties, including their duties to act in good faith in the best interests of the company for a proper purpose and to exercise their powers and discharge their duties with a reasonable degree of care and diligence. The protection will also not extend to insolvent trading that is dishonest (i.e. further to the existing criminal liability for insolvent trading).
- The company remains liable to pay the debts it incurs during the relief period.
- The relief is a temporary measure designed to relieve pressure directors may otherwise feel to make a quick decision to appoint an external administrator in these extraordinary circumstances. Directors still need to consider if the underlying financial position or long-term viability of the business is impacted, and if the business is suffering from a temporary liquidity challenge or an insurmountable endemic shortage of working capital.
- In some circumstances, directors may need to consider other longer-term options, which may include the use of the existing safe harbour regime to seek to restructure the business outside of a formal insolvency appointment.
- The relief does not affect the power of a liquidator to pursue certain payments made at a time when the company was insolvent as an unfair preference. Counterparties with stressed companies should be aware that if the company is trading on in reliance on the new relief but subsequently enters liquidation in any event, payments made by the company may still be clawed back under as an unfair preference.
The relief may enable a struggling business to properly review its position and consider various measures during the safe harbour period, such as:
- reviewing and renegotiating trade terms (of both the company and its suppliers)
- renegotiating debt facilities and drawing any available headroom in existing facilities
- undertaking a debt and/or equity restructuring
- renegotiating lease terms
- undertaking an operational or work-force restructuring
- selling non-core or underperforming assets (if there is a market for them)
- reviewing and changing product and service lines
- seeking professional advice
The statutory demand regime is often used by creditors as a cost effective way of pressuring debtors to pay outstanding debts. Non-compliance with a statutory demand can result in the creditor seeking a court order that the debtor be wound up on the grounds of insolvency.
For all statutory demands served on or after 25 March 2020, the threshold at which creditors can issue a demand has increased from $2,000 to $20,000, and the time period for compliance has increased from 21 days to six months.
These changes will have a significant impact on creditors who may otherwise rely on the statutory demand process as a cost effective way to force debtors to pay outstanding debts. It is expected that these changes will result in a dramatic reduction in the number of statutory demands being issued.
The provisions do not affect other methods of winding up, including where it is demonstrated that the company is unable to pay its debts other than by reliance on failure to comply with a statutory demand. These provisions also do not impose a general moratorium on creditor action, so a creditor can still sue a debtor for payment and enforce the judgment.
Please contact a member of the Hogan Lovells Business Restructuring and Insolvency team if you would like further information or advice on any of the legislative changes, or to discuss your circumstances further.
Authored by Scott Harris, Bryan Paisley, James Hewer and Jonathan Leitch.