Business in Financial Distress? Small Business Restructuring Could Be the Lifeline You Need
Businesses experiencing financial difficulty are often unaware of the options available to address financial stress and preserve the future of the business before matters escalate. Acting early can significantly increase the options available to a business and, in some cases, preserve an otherwise viable business.
The appropriate course will depend on a range of factors, including the extent of the company’s financial distress, its underlying viability, the nature and amount of its debts, and the level of control its directors wish to retain.
One option available to eligible small businesses is a Small Business Restructuring (SBR). A SBR provides a formal restructuring process through which an eligible company can propose a compromise of its debts to creditors and an extended time to pay the compromised debt, while its directors remain in control of the company and the business continues to trade.
Unlike liquidation, the purpose of SBR is not to bring the company’s affairs to an end. It is designed to give a financially distressed but potentially viable business an opportunity to restructure its debts and continue operating.
Small Business Restructure Eligibility
Broadly, to be eligible to enter the SBR process:
- the company must have total liabilities of no more than $1 million when the restructuring begins, subject to the liabilities excluded under the legislation;
- the company and its directors must satisfy the restrictions relating to previous use of the SBR and simplified liquidation processes; and
- before a restructuring plan can be proposed to creditors, the company must have complied with the applicable requirements concerning employee entitlements and taxation lodgements.
How does Small Business Restructuring work?
Step 1 – Appointment of a restructuring practitioner
The process begins with the appointment of a registered liquidator as the company’s restructuring practitioner. To do so, the Directors resolve that:
- they have reasonable grounds for suspecting that the company is insolvent, or is likely to become insolvent at some future time; and
- a restructuring practitioner should be appointed.
Step 2 – Protection while the company restructures
One of the significant advantages of SBR is the protection afforded to the company while it attempts to restructure. These protections can provide a company with valuable breathing space to assess its financial position and formulate a proposal to creditors without simultaneously defending multiple enforcement actions.
While the company is in restructuring, unsecured creditors cannot begin, continue or enforce their claims against the company without the restructuring practitioner’s consent or the court’s permission. That is to say, upon the appointment of the Restructuring Practitioner, all legal actions by creditors, including the ATO, are stopped for the duration of their appointment. For instance, if the company has been served with a creditor’s statutory demand, the creditor cannot simply file an application for the company to be wound up. Alternatively, if there is an application on foot made by one of the company’s creditors to wind up the company, the application will most likely be adjourned by the court until either the plan is approved or the appointment of the Restructuring Practitioner is terminated.
Furthermore, a creditor cannot enforce any personal guarantees held against a director or their spouse or relative in relation to a liability of the company, except with the leave of the court and, if leave of the court is obtained, in accordance with the terms (if any) the court may impose for the duration of the SBR.
However, SBR is not a blanket prohibition on every form of creditor action. The nature and extent of the statutory protections should be considered against the particular debts, securities, guarantees and proceedings affecting the company.
Step 3 – Developing the restructuring plan
The restructuring practitioner investigates the company’s affairs and works with the directors in relation to the proposed restructuring plan.
The plan typically sets out:
- by how much the unsecured debt is to be reduced;
- how the reduced debt is to be repaid over time;
- the implementation of solutions to restore cash flow to keep the business trading and financially back on track.
In practical terms, a successful restructuring may allow creditors to receive only a proportion of the amounts otherwise owing to them, with the balance dealt with in accordance with the plan.
Step 4 – Creditors vote on the plan
The restructuring plan is then proposed to each of the company’s creditors, who have 15 business days (or any longer acceptance period where the affected creditors disagree with the schedule of debts in the plan) to vote on whether to accept the plan. Voting is determined by value rather than the number of creditors. Accordingly, a creditor holding a substantial proportion of the company’s affected debt can have a significant influence over whether the plan is accepted.
For many small businesses, the Australian Taxation Office is the largest and therefore, the majority value creditor. The ATO’s position can therefore be critical to the success of a proposed restructuring. The ATO has published guidance concerning the matters it considers when deciding whether to support a restructuring proposal. The ATO will generally support a restructuring plan for an eligible company where:
- the plan would result in a higher payment to creditors within a reasonable period than would be received if winding up; and
- there are no potential public interest concerns or risks that would make support for the plan inappropriate.
A plan is accepted if, at the end of 15 business days (or any longer acceptance period), the majority in value of affected creditors who returned statements to the restructuring practitioner stated that the plan should be accepted.
If the restructuring plan is approved, it becomes binding on all unsecured creditors regardless as to how they voted.
Step 5 – Completing the plan
Once the restructuring plan is accepted, the company must comply with its obligations under the plan.
When the company’s obligations under the plan have been satisfied and all admissible debts or claims have been dealt with in accordance with the plan, the restructuring plan terminates, the company is released from all admissible debts or claims and the company is entitled to any property that was not required by the plan to be distributed to creditors.
What if creditors reject the plan?
A rejected restructuring proposal does not automatically place the company into liquidation.
Instead, the restructuring process generally comes to an end and the directors must consider what other options are available.
Depending on the company’s circumstances, those options may include negotiations with individual creditors, voluntary administration or liquidation.
This is an important distinction. Entering SBR does not guarantee that the company will survive, but it can provide an eligible business with an opportunity to restructure before more drastic insolvency procedures become necessary.
Are there risks in entering Small Business Restructuring?
Yes.
While SBR can be an effective tool, entering restructuring is a formal insolvency process and should not be treated simply as an informal payment arrangement with creditors.
The appointment of a restructuring practitioner may have consequences under the company’s existing contractual arrangements, finance documents, insurance policies, leases, licences and other agreements.
For example, the commencement of an insolvency process may engage contractual provisions or regulatory requirements. The effect of any such provisions must be considered in light of applicable insolvency laws, including restrictions that may apply to the enforcement of certain insolvency-triggered contractual rights.
Directors should therefore understand both the immediate benefits and the broader commercial consequences before commencing the process.
When should directors seek advice?
The earlier, the better.
If a company is struggling to pay debts as and when they fall due, is accumulating taxation liabilities, is receiving demands from creditors or is relying on increasingly stretched payment arrangements simply to continue trading, directors should obtain advice before the position deteriorates further.
Waiting until a winding-up application has been filed or the company has exhausted its available cash can materially reduce the restructuring options available.
Directors must also remain conscious of their duties concerning insolvent trading. Continuing to incur debts while a company is insolvent can expose directors to potential personal liability in certain circumstances.
Dark Legal is here to help
SBR can provide an eligible small business with an opportunity to compromise historical debt, continue trading and preserve the underlying business while its directors remain in control.
It is not suitable for every distressed company. The critical question is whether the business is fundamentally viable once its existing financial burden is addressed.
Dark Legal can assist directors to assess their company’s financial and legal position, understand the available restructuring and insolvency options, and determine the most appropriate course before creditor action limits those options.
If your company is experiencing financial distress or struggling to pay debts as they fall due, obtaining advice early can make a significant difference to the options available.
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