The World Bank insolvency principles: A framework to build more effective insolvency and restructuring processes in Australia

Introduction

On 22 April 2021, the World Bank released the revised edition of its Principles for Effective Insolvency and Creditor/Debtor Regimes (Principles).

The Principles are one of two components of the internationally-recognised standards for insolvency systems (along with a set of UNCITRAL Legislative Guides) and are intended to provide a policy framework that global governments can use to both support lending and credit transactions and create a best practice insolvency system.

Two of the particular focus areas of the Principles are the design of more effective formal restructuring regimes and the design of bespoke insolvency and restructuring alternatives specifically for micro, small and medium sized enterprises (SMEs).

The Principles provide a useful reference point that is relevant in assessing the effectiveness of Australia’s existing insolvency regime, as well providing a framework for possible future reforms. With the ongoing economic and financial impact of COVID-19 on businesses, especially SMEs, and the importance of an effective insolvency framework to the broader Australian economy, this is a priority area relevant to all government entities at a Commonwealth, state and territory level.

What are some of the specifics covered in the Principles?

In many jurisdictions, the insolvency regime is geared towards formal restructuring processes that take a ‘one size fits all approach’, insofar as they are too costly and time-consuming for financially distressed but viable smaller entities to use in an attempt to trade out of their difficulties. The result is that those entities often have no option but to undergo a value-destructive liquidation. This has an adverse impact on value-creation, employment and economic and financial stability.

The Principles therefore recommend that governments design specific insolvency rules for SMEs, with options for viable entities to pursue a restructure and for entities that have no realistic prospect of being able to resume profitable trade to enter a quick, simple and cheap winding up. The recommendation is that governments ought to ‘design and implement a streamlined regime that reduces the complexity and costs of ordinary insolvency processes, providing for expeditious and flexible mechanisms to rehabilitate and/or reorganise viable insolvent or financially distressed SMEs’.

That streamlined regime should, according to the Principles, be a debtor in possession (DIP) model, where the existing management of the SME remains in control of the business and works to implement a restructure, albeit with creditor protections such as requiring a restructure to be pursued under the supervision of an expert insolvency practitioner.

Apart from a standalone insolvency and restructuring framework for SMEs, the Principles also recommend that governments introduce more flexible formal insolvency processes for larger entities which maximise the prospect of those entities being able to undergo a successful restructure.

How is Australia tracking so far?

Following the lead of other jurisdictions such as the United Kingdom, Singapore and the United States, Australia introduced, with effect from 1 January 2021, a new small business restructuring (SBR) process in the Corporations Act 2001 (Cth) (Act) for SMEs with outstanding debts of less than AUD $1 million. There is also now a streamlined liquidation process for those entities. The SBR process provides for directors to appoint a small business restructuring practitioner (SBRP) while they remain in office and work to develop a restructuring plan to submit to creditors over a 20 business day period.

A SBR begins simply upon directors of an eligible SME appointing a SBRP in writing, conditional on a resolution from the board that, in its opinion, the company is insolvent or likely to become insolvent at a future time and that a SBRP ‘should be appointed’.

The appointment triggers a moratorium on the enforcement of creditors’ claims against property of the company, and the commencement of proceedings against the company or its property, absent the written consent of the SBRP or the leave of the court. There is also a stay on the enforcement of ipso facto contractual rights conditional on the company’s entry into the SBR process or by reason of the company’s financial position while it is undergoing restructuring.

An appointed SBRP has the discretion (but not an obligation) to terminate a SBR if it is unlikely to produce a better return for creditors than immediate liquidation or a period of voluntary administration.

The new SBR process broadly accords with the dedicated DIP-model restructuring process for SMEs recommended in the Principles and provides necessary flexibility for smaller Australian businesses to be able to pursue a plan for the compromise of claims, rights and liabilities with creditors and work towards resumed trade if agreed to by the required majority of creditors. However, there remains a question whether the commencement process for a SBR is sufficient to provide protection for creditors who may be impacted by the moratorium on the enforcement of their claims. There is no express requirement for a SBR to be limited to viable entities, unlike the comparative process introduced in the United Kingdom in July 2020, and this remains an issue of industry concern.

Apart from the SBR process, which is expressly designed for SMEs, Australia is also currently contemplating reforms that will introduce a more flexible restructuring framework for larger entities.

In that regard, on 2 August 2021, the Commonwealth Treasury released a discussion paper seeking submissions by 10 September on possible reforms to the current scheme of arrangement process in the Act, which allows a company to enter into a plan or arrangement with creditors and/or members to restructure the company’s affairs (whether in an insolvent or solvent context).

This is an important reform proposal. Indeed, a frequent concern identified in relation to the current scheme of arrangement process in Australia is that it is very costly (requiring a minimum of two court applications to implement) and it can also be difficult to secure the required approval of a scheme by creditors. That is because the existing legislation requires a debtor company to divide creditors into different classes based on their respective rights and for each class to then approve a proposed scheme by 75% in value and a majority in number of creditors.

One potential option for Australia is to look to introduce features of the United Kingdom ‘restructuring plan’ insolvency alternative introduced in June 2020. Under that new process, it is possible for a plan to be approved by the court even if one or more of the relevant creditor classes does not endorse the plan by the required 75% in value and majority in number threshold.

This has the benefit of enhancing flexibility and preventing single creditors or groups of creditors with large claims from effectively ‘holding out’ and derailing a restructuring plan unless their interests are fully accommodated. At the same time, requiring certain protections, such as making court approval conditional on each class of dissenting creditor being ‘no worse off’ than under a liquidation or other insolvency scenario (as occurs under the new United Kingdom process), provides a fair balance to different groups of creditors and ensures that a scheme will be used to support the restructure of viable entities with a reasonable prospect of continued trade.

Takeaway

Australia has made considerable progress in reforming and improving its insolvency and restructuring framework since the start of COVID-19. Indeed, the reforms to date are the most significant in 30 years in this country. With the potential for more flexible formal restructuring alternatives for larger enterprises to be introduced to go along with the dedicated restructuring process for SMEs that is already now in effect, there will be a strong foundation to build a more efficient insolvency system, and indeed a more innovative and entrepreneurial culture in Australia. This will form a pillar of the post-pandemic recovery period and will support long-term economic growth and financial stability.