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Insolvency Trading Laws Relief Gives Rise to Zombie Companies: BDO Comments

06 September 2020

The Federal Government has extended insolvent trading relief until the end of the year in a bid to prevent further job losses and avoid another massive hit to the economy expected to flow from increases corporate insolvencies once the moratorium ends.

“Government stimulus and support has been critical to keep viable businesses going and keep people in jobs, however it has also kept unviable businesses going and encouraged directors to ignore their duties.

“Those in the industry anticipate that when the support ceases, there will be an avalanche of insolvencies and unfortunately, many of these will take viable businesses down with them as accounts are not paid and liquidators pursue preferential payments.

“The current Government approach is to encourage directors to keep trading while insolvent, providing relief from the personal liability, however it does not protect suppliers of goods and services from not ultimately getting paid or being pursued for receiving preferential payments.

“The existing Safe Harbour process (subject to some adjustments) achieves the same protection from Insolvent trading, however to qualify, directors need to have prepared a plan, verified by an independent third party, which shows there is a future or at least a better outcome if the business continues to trade as opposed to immediate liquidation.

“An alternative solution to encourage businesses to continue to trade during these unique times could be along the lines of:

  • Adjust Safe Harbour legislation to temporarily remove the pre-conditions that need to be satisfied to qualify (i.e. having ATO lodgements up to date and employee entitlements paid up to date);
  • Provide suppliers of goods and services with better defences against preferential payments received in the ordinary course of business;
  • Provide funding via a grant (say $25k to $30k) for affected business/directors to seek independent Safe Harbour advice to determine if they have long term prospects of achieving a restructuring plan (i.e. are viable post Covid or alternatively)
  • Allow creditors to issue statutory demands in normal terms but adjust the act to allow a defence to winding up being in Safe Harbour – or agreeing to seek Safe Harbour advice giving a further defined period of protection from statutory demands being enforceable
  • For businesses unable to qualify for Safe Harbour – enact a change to the act to provide for an accelerated and streamlined (cheaper, quicker, less red tape) VA, debtor in possession process (new) or winding up due to Covid19 process to allow businesses to restructure or wind up quicker and cheaper

“This would give similar affect to the government’s intent to give directors of impacted business protection from insolvent trading liability while giving viable businesses some much needed support and protection. As Covid19 impacts extend well past the six months of the initial support measures these otherwise viable businesses need to be supported and encouraged to develop plans and strategies to work through the current environment rather than drift into insolvency at a later date.”

“It would also weed out the Zombie companies that have no hope of survival and that are continuing to operate and accruing liabilities they can’t pay.”

Background

The Coronavirus Economic Response Package Omnibus Act 2020 (Cth) which contains the reforms to the operation of various insolvency laws came into effect from 25 March 2020 for a period of 6 months. The temporary relief for financially distressed individuals and businesses has been extended to 31 December 2020.

The measures specific to insolvency law regimes are:

  • temporary increases to the threshold at which creditors can issue a statutory demand (from $2,000 to $20,000)
  • temporary increase to the threshold at which creditors can initiate bankruptcy proceeding (from $5,000 to $20,000)
  • increased time periods for responses to statutory demands and bankruptcy notices from 21 days to six months
  • temporary relief for directors from insolvent trading liability (although egregious cases of fraudulent or dishonest insolvent trading may still attract criminal actions).