30 Nov 2020

Debtor-in-possession vs creditor-in-possession


6 min

Does the reform strike the right balance?

Australia has traditionally had what is called a ‘creditor-in-possession’ style insolvency model. That’s because all our insolvency regimes take control of the company away from the owners and give that control to the creditors through appointing an independent external administrator. The thinking being that we shouldn’t leave company control in the hands of the very parties that got the company into its financial problems.

The proposed small business restructure moves away from that to a ‘debtor-in-possession’ style of arrangement. You will commonly hear references to Chapter 11 bankruptcy in the United States of America as a popular debtor-in-possession model. The United States is not the only jurisdiction with a debtor-in-possession style model. Around the world, insolvency laws are evolving to incorporate more forgiving debt relief and restructure arrangements. In 2017, Singapore introduced new restructuring laws, adopting parts of the Chapter 11 bankruptcy laws, reducing the barriers of entry for distressed businesses to seek support. In the United Kingdom (UK), company voluntary arrangements (CVA) has traditionally been the ‘debtor-in-possession’ tool but lacked the moratorium on creditors pursuing their debts. However, COVID-19 triggered the UK Government to introduce in June 2020 a new moratorium feature and a new permanent “restructuring plan” procedure, which keeps the current directors in office. However, this restructuring plan requires court supervision, which is likely to be too costly for small business.

Back in Australia, piecemeal changes were made to soften the perceived ‘creditor favouring’ insolvency laws through introducing safe harbour in late 2017 and a stay on ipso facto clauses in mid-2018. However, what has been continually left unaddressed is the ‘one-size-fits-all’ system that imposes the same duties, obligations, and restrictions, regardless of the administration’s size and complexity. This led to the perception of small business not engaging early enough with the insolvency system, reducing the prospect of the business surviving.

Enter COVID-19.

As a result of the pandemic’s economic impact, the government was forced to act—fast tracking insolvency law reform to better equip small business with affordable tools to restructure or seek debt relief through simplified liquidation. The restructuring process, known as a small business debt restructure, will allow directors to retain company control while it works with the restructuring practitioner to devise a plan to reorganise the company’s debts with creditor approval.

So, we can see that the government has solved one problem by introducing a new-size-to-fit-small, the next challenge to overcome is: is Australia’s culture ready to accept a recalibration of the balance between debtor and creditor control?

For that we must understand that the roots of our insolvency legal framework comes from the scale to which the country relies on credit to fuel the growth of its economy and subsequently, the country’s social tolerance to accepting business failure to promote risk taking and entrepreneurship. Inheriting the UK’s insolvency laws, Australia has historically been seen to be too tough on directors, with strict insolvent trading laws and the numerous ways that directors can be held personally liable for company debts.

Albeit rushed, through this reform, the government has set the stage to allow directors to retain control of their businesses while seeking external professional support. The intent of this reform is clear: the perception that the current insolvency framework is the end of the line and that directors lose all control must change.

From the business owner’s (debtor) perspective, the key is to recognise this initiative’s value and seize the opportunity. A critical factor in shifting the business owners’ mindset is getting the messaging right within the business community. Professional advisors, insolvency experts or otherwise, need to promote that it is acceptable to seek external advice when you need help and the earlier that advice is sought, the more chances the business has to survive and ideally thrive. While the ‘She’ll be right’ attitude is commendable, it is equally dangerous. Directors should not feel that they need to exhaust every dollar of working capital and external funding source before engaging with the insolvency system. They should feel comfortable enough to do it sooner, a lot sooner, without feeling shameful or that they will be punished. A cultural shift is needed, and hopefully, the small business restructure reform will be the trigger for that change. What should we see as a result? More instances of insolvency practitioners working with cases where the underlying ingredients of a viable business model, strong and competent management, modest working capital and accurate and reliable financial records are there to increase the chances of the restructure to work.

But, one final ingredient is needed to bring it altogether. That is, stakeholder (creditor) support.

Stakeholders include, but are not limited to, shareholders, financiers, employees, contractors, suppliers, landlords, regulators, industry bodies, and customers to name a few. Australians’ attitude when it comes to providing credit and supporting business has largely been positive, particularly in small business. We support each other, it’s in our culture. The challenge is for business to have continued support when it needs it the most, when the times get tough. Small business typically relies on other small business, whether it be a supplier or customer. And for them, every dollar counts. This is where the friction arises, and a compromise needs to be made. Again, this where a cultural shift is required. Creditors must be prepared to support, compromise, and understand that bad debt is a risk and cost of doing business, particularly in this current environment. Should the right ingredients be present, then creditors should step up to the plate and support a distressed business. This will mean suppliers not having the assurance of a voluntary administrator being personally liable to carry the cost of a distressed business. The insolvency practitioner then plays a minimalist role to reduce cost and facilitate debtors and creditors to negotiate. Remembering, small business demands affordability. Of course, loosening the insolvency framework too much is dangerous as well. Our economy depends on credit and therefore suppliers and lenders need confidence in a solid regulatory framework to keep credit flowing and keep credit affordable. Despite this, I believe the reform is a step in the right direction.

The recalibration is set to occur, and, in my opinion, our business community needs to have a bit of a re-think on its perception on credit, compromise, and control. After all, half a loaf is better than none.

Business can be tough

Our team is focused and ready to help

Get in touch

Subscribe for all the latest help and news