Small business restructuring—a practical guide

Popularity is increasing, and for good reason.

Small business restructuring (SBR) was introduced as a new form of insolvency appointment in January 2021, principally in response to a predicted “flood” of corporate insolvencies resulting from COVID-19 business interruptions. Australia has seen many floods since January 2021, but not in the metaphorical context predicted.

Despite a slow start, SBR is growing in popularity and is proving successful in providing small businesses and creditors with a commercially sensible alternative to liquidation or voluntary administration. As we approach the two-year anniversary of this legislation commencing, and with many successful SBR appointments under our belt, we think a practical guide to SBR is timely.

Debtor in possession 
SBR is not just a new type of insolvency appointment, it’s a new insolvency paradigm. Australia has always had a creditor-in-possession insolvency model where control is taken away directors.

SBR is a debtor-in-possession appointment, where company directors retain control of business operations. An unanticipated benefit is directors are more engaged in the process. By collaborating with creditors, restructuring advisors and their accountant to restructure the business, directors learn new things about running their business successfully. 

Debts under $1m 
To be eligible, the company's debts must not exceed $1m. We’ve had dealings with directors who execute strategies prior to an SBR appointment to reduce the company's total debt below $1m so that it qualifies. This is achievable by a combination of the following:

• Secured debts discharged.

• Superannuation debts discharged.

• Director penalty notices paid.

• Debt for equity deals done with related creditors.

We've also seen plans to provide safe harbour protection against an insolvent trading claim while directors execute the debt reduction strategy in the lead-up to an SBR appointment. 

Entitlements must be paid
Employee entitlements must be paid before a SBR plan can be executed. This means companies that can’t raise sufficient capital to discharge employee entitlement liabilities are ineligible to execute a plan. This mirrors difficulties that companies have traditionally had with proposals for Deeds of Company Arrangement. If a company is so hopelessly insolvent that it cannot even discharge its liabilities to staff, there is really no alternative but liquidation. SBR has not changed that. 

Division 7A loans are a problem 
Business owners who take drawings from their company in a nature similar to income, but record the drawings as a loan payable to the company shouldn’t expect to compromise that debt through the SBR process.

In a recent SBR conducted by our office, the directors proposed a contribution that was less than the balance of their combined Division 7A loans. The Australian Taxation Office (ATO) was the only creditor of note. Consulting with creditors made it clear that a plan providing for anything less than repaying the full loan account wouldn’t be approved. Fortunately, the directors were in a position to revise their proposal and increased the contribution equal to the Division 7A liabilities, and creditors accepted that proposal.

Of course, this is not to say that this a rule. Offers less than the value of shareholder loans will and should be considered on their merit. 

It's very flexible, but cash is king 
There are many ways to structure the deal. It can include contributions from future trade, debt contributions, equity contributions, introducing new business partners, changing equity structures, and any commercially sensible restructuring program you can think of. 

However, one rule of thumb reigns: cash up front for creditors with certainty of payment is best. Our experience shows creditors are far more likely to support a proposal with certainty of a quick resolution than proposals over longer periods with greater risk of failure. 

ATO has been collaborative and commercial 
The ATO is the biggest single stakeholder in this new insolvency regime. Early after the law commenced, the ATO provided clear guidance about what it is looking for from SBR proposals and outlined the information that it preferred to receive from restructuring advisors. To the ATO’s great credit, that initial position has held firm. ATO is engaging early and discussing proposals, providing constructive feedback, and taking a commercially-sound approach to voting on proposals. 

The upside for debtor companies is that they can enter the process with clarity about how the ATO may respond to their plan. This helps create confidence in the SBR process, because for many companies the ATO is the largest creditor. 

Conclusion
Despite slower than expected uptake and the non-existent flood of insolvencies, SBR is beginning to grow in popularity. There’s good reason for this; compared to other options it provides directors and shareholders with an option that is more affordable, more flexible, and lower risk.

If you would like to read more about the technical aspects of small business restructuring, then check out our other recent articles.

If you’d like to watch a video of me discussing this while riding my mountain bike, check out The Ride To Work.