What Is Small Business Restructuring and How Does It Work?
Overview
Small Business Restructuring, commonly referred to as SBR, is a formal insolvency process available to eligible companies.
It is intended for companies experiencing financial difficulty that may still have a viable underlying business. It allows the company to continue trading while it develops and puts forward a restructuring plan to compromise debts owed to creditors.
SBR is not an informal payment arrangement or simply a mechanism for writing off tax debt. It is a formal process under the Corporations Act, with eligibility requirements, statutory timeframes, creditor rights, director obligations and oversight by a registered liquidator acting as restructuring practitioner.
The statutory object of the process is to allow an eligible company to retain control of its business while developing a restructuring plan with the assistance of a restructuring practitioner, and then to enter into that plan with creditors.
Used in the right circumstances, SBR can preserve a viable business and provide creditors with a better commercial outcome than immediate liquidation. It will not, however, make an unviable business viable or remove the need to address the causes of the company’s financial problems.
The key difference: the company remains in control
The most significant difference between SBR and voluntary administration is control.
In a voluntary administration, the administrator takes control of the company’s business, property and affairs. In a liquidation, control passes to the liquidator.
During an SBR, the company remains in control.
That does not give the directors an unrestricted right to deal with company property.
A transaction or dealing affecting company property may only be entered into if:
- it is in the ordinary course of the company’s business;
- the restructuring practitioner has consented to it and any conditions imposed on that consent are satisfied; or
- it is authorised by the Court.
SBR is a debtor-in-possession process, but it remains a controlled formal insolvency process.
Who can use SBR?
SBR is available to eligible companies, including companies that operate as trustee of a trading trust.
It is not available to sole traders or partnerships. Other options under the Bankruptcy Act are available to deal with same.
The main eligibility requirements are:
- Liabilities must not exceed $1 million
This includes tax debts, trade creditors, loans, lease liabilities, related-party debts, secured creditor shortfalls and other claims.
- The company must not have used SBR or simplified liquidation in the previous seven years
Similar restrictions can apply where a current director, or a person who was a director during the previous 12 months, was involved with another company that used either process.
- Tax lodgements must be substantially up to date before a plan is proposed
The tax debt itself does not need to be paid in full, but the company’s required lodgements must be dealt with.
- Employee entitlements that are due and payable must be paid before a plan is proposed
This includes amounts such as unpaid wages and superannuation that should already have been paid. There are special rules that apply to related party entitlements, such as super.
Meeting the $1 million threshold is only one part of the eligibility test. The company’s prior insolvency history, tax compliance and employee obligations also need to be reviewed and explained as part of the process.
How does the process start?
The directors must resolve that:
- the company is insolvent or likely to become insolvent at some future time; and
- a restructuring practitioner should be appointed.
The company then appoints the practitioner in writing.
The practitioner must have consented in writing to the appointment and must be a registered liquidator.
What happens after appointment?
Once the practitioner is appointed, the company enters the restructuring proposal period.
The proposal period generally lasts 20 business days. If the company requests an extension, the practitioner may extend the period once by up to 10 business days.
During this time, the company continues to trade under the directors’ control, subject to the restrictions applying to transactions outside the ordinary course of business.
The company, its advisers and the practitioner usually work through:
- the company’s assets and liabilities;
- its creditor claims;
- the status of tax lodgements and employee entitlements;
- current and forecast trading performance;
- the causes of the company’s financial difficulties;
- the changes required to restore sustainable trading;
- the proposed source of funds for the plan;
- the amount and timing of the proposed contribution/s; and
- the likely commercial outcome for creditors.
The directors prepare the restructuring plan and restructuring proposal statement with assistance from the restructuring practitioner.
The proposal statement includes a schedule of the company’s debts and claims and gives creditors information relevant to their assessment of the proposal.
A comparison with the likely outcome in liquidation is commercially useful because it helps explain why creditors should accept the compromise.
The proposal still needs to make commercial sense. Creditors are being asked to compromise their claims, so they will usually want to understand what caused the debt, what has changed, how the proposal will be funded and whether the business can meet both the plan payments and its ongoing obligations.
Where the ATO is the major creditor, the company’s compliance history, outstanding lodgements, employee entitlements, future viability and capacity to meet ongoing tax obligations are likely to be particularly relevant.
If a company proposes to fund its plan from trading over 12 months, its cash-flow forecasts should demonstrate how it will make the plan contributions while also paying ongoing wages, superannuation, rent, suppliers, GST and PAYG withholding.
SBR is not simply an exercise in completing prescribed forms within a short timeframe. The proposal needs to be supported by reliable records, realistic assumptions and a coherent explanation of how the business will operate after restructuring.
What does a restructuring plan look like?
A restructuring plan sets out how the company proposes to deal with its admissible debts and claims.
The plan must comply with prescribed requirements.
- admissible debts and claims rank equally;
- creditors receive a proportionate share of the funds available;
- creditors cannot receive property other than money under the plan; and
- the plan cannot run for more than three years.
Related creditors may share in distributions under the plan, but they are excluded from voting on whether the plan should be accepted.
In practice, many plans involve the company making a fixed payments over a period of time in full and final satisfaction of admissible unsecured debts.
For example, assume a company has the following relevant liabilities:
- ATO: $550,000;
- trade creditors: $180,000;
- related-party loans: $150,000; and
- other unsecured creditors: $70,000.
The total is $950,000, before considering any other relevant liabilities or excluded employee entitlements.
The company might propose a restructuring fund of $300,000, paid either as a lump sum or by instalments, for distribution among admissible creditors.
Funding may come from:
- future trading profits;
- third-party funding;
- refinancing;
- the sale of surplus assets; or
- a combination of sources.
The funding proposal must be realistic. A plan dependent on optimistic forecasts, uncertain finance or the sale of an asset at an unsupported value carries a greater risk of rejection or later failure.
How do creditors vote?
Once the plan has been finalised, the practitioner sends creditors the prescribed documents, including:
- the restructuring plan;
- the restructuring proposal statement;
- the applicable standard terms;
- the practitioner’s declaration; and
- voting and relevant information.
Creditors have 15 business days to accept or reject the proposal.
The plan is accepted if a majority in value of the creditors entitled to vote and who actually vote support it. It is not a majority by number of creditors.
Related creditors are not entitled to vote. This prevents directors, shareholders or associated entities from controlling the outcome through related-party claims.
Where the ATO holds most of the unrelated voting debt, its vote may determine whether the plan is accepted. The quality of the company’s records, compliance history, loan accounts and proposal will then be critical.
What happens if creditors accept the plan?
If the required majority accepts the proposal, the restructuring plan is made and the practitioner administers it in accordance with its terms.
The company must then make the required contributions and comply with the plan conditions. The practitioner receives the plan funds and distributes money to creditors.
Where the value of a secured creditor’s security is less than its debt, the plan binds the secured creditor in relation to the unsecured shortfall. The plan does not generally prevent the secured creditor from enforcing its security.
Once the plan has been fully performed, the company is released from the admissible debts and claims covered by it.
That release is one of the principal commercial benefits of SBR. It allows the company to continue operating without the historical debt burden compromised under the plan.
The release applies to the company. It does not automatically release directors or other guarantors from personal guarantees unless the relevant creditor agrees. It also does not release a director from a separate director penalty liability, including a lockdown or expired notices.
This is why it is important to deal with DPNs before they expire.
A company’s restructuring therefore needs to be considered alongside the directors’ personal position.
A plan may terminate before completion in prescribed circumstances, including a breach that remains unrectified for 30 business days, failure of a condition precedent, a Court order or the subsequent appointment of an administrator, liquidator or provisional liquidator.
If a plan terminates without being completed, the company does not obtain the completion release.
What happens if creditors reject the plan?
If creditors reject the plan, the restructuring ends. The company does not automatically enter liquidation.
A rejected plan should lead to an immediate assessment of the company’s position and the directors’ duties.
Depending on the circumstances, the available options may include voluntary administration, liquidation or another properly advised course of action.
What protection does SBR provide?
The Corporations Act provides the company with temporary protection while it is under restructuring.
During that period:
- court proceedings against the company or in relation to its property generally cannot be commenced or continued without the practitioner’s written consent or the Court’s leave;
- enforcement processes against company property are suspended;
- certain owners, lessors and secured parties are restricted from recovering property or enforcing rights; and
- a winding-up application may be adjourned where the Court is satisfied that continuing the restructuring is in creditors’ interests.
These protections are subject to exceptions per the Act.
There is also a temporary restriction on enforcing a company liability guarantee against directors.
This protection applies only while the company is under restructuring. It does not ordinarily continue throughout the term of an accepted restructuring plan and does not itself release the guarantor from the underlying guarantee.
The moratorium provides breathing space to develop and put forward a genuine proposal.
When does SBR work best?
SBR is generally best suited to a company where:
- the underlying business is viable;
- the company has a historical debt problem rather than an ongoing loss-making business;
- reliable financial records are available;
- tax lodgements can be brought up to date;
- due and payable employee entitlements can be paid;
- there is sufficient working capital to continue trading;
- there is a realistic and identifiable source of plan funding;
- the company can meet its ongoing obligations after appointment; and
- creditors have a commercial reason to accept the proposed compromise.
A common example is a business that has returned to profitable trading but remains burdened by historical ATO or trade debt from an earlier period.
If current operations are profitable, lodgements are current, employee entitlements are dealt with and the company or its directors can fund a sensible proposal, SBR may provide a pathway for the company to continue.
When is SBR unsuitable?
SBR is unlikely to solve the problem where:
- the business continues to trade at a loss with no credible turnaround strategy;
- the company cannot satisfy the liability threshold or other eligibility requirements;
- due and payable employee entitlements cannot be paid;
- taxation lodgements cannot be brought into substantial compliance;
- the company lacks reliable books and records;
- there is insufficient working capital to trade during the process;
- the proposed funding is uncertain or unsupported;
- the business cannot meet its ongoing obligations;
- material transactions or assets have not been properly disclosed; or
- there is no genuine commercial basis for creditors to accept the compromise.
SBR compromises eligible historical debts. It does not repair an operating model that continues to generate new losses and liabilities.
Using the process merely to delay creditors, without a viable business or fundable proposal, is likely to add cost and postpone another insolvency appointment.
Questions directors should consider
Before appointing a restructuring practitioner, directors should ask:
- Do the company’s total liabilities fall within the $1 million limit?
- Are all required tax lodgements substantially up to date?
- Have all employee entitlements that are due and payable been paid?
- Is the underlying business currently profitable, or is there a credible and immediate path to profitability?
- Can the company pay its ongoing wages, superannuation, rent, tax and suppliers?
- What amount can realistically be offered to creditors?
- Where will the restructuring contribution come from?
- Can the proposal be completed within its proposed timeframe?
- How does the proposed return compare commercially with the likely alternatives?
- Are there director loan accounts, asset transfers or related-party transactions that require explanation?
- Are the directors able and willing to provide complete and accurate information to the practitioner?
The answers will usually reveal whether SBR is a genuine restructuring option or simply an attempt to defer a more difficult decision.
Final comment
SBR is a useful restructuring process for eligible companies with a viable underlying business.
It allows the company to retain control, continue ordinary trading, obtain temporary protection from certain creditor action and put forward a formal compromise of admissible debts.
It is not a shortcut.
Eligibility must be properly established. The directors must provide complete information. Tax lodgements and due employee entitlements must be addressed. The business must be capable of meeting its ongoing obligations. The proposal must be realistic, properly funded and commercially defensible.
SBR is most effective when the company’s position is reviewed early, while there is still sufficient cash, reliable information and stakeholder support to develop a workable plan.
The longer the company continues to accumulate liabilities or consume its remaining working capital, the fewer restructuring options are likely to remain.
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