Last month, the federal government enacted temporary measures to avoid unnecessary insolvencies and bankruptcies in light of the challenges COVID-19 poses, by providing a safety net for directors and businesses to help them operate during a temporary period of illiquidity.
Intended to run for six months, the changes grant directors temporary relief from the risk of personal liability for insolvent trading with respect to any debts incurred in the ordinary course of the company’s business.
However, head of commercial disputes at Bartier Perry Gavin Stuart has warned that, given the expanse of the coronavirus financial impact, the six-month moratorium could simply delay the collapse of a large number of businesses.
Essentially, at the end of the six-month period, many directors will be forced to rely on complex, existing legislation, which could be particularly detrimental to small- to medium-sized companies.
“Come September, many directors whose businesses are struggling will then have to rely on the existing safe harbour legislation, which like chapter 11 bankruptcy laws in the United States aims to help businesses restructure and trade through tough times,” Mr Stuart said.
“The reality though is that even before COVID-19, very few smaller- to medium-sized Australian companies used these laws because of the complexity, cost and confusion that surround them.”
Mr Stuart opined that the economic hibernation would only exacerbate the challenges directors faced in seeking to enact these laws.
“As an example, a company only qualifies for safe harbour protection if all its employee payments are up to date and it has complied with its tax reporting obligations,” Mr Stuart said.
“How realistic will that scenario be for many businesses whose cash flow has dried up? This is not a case of business owners not wanting to fulfil their obligations, but rather we are in an environment where many simply can’t.”
The existing safe harbour protection also requires a director to develop and implement a course of action that is reasonably likely to lead to a better outcome for the business than administration or liquidation.
But Mr Stuart has argued that this could be very difficult in light of the accrued debt.
“The reality is that debts such as rent or finance repayments and interest, while currently deferred temporarily, continue to accrue during the COVID-19 hibernation period and will require repayment some time in the future,” Mr Stuart said.
“Potentially, the financial position of a business could be significantly worse than it was pre-COVID-19, making the development of a course of action reasonably likely to lead to a better outcome all the more difficult. Particularly, as is expected by many, a return to pre-COVID-19 levels of business activity and cash-flow takes time.”
Mr Stuart suggested that the government could either extend the moratorium on insolvent trading with respect to debts incurred during the COVID-19 pandemic, or amend the existing safe harbour legislation to make it easier and less costly for businesses to trade through continuing tough times.
“The federal government has given companies welcome breathing space,” Mr Stuart said.
“Now it has to weigh up the risk of a huge wave of companies collapsing just as the economy reopens or extending and amending legislation to give directors and the businesses they run every chance to trade through one of the greatest economic downturns of our lifetime.”
Mr Stuart concluded that while the focus has been on the collapse of large companies such as Virgin, the economic impact of insolvency on just a small percentage of the 700,000-plus Australian businesses that have 20-plus employees could prove far more significant.