Major short-term changes to Australian insolvency regime

On Sunday morning, the Prime Minister and Treasurer announced further measures to assist struggling Australian companies in dealing with the COVID-19 outbreak including temporary changes to the Statutory Demand regime and the prohibitions on insolvent trading in the Corporations Act.  While these changes may bring comfort to struggling companies and their employees, the changes will also materially increase the risks to anyone doing business with them.

 

Before the proposed changes:

    • If a company owes a debt of $2,000 or more, the creditor can send the company a Statutory Demand requiring the company to pay the debt.  The company then has 21 days from service to either pay the debt or to file and serve an application for a Court order setting aside the Demand.  The 21 day time period is strict.  If the company does not pay or correctly apply to set aside within the 21 days, the company is deemed to be insolvent and the creditor may apply to the Court for the appointment of a liquidator.  In this regard, a Statutory Demand can be a powerful tool for a creditor seeking to recover a debt.
    • Companies may not trade while insolvent.  A director who permits their company to trade while insolvent may be held personally liable for debts incurred in breach of this prohibition.

 

The proposed changes (outlined in more detail here)  include temporarily:

    • increasing the threshold for issuing a Statutory Demand from $2,000 or more to $20,000 or more;
    • increasing the time companies have to pay amounts demanded in a Statutory Demand from 21 days to 6 months; and
    • relieving directors of personal liability for insolvent trading for debts incurred in the ordinary course of business.

The above changes will effectively allow struggling companies (and unscrupulous companies) the latitude to avoid paying debts for an extended period of time as well as to obtain credit while insolvent and so unlikely to have the capacity to repay.

 

These new risks are in addition to the existing risks of unfair preference claims.  These are claims that a liquidator can make to recover payments of debts made to creditors in circumstances where the creditor knew or ought to have known that the company was insolvent.

Businesses who wish to protect themselves when dealing with risky counterparties can take steps such as:

    • not providing credit and instead dealing on an upfront payment or cash on delivery basis; and
    • taking care when chasing debts not to give the impression of knowledge of insolvency both in communications with the debtor as well as in your internal recordings regarding debt recovery efforts.

 

Mark Farquhar and Peter Clay from our litigation and insolvency team regularly deal with issues relating to dealing with distressed companies.  We would be happy to assist you further with these issues and with commercial disputes more generally.