The federal government's relief package aims to provide a safety net so that as many financially distressed businesses as possible can return to normal operation after the crisis passes, a possibility that is considered essential amid mass closures and job losses due to COVID-19.
Relaxing insolvency laws and changes to rules about statutory demands provide breathing room for businesses that suddenly find themselves facing insolvency, says UNSW Business School Professor of Commercial Law and Regulation Pamela Hanrahan.
The government’s announcement deals with two aspects of corporate law that impact on businesses in financial distress – statutory demands and directors’ liability for insolvent trading.
“It may go part of the way to giving people comfort to keep trading and not feel like they have to shut the door,” Professor Hanrahan says.
However, if the lockdown procedures become more severe the federal government may need to re-evaluate the measures.
“If it gets really bad … if you believe in a market system, then there’s going to be a point, because every piece of relief that you give a debtor comes at the expense of a creditor, where more extreme measures like moratoria may be in play.”
Government measures introduced
Temporary higher thresholds and more time to respond to demands from creditors
- Until September, temporarily increasing the current minimum threshold for creditors issuing a statutory demand on a company under the Corporations Act from $2,000 to $20,000.
“This is the mechanism that starts a creditor’s winding up. It is good that it will be reserved for more significant, rather than low-level, defaults,” says Dr Hanrahan.
“[It] probably helps small business more than large business because large business may have much bigger debts than that,” she says.
- Until September, the statutory timeframe for a company to respond to a statutory demand will be extended temporarily from 21 days to six months
“This is the more significant of the measures. Usually, if you don’t respond within time the company is assumed to be insolvent and can be put into winding up.”
Although it doesn’t mean the company is excused from paying the debt, Dr Hanrahan says, it reduces the risk of precipitous action by creditors.
“This gives not just breathing room, but also overcomes [the] difficulties in accepting service at your company’s registered office if everyone has been sent home.”
Temporary relief from directors’ personal liability for trading while insolvent
The directors’ liability announcement ‘turned off’ a provision of the law that can make company directors personally liable for any new or further debts their company incurs once it is insolvent.
- Suspend directors’ personal liability for debt incurred when the company is insolvent (sometimes called ‘insolvent trading’ liability)
“The Corporations Act makes directors personally liable for new debts incurred once a company is insolvent or would become so by incurring that new debt,” says Dr Hanrahan.
- Temporary relief from personal liability for insolvent trading will apply with respect to debts incurred in the ordinary course of the company’s business.
Dr Hanrahan says this could be an issue for directors.
“Remember, you still have a duty to act with care and diligence and in the best interest of the company – which includes looking after your creditors’ interests.”
Also, dishonest or fraudulent conduct is not protected.
“Don’t think you can run up a heap of new debts then phoenix the company at the end of the year.
“In the relief package, it isn’t entirely clear what 'ordinary course of business' will mean in these extraordinary times.
“The government has said 'debts incurred to keep the business operating', but that may need some clarification.”