On 22 March 2020, the federal Government announced the following temporary changes to existing insolvency laws in order to provide relief for businesses in financial distress during the COVID-19 crisis:
Statutory demands against companies can only be used in relation to company debts exceeding $20,000 (up from $2,000).
Companies will have 6 months to comply with the statutory demand (up from 21 days).
The personal liability of directors for company debts incurred while the company is insolvent has effectively been suspended.
Bankruptcy notices can only be issued to individuals with eligible debts over $20,000 (up from $5,000), who will also have 6 months to comply.
Statutory demands
Prior to 22 March 2020, a statutory demand was a document which required a company to pay a debt within 21 days. If the company did not pay the debt or apply to set aside the demand within that time, it would be deemed to be insolvent and could be placed into liquidation. Although a statutory demand is not a debt collection tool, in practice they are widely used to short cut the relatively laborious court process.
The period for dealing with a statutory demand is now 6 months and the minimum amount for which a statutory demand can be issued is $20,000.
These changes are intended to ensure that the current cash flow crisis resulting from COVID-19 does not result in an immediate wave of involuntary liquidations caused by debt collection activity.
Insolvent trading
Until this announcement, company directors could be personally liable for their company's debts if they allowed the company to trade while insolvent - In other words, while the company could not pay its debts as and when they fell due.
This had the potential to spark a separate wave of voluntary liquidations caused by directors closing down companies rather than becoming liable to pay company debts from their own pocket. The suspension of this personal liability will encourage directors to keep trading, although whether that turns out to be a good thing will depend on the director's willingness and ability to successfully guide their business through this crisis.
Directors’ duties still apply
Even if directors are relieved of liability from insolvent trading, they must still consider their duties (fiduciary, care and diligence, prohibitions of misleading and deceptive conduct). All directors should be aware that if their company is (or near) insolvent, they have a duty to consider the interests of creditors.
A failure to act with due care and diligence in a manner that prejudices creditors may leave directors personally exposed to claims, by the company (either directly or by external administrators). As such, directors must continue to identify and deal with the issues confronting their businesses, and mitigate the impact those issues may have on their creditors, particularly if they envisage the issues extending beyond the next six months. The documentation and implementation of plans to address business issues will be critical for directors. Where plans become impractical or unrealistic, consideration should be given to external administration options.
What this means for creditors
The changes to the statutory demand provisions will impact creditors who would otherwise rely on the statutory demand process as a reasonably cheap and simple way to pressure debtors to pay outstanding debts.
More broadly, the temporary changes to insolvency laws in relation to the COVID-19 crisis will increase risks for businesses who are creditors to companies in distress themselves, or have counterparties and customers experiencing financial difficulty. Now is the time to think about ways in which you can reduce your own risk and minimise the impact if one of these parties were to become insolvent. For instance, you may consider:
staying on top of your terms of trade. If possible, more frequently require payment upfront rather than extending credit. This will reduce your risk of voidable transactions.
reviewing your contracts and terms of trade to ensure that they are enforceable.
asking for personal guarantees from directors.
understanding your PPSR position – Are you able to register an interest? If you have existing registrations, have these been registered correctly?
if necessary, take legal proceedings to enforce your debts.
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