Show me the money … in 6 months

Anyone in business today would be acutely aware that cash is king. Without a steady hand on your cashflow in the midst of this pandemic, you won’t have a business.  That applies as much to paying your debts as it does to getting paid.

Getting paid has just become far more uncertain, as a result of very recent legislation rushed through Federal Parliament on 23 March 2020¹. These changes affect the strict timing provisions and monetary limits on the use of Creditors’ Statutory Demands and Bankruptcy Notices, as well as the enforcement of insolvent trading laws against directors.

I understand the tough times we are all living through, but there are always two sides to every debt: a creditor and a debtor. These legislative amendments make the divide between them even wider.

The power to make these changes

The Federal Treasurer now has the power to make “instruments” under the Corporations Act that exempt certain classes of persons from the application of the Act, or to modify the application of the Act.  That power is now in force for the next 6 months.

Changes to the Creditor’s Statutory Demand system

Until 22 March 2020, a creditor was able to issue a Creditor’s Statutory Demand under the Corporations Act where that creditor was owed at least $2,000. This Coronavirus Omnibus legislation increases this minimum amount to $20,000. Personally, I don’t have an issue with this, since much court time and costs have already been wasted in the appointment of liquidators to companies over debts marginally above $2,000 for too long.

The big change however is the time within which a debtor will have to respond to a Creditor’s Statutory Demand. Originally, that period was 21 days, which was then strictly enforced by the Courts. Failure to comply within that period had potentially dire consequences: the company was deemed to be insolvent, and directors then exposed to personal liability for future company debts.  This compliance period has now been extended to 6 months from the date of the service of the Demand.

What does that mean for a corporate debtor who is now suffering to meet the monthly bills? Firstly, if any single debt is under $20,000 then the creditor cannot issue a Statutory Demand at all until the legislation is amended back to “normal”.

Secondly, if a debt is over $20,000 the Statutory Demand does not need to be complied with for 6 months!  You just got a 6 month extension on your credit.  BUT: That does not prevent a creditor from issuing a Statement of Claim, for instance, in a court to obtain a judgment for the debt.  It does not prevent the Sheriff then turning up with a Writ of Possession, or a garnishee order over your bank account being issued.  But the creditor cannot wind up the corporate debtor for at least another 6 months.

As a creditor, what do you think will occur during that six-month period? The debtor company will obviously continue to incur more debts (for things such as rent, wages, and other month-to-month expenses). What will happen at the end of the six-month period if your debt remains unpaid?  Without doubt, more debts will have been allowed to accumulate.  That may not be anyone’s explicit intention, but it will happen if the debtor does not receive significant revenue to pay your invoice.

At the end of the 6 month Statutory Demand period, the debtor company is still “deemed” to be insolvent, i.e. unable to pay its debts as and when they fall due. But that “deeming” only commences from the end of the six-month period, not from the date that you issue the Statutory Demand.

Moreover, if a liquidator is subsequently appointed, the liquidator is entitled to recover “voidable transactions”. Most of those transactions have a six-month recovery period (usually described as the “relation-back period” immediately prior the commencement of the liquidation). The effect of extending the life of a Creditor’s Statutory Demand to 6 months will simply result in a massive increase in these “voidable transactions” against other creditors who have been paid being pursued by liquidators. So, creditors who may have been paid are likely to be pursued by the liquidators anyway.

These changes to the Creditors Statutory Demand scheme are only in place for the next 6 months. What then happens very much depends on the course of this pandemic.

But the most basic effect of these extensions is this: if you are owed money by a company, it is highly likely that you won’t be paid for at least 6 months.  And if you owe money, you have much longer to pay it before any insolvency axe finally falls.

Insolvent trading changes

Where a company incurs debt at a time when the company is insolvent, the company’s directors can be personally liable for those debts, when those directors should have suspected that the company was insolvent². The Government has temporarily relieved directors of this duty to ensure that companies do not trade whilst they are insolvent for the next 6 months³. In the past, such a personal liability risk may have been sufficient to ensure the company was either properly restructured or, where it was beyond immediate resuscitation, put into some formal insolvency arrangement.

Instead of the Federal Treasurer urging directors to exercise their statutory entitlements under the “Safe Harbour” provisions to protect themselves against personal liability now (and in this regard, I highly recommend the article of my Keypoint colleague, Penelope Pengilley here), the Government has instead simply suspended the insolvent trading provisions of the Corporations Act against directors for another 6 months.  The exemption will not be available for “egregious and flagrant breaches” though.  However, the “big stick” of insolvent trading has pretty much disappeared for the next 6 months. Stand back as the floodgates open.

Changes to the Bankruptcy Act

Where a creditor obtains a judgment debt against an individual in the sum of $5,000 or more, that creditor was previously entitled to file a Bankruptcy Notice and serve it upon the debtor. Up until 22 March this year, that Bankruptcy Notice would normally expire 21 days after service. If the debt was not paid in that time, the debtor would have committed “an act of bankruptcy”. The creditor would then be entitled to apply to the Court to have that debtor declared bankrupt.

The Coronavirus Omnibus legislation has now also extended the time period within which to comply with a Bankruptcy Notice from 21 days to 6 months.  That means creditors will have much longer to wait before pushing non-paying debtors into bankruptcy, and debtors have 6 months more breathing space, which is what this legislation is all about.

As in the case of the liquidation of corporate debtors, historical transactions for the previous 6 months prior to the commencement of the bankruptcy are able to be pursued by a Trustee in Bankruptcy. That period has now been pushed out by at least another 6 months whilst an extant Bankruptcy Notice debt remains unpaid.  That will allow Trustees who are eventually appointed to capture many more voidable transactions.  But it might also put property of the bankrupt, that otherwise would have “vested” in the hands of the trustee, out of reach.

The overall effect of these immediate and temporary provisions is that creditors will be even harder-pressed to recover their unpaid debts in order to maintain their cash flow. Obviously, that will have a domino effect on their own creditors. The Government obviously believes that it is better to suspend people’s obligations to pay their debts for at least six months, rather than enforce the provisions that have been in place for decades.

What if you’re a debtor?

If you owe significant debts, either as an individual or a company, if you can reduce each of your creditors below $20,000 then the creditor cannot bankrupt you (if you’re an individual), or wind up the company, for at least 6 months. Your creditors can still issue claims against you for the debt through the slower and more expensive process of a Statement of Claim or similar court process, which may result in a judgment. But the bankruptcy or corporate liquidation processes will still take 6 months after a judgment.

The first step for debtors is to try and reduce each debt to below $20,000. That should buy you 6 months to pay that debt at least.

What should a creditor do?

It starts with your contract:  can you incorporate a “retention of title” clause into your terms, to ensure that you can at least recover possession of your stock if you haven’t been paid for it?  That contract can then be registered under the Personal Property and Securities Act which puts you in the position of a secured creditor, and able to enforce rights over your stock.  It is likely to be too late to re-write your contracts though.

Secondly, creditors should be super-diligent about collecting their receivables. Make cash collections a daily function.

Lastly, if you are going to be a little more generous with your terms and the payment of your debts, stick to what is agreed. Get it in writing and enforce it. Even in these pandemic times, a squeaky wheel will get some grease.

1 Coronavirus Economic Response Package Omnibus Bill 2020, passed by both Houses on 23 March 2020.

2 Section 588G Corporations Act

3 By amending the Safe Harbour provisions in s588GAAA of the Corporations Act