Economic Contagion: insolvency but not claims relief

Found in: Blog

The effects of COVID-19 are yet to play out, but it appears inevitable that there will be a period, perhaps a significant period, of economic distress and uncertainty in Australia and internationally.

Some industries will be particularly exposed to the effects of the shutdowns in response to COVID-19, and it seems likely that most sectors will at least feel its ripple effects. In such times, money often does not flow easily along supply chains for goods and services. If a company along the supply chain suffers an insolvency event or cannot promptly pay its creditors, it can cause significant cash flow problems for the other parties in the chain, particularly those downstream.

As most are aware by now, the Coronavirus Economic Response Package Omnibus Act 2020 (Cth) introduces temporary changes in insolvency law to deal with the issues raised by COVID-19 and to assist small businesses operational. These changes, together with the ‘ipso facto’ regime introduced in 2018, may go some way to alleviate pressure on contracting parties in the next 6 months.

Some of the key temporary measures introduced by the Act are:

  • Directors are granted a reprieve from their duty to prevent insolvent trading under section 588G of the Corporations Act. However, the relief applies only in respect of debts of a company which are incurred in the next 6 months and which are in the company’s ordinary business. This provides a net of protection for directors from personal liability for such debts, in addition to the ‘safe harbour’ laws introduced in 2018.
  • Statutory demands may now only be issued for debts of $20,000 or greater (increased from the previous threshold of $2,000). The strict time limit for a company to respond to a statutory demand by complying with the demand or applying to set it aside has been increased from 21 days to 6 months.
  • Bankruptcy Notices may only be issued against an individual for debts of $20,000 or more (increased from the previous threshold of $5,000). Debtors will also have 6 months to respond to a Bankruptcy Notice.

Whilst these measures will be a welcome relief for distressed companies in the wake of COVID-19, they may also make it more difficult for some creditors to obtain timely payment of the debts owing to them. Further, for contracts entered into after 1 July 2018, a party will not be able to rely on ‘ipso facto’ clauses triggered by the other party’s insolvency event to terminate the contract, accelerate payments due or exercise other rights afforded by clauses of this nature. As such, it is worth knowing the formal and informal avenues which might be available to creditors for relief. For instance:

  • Contractual dispute resolution regimes: Many contracts contain mandatory dispute resolution regimes, sometimes including meetings between senior company representatives, arbitration or expert determination. In the event of a dispute, creditors should check whether such processes are required under their contracts.
  • Senior Negotiations or Mediation: Even if the relevant contract does not contain a mandatory dispute resolution regime, there is nothing to prevent parties from agreeing to undertake such processes. Meetings between senior executives of companies can sometimes cut through unnecessary grandstanding to reach a commercial resolution. Similarly, private mediators can assist parties to identify the key differences between them and reach a compromise position, without resort to more formal court processes. The new norm may be for such meetings and mediations to take place via phone or video.
  • Construction Contracts Act Adjudication: If the relevant contract is a ‘construction contract’ and involves a dispute about money owed under such a contract, consider whether the adjudication process under the Construction Contracts Act 2004 (WA) may apply. The adjudication process is designed to be swift and to keep money flowing along the contracting chain.
  • Calls on performance bonds, guarantees and other security: A party seeking payment or performance of a contract may consider calling on any contractual security arrangements in place, such as performance bonds, bank guarantees or parent company guarantees. However, parties should seek advice and be careful to comply with the terms of any such security, to minimise the risk of further dispute in relation to such calls on security.
  • Winding up proceedings: Another option is to issue a statutory demand to the debtor company, as the first step in commencing winding up proceedings (statutory demands should not be issued as a debt recovery mechanism). However, as can be seen above, the extended 6 month time limit for responding to a statutory demand, and therefore the time before the issuing party can commence winding up proceedings, is such that this may not be a particularly effective method for creditors seeking urgent payment of all or part of a debt. Further, this is not an appropriate mechanism where there is a genuine dispute about the debt said to be owed.
  • Litigation: If parties cannot resolve the issues between them, it may be appropriate to commence Court proceedings, particularly where the right to payment requires the resolution of complex factual issues or construction of the relevant contract terms. Further, litigation may be a more attractive option for creditors than waiting 6 months for a statutory demand to expire before commencing winding up proceedings.

The amendments introduced by the Act have changed the landscape of insolvency law in some respects, but do not constitute a general moratorium on all claims or methods of recovery. Creditors can still take action to recover debts owed to them or pursue claims which are disputed by the other contracting party or parties. Sometimes, that action can be as simple as picking up the phone. At other times, a more structured approach may be required. In either case, early management of debts and short-term liabilities is essential, but if that fails, there are other avenues that may still be pursued. 

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