Banking & Finance Alert: Coming out of the Pandemic – Practical Considerations for Financiers

20 May 2020


Less than a month after JobKeeper payments started flowing to eligible businesses, the Commonwealth and State governments have started relaxing various restrictions that have been imposed on businesses during the COVID-19 pandemic, with a view to reviving the Australian economy. However, customers and their financiers face significant challenges in the near future as various legislative and other protections are lifted in trying to manage increased liabilities and competing creditor claims, while directors once again face the risk of personal liability associated with insolvent trading. Financiers should not wait for these claims and liabilities to crystallise, they should work with their customer, and potentially other creditors, before the existing protections cease, to manage this significant challenge.

This relaxation of restrictions is occurring while certain key temporary measures, which have been put in place to assist businesses adversely affected by the pandemic, continue to apply, including (among others):

  • Increasing the minimum threshold for creditors issuing a statutory demand on a company under the Corporations Act 2001 from $2,000 to $20,000. The temporary threshold applies for a period of 6 months from 25 March 2020;
  • Extending the statutory timeframe for a company to respond to a statutory demand from 21 days to six months. The extended timeframe applies for a period of 6 months from 25 March 2020;
  • Relieving directors of their duty to prevent insolvent trading with respect to any debts incurred in the ordinary course of a company’s business (which also applies for a period of 6 months from 25 March 2020);
  • The introduction of the JobKeeper scheme set out in the Coronavirus Economic Response Package (Payments and Benefits) Rules 2020 which provided assistance to businesses affected by the coronavirus to cover the costs of wages of their employees. The scheme is presently legislated to end on 27 September 2020 (but is scheduled to be reviewed in June 2020);
  • Most businesses with less than $10 million of debt can defer principal and interest obligations under their banking facilities (note these obligations are not waived);
  • Introducing a mandatory Code of Conduct for commercial tenancies which, among other things:
    • provides for the waiver and deferral of rent;
    • suspends the landlord’s right to terminate for non-payment of rent for the duration of the pandemic period (as well as suspending certain other common landlord remedies for default by a tenant); and
    • potentially extends the term of tenancy arrangements to facilitate the amortisation of deferred rent.

These protections generally apply for a period of 6 months (although this does vary from state to state).

These temporary measures will generally cease to apply from the end of September 2020 (although this varies from measure to measure).

It is not known when economic activity will return to normal, however it is clear, as these temporary measures are lifted, there will likely be many businesses that:

  • have materially increased their secured debt;
  • have incurred an accrued debt in respect of rent which will be payable to landlords in addition to usual rent payments;
  • having delayed payment to its unsecured creditors, will imminently face the prospect of unsecured creditors issuing statutory demands which if not satisfied will precipitate the appointment of liquidators; and
  • have deferred the payment of accrued tax liabilities by agreement with the Australian Taxation Office (ATO) or will otherwise seek to do so.

From the perspective of the customer’s directors and their financiers, it looks like the perfect storm.

Some business commentators have said that there are a vast number of enterprises that are really insolvent but are still trading presently. As directors again become personally liable for trading while insolvent, there is a pressing and urgent need for businesses to enter satisfactory arrangements with creditors.

For financiers, who have been busily dealing with hardship applications and requests for funding under the Guarantee of Lending to Small and Medium Enterprises (Coronavirus Economic Response Package) Act 2020, they must now turn their attention to these issues.

What should financiers consider?

Financiers may need to consider the following matters if they are to continue to support their customers:

1. Obtaining more specific customer information

As always, the first step will be to assess the status quo. Obtaining the usual financial statements will likely not be sufficient. Financiers may need to request some very specific information, including:

  • Obtaining financial ledgers which itemise all creditors;
  • Requesting copies of all creditor demands received;
  • Obtaining details of any negotiated or mediated outcome with the customer’s landlord;
  • Verifying any deferral arrangements entered by the customer with the ATO;
  • Checking the status of key contracts including:
    • any key supply contracts to the financier’s customer (including ascertaining any changes to payment terms, any delays in supply, disputes with suppliers); and
    • any supply contracts by the financier’s customer (including obtaining details of any ballooning receivables balances, variation or termination of supply arrangements);
  • Searching the Personal Properties Securities Register to identify any new secured creditors, including asset finance and supplier security interests. In some cases, it may even be appropriate to make other searches to confirm no pending litigation or insolvency processes; and
  • Obtaining regular forecasts.

Tailored information requests will likely be appropriate for individual customers. Financiers should consider incorporating such arrangements as an ongoing obligation of the customer under the terms of their finance agreement, at least for an interim period.

Financiers will need to quickly understand the financial landscape which confronts directors of the customer as their personal liability for insolvent trading is revived.

2. Easing usual financing restrictions and managing creditors

Assuming the financier’s analysis of the customer’s current financial position does not reveal an impending insolvency, financiers may need to reassess their existing approach to common financing restrictions and inter-creditor arrangements.

Typically, the secured financier will seek to substantially restrict other liabilities. Where they do consent to subsequent ranking debt, financiers often expect that such debt will be subordinated. However, the situation confronting some customers at the scheduled expiry of the JobKeeper scheme may not accommodate that approach as:

  • Financier leverage ratios will have deteriorated discouraging financiers to advance further funding; and
  • Customer cash flow may still worsen once the JobKeeper payments cease (despite any increase in trade).

Financiers could consider a more tailored approach to finance agreements which could include:

  • Varying finance agreements to permit customers to enter into appropriate alternative financing arrangements for business investment (for example, new and more cost effective asset finance agreements which may be calculated on a user pays basis);
  • Permitting appropriate asset disposals to pay down debts;
  • Entering into inter-creditor agreements which give more flexibility for permitted payments to creditors (where such arrangements would typically be fully subordinated); and
  • Entering standstill arrangements to allow a financier approved customer strategy to be implemented despite covenant breaches.

Of course, such an approach will only be effective if the customer’s directors are satisfied that they will not be in breach of their obligation not to trade while insolvent. This in turn likely means creditors must commit in a binding manner to the deferral of any enforcement action.

As legislators remove those temporary measures which have protected businesses from failure during the COVID-19 pandemic, now creditors may need to proactively co-operate with each other if customers are to survive.

Please feel free to contact us to discuss these and other steps that may assist you to manage the many issues which are likely to arise following the end of the COVID-19 pandemic protections.

For further information, please contact:
David Murray-Nobbs | Partner | +61 2 9225 2714 |
Jonathan Grunstein | Special Counsel | +61 2 9225 2621 |
or a member of our national Banking and Finance team.