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4 December 202032 minute read

The small business restructuring process – some thoughts and considerations

Introduction

This article discusses the proposed new Part 5.3B of the Corporations Act 2001 (Cth) (Part 5.3B), which is to introduce a “small business restructuring process” (Process) that includes the appointment of a small business restructuring practitioner (Practitioner) to companies with liabilities of less than AUD1 million. The new Part 5.3B is to be introduced into the Corporations Act by the Corporations Amendment (Corporate Insolvency Reforms) Act 2020 (Cth), which is currently introduced into the Commonwealth Parliament as a bill. Part 5.3B leaves much detail of the Process to regulations, for which there is currently an exposure draft entitled Corporations Amendment (Corporate Insolvency Reforms) Regulations 2020 (Cth) (Regulations).

There are also changes and additions to the Insolvency Practice Rules, which set out among other things rules around the remuneration of the Practitioner, to be made by the Insolvency Practice Rules (Corporations) Amendment (Corporate Insolvency Reforms) Rules 2020 (Amended Rules), for which there is an exposure draft released.

The Process is to be termed restructuring, and the debtor company comes under restructuring when it enters the Process.

Liability cap of AUD1M

It is proposed that the Process be limited to businesses with liabilities of AUD1 million or less (Liability Cap). Liabilities is defined broadly, to include any liabilities or obligations other than those that are contingent – regulation 5.3B.03. When one considers unpaid rent (both arrears, and potentially some future rent), ATO debt, employee entitlements (these must be paid out if in arrears before a Restructuring Plan is proposed – see below), and bank or other lending, total aggregate liabilities are likely to reach the AUD1 million mark quickly. So only the smallest of businesses seem likely to be eligible for the Process.

Restructuring that relies, as the Process does, on statutory legal processes for its implementation, is necessarily a fairly involved process. This much is evident from the significant complexity that exists in the Act and the Regulations. Most very small businesses simply do not engage with these legal restructuring processes. Instead, in the author’s experience, very small businesses proceed to restructure by agreement / negotiation. To this extent, the smallest of businesses may not use the Process even if it is available to them. Thought could be given to increasing the Liability Cap, to make the Process available to a broader range of businesses.

Contingent liabilities

Contingent debts and claims are excluded. Creditors who vote on the restructuring plan (Restructuring Plan), and are bound by the Restructuring Plan, exclude creditors holding contingent claims – regulation 5.3B.27(2)(a). The reason for this is not entirely clear. Contingent claims could be included and valued at AUD1 if incapable of valuation. Naturally, it is important to compromise both actual and contingent claims and obligations, to give the company a fresh start.

If contingent creditors are not bound by the Restructuring Plan, then one can see trouble ahead. Contingent claims may materialise into significant actual claims that the Restructuring Plan did not or could not predict, and did not compromise, and which the company may not be able to meet when they arise.

Insolvency

In order to enter restructuring the debtor company must be insolvent, or likely to become insolvent (section 453B(1)(b)). This is similar to the existing voluntary administration process. This is reinforced by the fact that proposing a Restructuring Plan would create a presumption of insolvency for various purposes (section 455A(2)). Once a company has become insolvent it is often too late to meaningfully assist it.

By contrast, under the recently passed (June 2020) Corporate Governance and Insolvency Act 2020 (UK) (CIGA), and the new Part 26A of the Companies Act 2006 (UK) which provides for a modified scheme of arrangement (Part 26A), the United Kingdom has provided for a comprehensive restructuring regime that is open to businesses of all sizes, and at least so far as Part 26A is concerned, becomes available to businesses while they are experiencing distress but importantly before they become insolvent. The test of entry under Part 26A is “[the] company has encountered, or is likely to encounter, financial difficulties that are affecting, or will or may affect, its ability to carry on business as a going concern”. An entry point before the onset of insolvency may be helpful to catch problems before they become difficult to solve, and result in more successful restructuring outcomes.

Restructuring – how long does it take?

The restructuring Process is relatively short. How long it takes matters, because this in turn determines how long the moratoriums on creditor enforcement action last – moratoriums are discussed below. An approximate timeline for the restructuring Process is as set out in the table below. This assumes that neither the directors of the debtor company nor the Practitioner end the process prematurely (both have the right to do so – see below):

Event

Timeframe / Comment

Restructuring commences – 20 business day (30 business days if extended) Proposal Period begins to run

Board resolves to appoint restructuring Practitioner and s/he accepts appointment

Restructuring begins and moratoriums on adverse creditor action apply

Company / directors maintain control of company’s business, property and affairs – debtor in possession – s453K

“Proposal Period” commences. The company and the Practitioner have 20 Business Days to work up a Restructuring Plan

Proposal Period Business Day 1

Section 453B

Regulation 5.3B.12; Regulation 5.3B.15(1)

Proposal Period ends (if not extended by Restructuring Practitioner)

Proposal Period Business Day 20

Regulation 5.3B.12; Regulation 5.3B.15(1)

Proposal Period extension ends

Proposal Period Business Day 30

Regulation 5.3B.15(2)

Employee entitlements and tax returns and statements must be paid and lodged by the end of the Proposal Period

This enlivens the ability to propose a Restructuring Plan – regulation 5.3B.12(1)(e)

Restructuring Plan proposed – 15 business day Acceptance Period begins to run

Restructuring Plan, Restructuring Proposal Statement and Practitioner’s Certificate circulated to Affected Creditors

Restructuring Proposal Statement must include schedule of debts and claims of Affected Creditors

Acceptance Period Business Day 1

Regulation 5.3B.12-16

Affected Creditors must make any notifications to the Practitioner within five (5) business days of receiving the Restructuring Plan and materials, of any disagreement with the company’s assessment of their:

  • admissible debts or claims
  • status as an excluded creditor (eg, related entity)

Acceptance Period Business Day 5

Regulation 5.3B.20(2)

Practitioner serves any notices on company and relevant creditor(s) within five (5) business days adjudicating any disagreements about the schedule of debts and claims, and recommending whether the schedule of debts and claims must be amended (Relevant Notice)

Acceptance Period Business Day 10

Regulation 5.3B.20(5)

Creditors may within five (5) business days of receiving the Relevant Notice, withdraw votes already cast, and vote again, if schedule of debts and claims is amended

Acceptance Period Business Day 15

Regulation 5.3B.21

Acceptance Period ends

Acceptance Period Business Day 15

Regulation 5.3B.19

Restructuring Plan is accepted if a simple majority by value only of Affected Creditors who vote during the Acceptance Period, vote in favour

Acceptance Period Business Day 15

Regulation 5.3B.23(1)

As can be seen, the time from resolution by the debtor company to appoint a Practitioner, through to preparing and proposing a Restructuring Plan and then circulating the plan and materials to creditors and having them vote, takes approximately seven (7) weeks (approximately 35 business days) without extension of the initial Proposal Period, or approximately nine (9) weeks (approximately 45 business days) with such extension. So it takes around two months to get a Restructuring Plan up and approved. This appears to be slightly longer that an administration procedure under Part 5.3A if the convening period for the second meeting of creditors is not extended or the second meeting adjourned, although there is not much difference.

Barleese – premature cessation of restructuring at any time for any reason

The directors of the debtor company can end the restructuring Process at any time for any reason, simply by making a declaration in writing to that effect, and providing it to the Practitioner, creditors and ASIC – regulation 5.3B.02(2). Similarly, the Practitioner has the power to end the restructuring Process under section 453J of the Corporations Act if they believe on reasonable grounds that the company does not meet the eligibility criteria (for example, liabilities exceed AUD1 million, or employee entitlements have not been paid), or it is in the interests of creditors for the company not to undergo restructuring, or for restructuring that has commenced to end. The restructuring also ends if an administrator, liquidator or provisional liquidator is appointed, or the court orders that the restructuring end – regulation 5.3B.02(1).

Restrictions on disposals of the company’s property while under restructuring

The directors of a debtor company under restructuring may not enter into a transaction or dealing that affects the company’s property unless it is in the ordinary course of the company’s business, or the Practitioner consents or the court provides leave – Corporations Act section 453L. The Regulations deem that the transfer or sale of the whole or a part of the business, declaration of dividends, and transactions to satisfy a debt or claim, are not in the ordinary course of business – regulation 5.3B.04(2).

The idea here is to preserve the debtor company’s asset position while it undergoes restructuring, to preserve the status quo and with it the position of creditors, yet permit the company to trade in its ordinary course of business (which itself preserves value).

Moratorium on security and other enforcement, including “ipso facto” protection for contracts

Moratoriums on the enforcement of security and other exercise of rights, which closely track the Part 5.3A moratoriums that apply upon voluntary administration, apply while the debtor company is under restructuring. In addition, ipso facto protections have been included to prevent the termination or exercise or other rights under contracts to which the debtor company is party – Corporations Act section 454N. The ipso facto provisions are essentially equivalent to the provisions that currently apply for companies that enter voluntary administration or controllership of all or substantially all assets, or a Part 5.1 scheme of arrangement.

Secured creditors

Secured creditors are fundamentally given similar treatment to that they receive upon voluntary administration under Part 5.3A. In summary, secured creditors are only bound by a Restructuring Plan if they consent to it. Secured creditors do not vote on the Restructuring Plan, and secured debt is not compromised. What is interesting is that secured debt is ruled off at the value of the secured property – only debt in excess of collateral (secured property) value is unsecured and can vote and be compromised under the Restructuring Plan. This is discussed further below.

Secured parties holding security over all or substantially all property of the debtor company can enforce security during the “decision period”. For this purpose, the definition of “decision period” in the Corporations Act is amended to include both voluntary administration, and restructuring. In relation to restructuring, the decision period will be 13 business days from commencement of the restructuring, or notification to the relevant secured party by the Practitioner of their appointment – sections 454C, and 9 (decision period).

If a secured creditor does not consent, they can stand outside of a Restructuring Plan, are not bound by it, and wait for the moratorium to end (if subject to the moratorium) and then enforce their security. The moratoriums, which are essentially the same as those which apply in Part 5.3A administration, apply to the enforcement of security during the restructuring period, unless the Practitioner consents or secured creditors obtain court leave – section 453R.

Where there are significant secured assets, such as mortgages of real property or leasehold interests, leases of plant and equipment that exceed two years (PPS Leases), commercial consignments, invoice financings, or assets acquired on purchase money security interest (PMSI) finance, then each of those secured creditors can stand outside of the Restructuring Plan. The Personal Property Securities Act 2009 (Cth) (PPSA) has significantly broadened the scope of secured creditors for these purposes. This is likely to see various secured parties able to stand outside of the Restructuring Plan, and with whom the debtor company may need to reach independent restructuring outcomes.

Related creditors

So called “related creditors”, who are creditors that are related entities of the debtor company under restructuring, are treated as “excluded creditors” along with the Practitioner him or herself, and related entities of the Practitioner (Excluded Creditors). Excluded Creditors are not permitted to vote on the Restructuring Plan – regulation 5.3B.23(2)(c).

Restructuring Plan Materials

The key documents that make up the Restructuring Plan include the following (together the Plan Materials):

  • the plan document itself (Restructuring Plan), including the so-called “restructuring plan standard terms” set out in regulation 5.3B.25(1) (Standard Terms) which are discussed below;
  • the debtor company’s “restructuring proposal statement” (Restructuring Proposal Statement), as discussed below; and
  • the Practitioner’s certificate issued under regulation 5.3B.16 (Practitioner’s Certificate), again which is discussed below.
The Restructuring Plan

The Restructuring Plan would set out what the debtor company proposes to restore its solvency and viability. For example, in its most simplest form, the plan could encompass something like the following: contribute AUD50,000 to the plan fund for distribution among affected creditors; Affected Creditors prove against the AUD50,000 fund and receive a proportionate distribution in exchange for the extinguishment of their debt/liabilities against the company.

Naturally, the sky is the limit in terms of possibilities, although given the apparent closeness with Part 5.3A voluntary administration, the ability to discriminate between the treatment of creditors with similar rights under a Restructuring Plan (for example, write off some creditors’ claims, and retain and term out for later payment the claims of others, etc) may be guided, or at least informed, by the principles established for deeds of company arrangement under Part 5.3A.

A Restructuring Plan must include the Standard Terms, which (from above) are set out in regulation 5.3B.25. The Restructuring Plan is void to the extent it is inconsistent with any of the Standard Terms, which broadly are:

  • all admissible debts and claims rank equally. This effectively emulates the pari passu principle that applies to unsecured debts and claims;
  • admissible debts and claims are to be paid out proportionately (that is, on a cents in the dollar basis relative to the quantum of the debts or claims);
  • creditors cannot be paid out more than the amount of their debt or claim (unlikely, but helpful clarification); and
  • for secured creditors, if the secured creditor does not realise their security while the Restructuring Plan is in force, then they stand outside the Restructuring Plan to the extent of their secured property, and are considered to be an Affected Creditor under the Restructuring Plan only to the extent that the creditor’s admissible debt or claim exceeds the value of the secured property.

    This appears to be different to the treatment of secured creditors upon a DOCA under Part 5.3A, where secured creditors can vote with their full debt amount and not forfeit their security by doing so, and equally are not bound by the DOCA unless the DOCA purports to bind them and they vote in favour of it.

    This treatment of secured creditors will likely require a professional independent valuation, to establish the creditor’s secured and unsecured claims.

    Interestingly, enforcement costs, default interest, and receivers fees, etc, which would all normally be secured monies and so secured by security interests, would therefore all be capable of compromise under a Restructuring Plan to the extent the total secured debt exceeds the value of the secured property, except of course to the extent these claims remain contingent, because contingent claims are excluded from a Restructuring Plan.

    The interesting question arises, is the debtor company to be saddled with enforcement costs, default interest, and receivers fees, later upon the enforcement of security by a secured creditor, because a Restructuring Plan was not able to compromise these claims given they were contingent at the time. That could be a very real, practical consequence for debtor companies to bear in mind; 
  • if the secured creditor does realise their security while the Restructuring Plan is in force, then the secured creditor is taken to be a creditor under the Restructuring Plan only to the extent of any balance due to the secured creditor after deducting the “net amount realised” (regulation 5.3B.25(1)(e)(ii)).

    What does “net amount realised” mean? Conventional interpretation would say this means the net return to the secured creditor after deduction of enforcement costs and expenses including say receivers’ costs, legal fees and other enforcement costs.

    Where the secured creditor enforces during the period of the Restructuring Plan, then they are taken to be an unsecured creditor for the balance of their debt (after deducting enforcement costs?) and can prove under the Restructuring Plan for this balance, and naturally the balance would be compromised as an unsecured claim under the Restructuring Plan.

These provisions on how secured debt is to be treated under a Restructuring Plan are helpful because, presumably they by extension mean that a secured creditor cannot use the entirety of it secured debt to vote for, or against, a Restructuring Plan, to unduly influence the plan. Rather, secured creditors are “ruled off” as at the time of the Restructuring Plan, to be secured to the extent of the value in their secured property only, and unsecured for the balance, and can only vote, prove under, and receive a dividend from, the Restructuring Plan to the extent of the unsecured balance. These concepts appear to be drawn from US Chapter 11, where similar principles apply to secured debt.

Conditions to the Restructuring Plan

A Restructuring Plan can be approved subject to conditions, which when satisfied mean that the plan comes into effect when the condition(s) are satisfied – regulation 5.3B.24. This is helpful. One can see various conditions included in Restructuring Plans, for example, conditions around reaching agreement with secured creditors who are not bound by and cannot vote upon the plan, or landlords around new lease terms.

The Restructuring Proposal Statement

The Restructuring Proposal Statement is to be a prescribed form, which presumably will be released closer to the time of commencement of the Process on 1 January 2021. The Restructuring Proposal Statement must include a schedule of debts and claims, which is the debtor company’s view of the world in terms of what is owes to its creditors – a listing of debts owed and claims and liabilities of the company. In proposing the Restructuring Plan, the Practitioner circulates the Restructuring Proposal Statement, including as it does the schedule of debts and claims, to Affected Creditors.

Naturally, Affected Creditors have the right to disagree with the amount owed to them as listed in the Restructuring Proposal Statement, which they do by issuing a notice to the Practitioner within five (5) business days of receiving the Restructuring Proposal Statement – see the timeline in the table above. This is effectively the adjudication process for the proof of debts and claims. And it is lightening. Five business days passes quickly. Affected Creditors will need to be on their toes to ensure the full amount of their debt or claim is accurately recorded.

The Practitioner’s Certificate

The Practitioner must issue and sign a certificate that certifies various things about the Restructuring Plan they have prepared together with the debtor company, including the following where the Practitioner has reasonable grounds to believe them, and if not identify where and why, namely whether (regulation 5.3B.16(2)(a) and (b)):

  • the company meets the eligibility criteria, such as having liabilities less than AUD1 million, and being current with employee entitlements and tax lodgements before the Restructuring Plan is proposed;
  • the company is likely to be able to discharge its obligations under the Restructuring Plan, if it is approved; and
  • all information required to be set out in the Restructuring Proposal Statement, has been so set out.
The Practitioner commits an offence if they do not (regulation 5.3B.16(4)):
  • make reasonable enquiries into the company’s business, property, affairs and financial circumstances; and
  • take reasonable steps to verify the company’s business, property, affairs and financial circumstances.

Given that small business has the propensity for less rather than more record keeping, these duties of the Practitioner may at times prove challenging. Nevertheless, these matters are important to provide some level of independent verification and reliability to the Restructuring Plan, to protect Affected Creditors who are to vote upon it.

Voting on the Restructuring Plan – one class of unsecured creditors only vote for net (after set off) claim amounts only, and purchased claims vote only at the purchase price (not full value)

Regulation 5.3B.23 is key and all stakeholders and lawyers alike will often refer to it. Creditors eligible to vote on the plan (contingent, and related, creditors are from above excluded from voting) can vote if they reply before the end of the “Acceptance Period”. The Acceptance Period is 15 business days (3 weeks) from the time the Practitioner gives the Plan Materials to the debtor company’s Affected Creditors.

Broadly, within that 15 business day (3 week) Acceptance Period, should an Affected Creditor disagree with the company’s assessment of the creditor’s admissible debts and claims, the creditor may issue a notice to the Practitioner of the disagreement within five (5) business days from receiving the Restructuring Plan – regulation 5.3B.20(2)). The Practitioner then has a further five (5) business days of receiving such notices from Affected Creditors to review and adjudicate on the position, and issue a notice back to the company and the relevant Affected Creditors with the adjudication – regulation 5.3B.20(5).

If the Practitioner’s adjudication means the schedule of debts and claims changes, then Affected Creditors have five (5) business days from receiving notice of the adjudication from the Practitioner, to withdraw their vote, and vote again (given the change to the schedule of debts and claims).

So this series of three sets of five (5) business days broadly lines up and accords with, and appears designed to run within, the 15 business day Acceptance Period.

Turning to the approval of a Restructuring Plan, this is by simple majority by value of unsecured creditors only, with (see above and regulation 5.3B.23):

  • secured creditor’s claims deemed unsecured to the extent the claims exceed the value of the secured property; and
  • mutual credits and debits between the debtor company and Affected Creditors set off, and the balance of the account (post set off) only is used for voting.
  • Presumably a set off mechanism would be included in the Restructuring Plan to mirror this voting mechanism; and •
  • importantly, only those Affected Creditors that respond during the three week Acceptance Period get to vote.

So conceivably a Restructuring Plan could be passed with well less than 50% by value of unsecured creditors’ claims, allowing for some unsecured creditors that do not respond during the Acceptance Period. A debtor company and the Practitioner might rightly consider that they could probably pass a Restructuring Plan with support from around 40% (or possibly less) by value of Affected Creditors, allowing for some who simply do not vote.

Importantly, claims cannot be purchased at discounts and then voted for full value. Put another way, purchased claims vote only at the purchase price (not full value) – regulation 5.3B.23(2)(a)(ii). This is no doubt designed to prevent the scrupulous buying up of claims at a discount to vote through certain results – that will not work.

Administering the Restructuring Plan

The Practitioner plays a large role in administering the Restructuring Plan on behalf of the debtor company. The Practitioner is to play a key role under the Restructuring Plan in terms of interfacing the debtor company’s key stakeholders such as secured creditors. This can be a time consuming process, and tensions may arise between these commitments, and the Restructuring Practitioner’s permissible fees.

Separately, the Restructuring Practitioner is to administer the fund for distribution to creditors under the Restructuring Plan, being empowered to receive money from the debtor company and hold it on trust, pay money to creditors under the plan, and if requested by the directors of the debtor company realise the debtor company’s property that is available to pay creditors under the plan and distribute the proceeds to creditors – regulation 5.3B.33.

Accordingly, the Practitioner has power under a Restructuring Plan to dispose of the debtor company’s property to give effect to the Restructuring Plan, but not where the property is subject to a security interest, or belongs to another and is used or occupied by the company – regulation 5.3B.34(1). Exceptions to this are that the Practitioner can dispose of the debtor company’s property in the ordinary course of business even where it is subject to security (such as selling property that is subject to retention of title security, to facilitate a trade-on).

Alternatively, the Practitioner can dispose of the company’s property that is subject to security or owned by another (where the company has possession or control), either with the written consent of the secured party or owner, or with court leave – regulation 5.3B.34(2). This regime around disposal of assets, assuming (from above) the Practitioner is delegated that power by the directors of the debtor company, is very similar to that which applies under Part 5.3A voluntary administration.

Indemnity and lien of Restructuring Practitioner

Given the significant role the Practitioner is to play, they can be exposed to obligations to third parties and the debtor company itself, and need protection. To this end, essentially the same indemnification and lien regime as applies to an administrator under Part 5.3A, applies to the Practitioner – see regulations 5.3B.38-40.

To summarise the position, the Practitioner will have a right of indemnity and lien over the company’s assets, which will cover all property of the debtor company, and have priority to both unsecured debts and debts secured by circulating security, except where a controller is appointed:

  • before the restructuring commences; or
  • during the restructuring, in which case the priority of the Practitioner’s indemnity and lien survive up to the point of appointment of the controller.

To the extent they secure the repayment of money borrowed by the Practitioner or interest and borrowing costs, the right of indemnity and lien of the Practitioner do not have priority over debts secured by a circulating security interest unless the secured party under the circulating security interest consents – regulation 5.3B.39(5).

Payment of employee entitlements and lodgement of tax returns

The debtor company must continue to pay employee entitlements, and lodge tax returns and statements, not to commenced restructuring but (from above) before the debtor is entitled to propose a Restructuring Plan at the end of the Proposal Period - regulation 5.3B.22(b) read with regulation 5.3B.12(1)(e). It would appear that substantial rather than absolute compliance is required – regulation 5.3B.22(b).

This is essentially the same as the safe harbour provisions of the Corporations Act in section 588GA. That is, to qualify for safe harbour protection from insolvent trading under section 588GA, the company in question must be in substantial compliance with employee entitlement payments, and the lodgement of tax returns and statements.

When coupled with the other requirements to implement a Restructuring Plan, a debtor company will clearly require some level of kitty to make it through the Proposal Period for a Restructuring Plan, when considering:

  • that employees and tax lodgement obligations must be kept current;
  • the Practitioner will probably want cash upfront on account of his or her fees, lest s/he take the risk of going unpaid;
  • the debtor company’s lawyers may also want cash upfront on account of their legal fees;
  • valuations are likely required (from above) of secured property, so that secured debt can be ruled off at the level of the value of the secured property, for voting and participation in the Restructuring Plan. The valuer will also likely want to be paid upfront.
The Practitioner’s remuneration

The Amended Rules make provision for certain rules around the Practitioner’s remuneration. The Amended Rules appear to provide that the board of the debtor company must make a determination (presumably, pass a resolution) before the Practitioner is appointed as to the dollar amount of remuneration that the Practitioner will receive for work to advise upon and plan and prepare the Restructuring Plan, before it is approved.

This would appear to require there to be an upfront and fixed dollar amount determination of the Practitioner’s remuneration for work during the Proposal Period and the Acceptance Period – the time leading up to approval of the Restructuring Plan. See Rule 60-1C. Then, should a Restructuring Plan be approved, Rule 60-1D provides that the plan must specify the remuneration to be allowed to the Practitioner for work administering the plan, and that must be by way of a specified percentage of payments made to creditors in accordance with the plan. This is significant, because the payments made to creditors (say, AUD50,000) may be much lower than the total liabilities compromised by the plan (say, AUD800,000).

Conclusion

The Process is a sophisticated and carefully considered restructuring process for small business. The Process is modelled upon and draws heavily from the existing and tested Part 5.3A voluntary administration process. There is much existing case law that will be readily applicable to the Process.

Perhaps after a period of implementation, consideration could be given to expanding the process to a wider range of businesses, beyond the AUD1 million liability cap. The Process can likely handle much larger businesses, and may even be better suited to much larger businesses, than those with liabilities less than AUD1 million. The liability cap of AUD1 million seems to place a brake on the wide and potentially very constructive use of the Process.

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