Phoenix Companies – What Are They, Are They Legal and What is Being Done About Them?
What is phoenixing?
There is currently no express prohibition, proscribed under Australian law, from carrying out “phoenix activity”. Australian law also does not define “phoenix activity”.
Such ‘activity’ can be broadly summarised as the exploitation of the corporate form to the detriment of unsecured creditors when directors/ officers/ controllers liquidate the former company and start a new company to carry on the same business.
The numerous references to “phoenix activity” in recent case law and the resulting criticism against directors engaging in such activity suggests that this subject is increasingly concerning the business community (Deputy Commissioner of Taxation v A & S Services Australia Pty Ltd [2017] FCA 437, UTSG Pty Ltd v Gwynvill Properties Pty Ltd [2017] NSWSC 558).
Despite there being no express phoenix prohibition, it is highly likely that if any person engages in this sort of activity that they will have contravened an existing law. This may include: An insolvent transaction of the company and voidable under s 588FE(2) of the Corporations Act 2001 (Cth) (‘the Act’); An insolvent transaction and also an uncommercial transaction and voidable under s 588FE(3) of the Act; An insolvent transaction of the company with a related party and voidable under s 588FE(4) of the Act; An insolvent transaction of the company where the company became a party to the transaction for the purpose, or for purposes including the purpose, of defeating, delaying, or interfering with, the rights of any or all of its creditors on a winding up of the company and voidable under s 588FE(5) of the Act; An unfair loan to the company made at any time on or before the day when the winding up began and voidable under s 588FE(6) of the Act; An unreasonable director-related transaction of the company and voidable under s 588FE(6A) of the Act; A breach of director duties under the general law, equity and/or ss 180, 181 and/or 182 of the Act and/ or insolvent trading in contravention of s 588G of the Act; Aiding, abetting, counselling or procuring the contravention; inducing whether by threats or promises or otherwise, the contravention; been in any way, by act or omission, directly or indirectly, knowingly concerned in or party to the contravention; or has conspired with others to effect the contravention; Knowing assistance and/ or knowing receipt under equitable principles; 10.Failure to disclose all the property of the company, and how and to whom and for what consideration and when any part of the property of the company was disposed of within 10 years next before the relevant day, except such part as has been disposed of in the ordinary course of the business of the company; s 590(1)(a) of the Act; Fraudulent concealment or removal of any part of the property of the company and/ or fraudulent concealment of any debt due to or by the company contrary to s 590(1)(c) of the Act; Fraudulently making any material omission in any statement or report relating to the affairs of the company in contravention of s 590(1)(d) of the Act; Taking action to defeat creditors in breach of s 37A of the Conveyancing Act 1919 (NSW).
Further, directors may find themselves exposed via guarantees & indemnities they have provided to creditors, director penalty provisions contained in the Taxation Administration Act 1953 (Cth), accessorial liability for contraventions of civil penalty provisions under the Fair Work Act 2009 (Cth), disqualification provisions of the Act that allow ASIC, or the Court, to disqualify a director involved in two or more failed companies (ss 206D and 206F of the Act), potential criminal prosecution by the Commonwealth Director of Public Prosecutions for contraventions of s 530A(1) of the Act (see ss 540A(6) and 1311(1)(b) of the Act). The list continues. We have not even named specific provisions under: the Competition and Consumer Act 2010 (Cth); WHS/OHS legislation; and environmental protection laws to name a few.
The advisors of illegal phoenix activity are not exempt from these laws. In ASIC v Somerville & Ors [2009] NSWSC 94, the Supreme Court of New South Wales found a solicitor liable for aiding and abetting directors to breach their duties and found that there was no proper purpose in the phoenix transactions other than to preserve the assets in a new company without the liabilities of the old company.
The case serves as a cautionary tale to all advisors that are considering overstepping their boundaries.
Some countries that prefer to take a more direct approach by way of express laws against phoenixing. New Zealand, for example, defines phoenix activity under the New Zealand Companies Act 1993 as:
In relation to a failed company, a company that, at any time before, or within 5 years after, the commencement of the liquidation of a failed company, is known by a name that is also:
(a) a pre-liquidation name of the failed company; or
(b) a similar name.
“similar name” is defined therein as: a name that is so similar to a pre-liquidation name of a failed company so as to suggest an association with that company.
There have been attempts to change the Australian laws, which would have brought them closer to the New Zealand laws in this area. For example, the Corporations Amendment (Similar Names) Bill 2012 was proposed to impose personal liability on directors engaged in phoenix activity via being directors of similar name companies to failed companies. This bill never passed.
Nevertheless, with so many laws already in place to indirectly combat phoenixing, how can there be any problem?
Law or Enforcement (or both)?
The problem is not necessarily a lack of regulation. It includes a lack of knowledge/ education and enforcement.
Dr Helen Anderson, Jasper Hedges, Ian Ramsay and Michelle Walsh report in ‘Illegal Phoenix Activity: Is a ‘Phoenix Prohibition’ the Solution? (2017) 35 Company and Securities Law Journal 184-203, at [14] and [16]: [there is] a question about the efficacy of enforcement actions taken against illegal phoenix operators, who are not being deterred from continuing their unlawful activities and: the reality of phoenix enforcement is that ASIC expects liquidators to bear the principal burden of bringing actions. However, phoenix liquidations usually involve companies will little or no assets. Liquidators are not obliged to do any work other than the minimum reporting requirements [subsection 533(1) of the Act] unless they are paid [subsection 545(1) and (3) of the Act]. Assetless administration funding requires liquidators to establish a case that there has been wrongdoing, which is extremely difficult in the absence of books and records“.
Reform
On 13 September 2017, the Minister of Revenue and Financial Services announced a package of anti-phoenixing reforms.
Most significantly, the reforms will introduce a requirement for every director to hold a unique Director Identification Number (‘DIN’). The DIN will allow government agencies and credit agencies to track and map the relations between individuals and entities and individuals and other people.
The practical effect is that an individual’s current and prior directorships will be readily available for inspection to the public and government agencies. The effect is that it will make it significantly easier for the public and government agencies to track phoenix practices and in the case of government agencies, to take action against the relevant people.
In addition to the DIN, the government will consult on implementing a range of other measures to combat and deter phoenix activity (‘non-DIN measures‘). Consultation on the non-DIN measures is currently underway.
It is proposed that the non-DIN measures will include:
- Specific phoenixing offences to assist regulators in taking decisive action on illegal phoenix activity;
- A dedicated hotline as a single point of contact for reporting illegal phoenix activity;
- An extension of the penalties applying to tax avoidance schemes to extend to advisors who assist phoenix operators;
- Stronger powers for the ATO to recover security deposits from suspected phoenix operators to cover any outstanding tax liabilities;
- Making directors personally liable for GST liabilities as part of extended director penalty provisions;
- Preventing directors from backdating their resignations to avoid personal liability or from resigning and leaving a company with no directors;
- Prohibiting related entities to the phoenix operator from appointing a liquidator.
Additional Reforms
Other measures which have been proposed include the strengthening of existing ASIC measures (such as heavier penalties for failure to provide books and records to liquidators), increased number of prosecutions, better resourcing to regulators and better clarity over the role and funding of liquidators particularly in relation to the Assetless Administration Fund which has been criticised as being hard to use.
Until the completion of consultation and the implementation of the other measures, the extent of the recent anti-phoenix reforms remains unclear. As such, it is difficult to tell whether these reforms will have a material effect on reducing problematic phoenix activity.
Do you know of an insolvent company which is considering transferring its assets to a new company? There are ways to transfer assets without breaching the law. This is the difficult line between illegal phoenix activity and merely selling a business.
Contact us today and we can help you with a proper business restructure to ensure this will not be illegal phoenix activity.