Article by Mark Davidson

Proposed legislation to combat illegal phoenix activity has been released for consultation and promises some big changes for companies facing insolvency.

Illegal phoenix activities cost the Australian economy between $2.85 and $5.13 billion annually.

This affects all Australians – either indirectly as a taxpayer or directly as a creditor of a company which goes into liquidation.

What is illegal phoenix activity?

Illegal phoenix activity is generally when the following happens:

• A director of company A, which has assets and liabilities, creates company B;
• The assets of company A are transferred to company B for no consideration, or consideration of less than market value, and;
• All the liabilities are left in company A.

The director may put company A into liquidation or he or she may let a creditor of company A engage a solicitor to wind it up. Better still, if the director doesn’t pay the ASIC annual fee then the company may automatically be deregistered.

Often the company which ends up in liquidation is just an empty shell.

Additionally, commonly where illegal phoenix activity occurs the director will dispose of most of the books and records – particularly those that record their actions – but leave enough to provide a liquidator, if appointed.

Shouldn’t the liquidator sue the director for misconduct?

There are difficulties for the liquidator in pursuing the director for misconduct.

If the director has intentionally engaged in questionable conduct, they are unlikely to want to discuss it. They may also engage an unregulated pre-insolvency advisor or facilitator to help them. The pre-insolvency advisor will act as the ‘middle man’ between the director and liquidator, intercepting all correspondence and pre-reviewing records provided to the liquidator.

When records of the company have been screened and possibly tampered with, it becomes difficult to prove misconduct.

Additionally, proving illegal phoenix activity can be difficult as, in itself, it’s not an actual offence. The liquidator must prove that, in conducting the phoenix activity, the director breached his or her duties; or that the activity gave rise to an unfair preference or uncommercial transaction; or that the director traded while insolvent.

Who’s going to fund the misconduct pursuit?

Let’s assume that the liquidator in our case can prove misconduct and allege illegal phoenix activity and that this gives rise to a monetary claim the Liquidator can pursue. The main questions they will face are:

• How is the legal action going to be funded?
• Does the director have the financial capacity to repay the company/creditors?

To fund legal action, liquidators usually seek assistance from creditors. But this is not often well-received as creditors have already lost money. A litigation funder may help but will want to know how they will be repaid. If the director does not have the funds or access to assets such as real property, the funder won’t be keen to move forward.

If there is no funding and/or the director does not have the capacity to meet claims against him or her, the matter may not be pursued, as a liquidator won’t want to carry out work and incur costs on a matter where there is limited prospects of recovery funds to meet the costs incurred.

What’s the Australian government doing about illegal phoenix activity?

The Australian government is now responding to the damage that has been done to the economy. It has proposed draft legislation to deter and disrupt behavior associated with illegal phoenix activity in the following ways:

• Introducing new offences and recovery actions that target those who conduct or facilitate phoenix transactions:
  • It will now be an offence for company directors to engage in creditor-defeating transfers of company assets that prevent, hinder or significantly delay creditors’ access to those assets.
  • Pre-insolvency advisers and other facilitators of illegal phoenix activities will also be liable, as there will be a separate offence for any person who procures, incites, induces or encourages a company to make creditor-defeating transfers of company assets.
  • These will be both criminal and civil offences, attaching the highest penalties available under the law.
  • The offences will be supported by an extension of the existing liquidator asset claw-back avenues to cover illegal phoenix transactions.
  • ASIC will also receive a new regulatory tool to recover property that has been transferred under an illegal phoenix transaction.
• Preventing directors from backdating their resignations to avoid personal liability;
• Preventing a sole director from resigning and leaving a company as an empty corporate shell with no director;
• Extending the director penalty provisions to make directors personally liable for their company’s GST and related liabilities;
• Expanding the Australian Taxation Office’s existing power to retain refunds where there are tax lodgements outstanding;
• Restricting the voting rights of related creditors of the phoenix operator at meetings regarding the appointment or removal and replacement of an external administrator.

Will these measures work?

The above changes have received general support. However, they have also attracted some criticism from key bodies, including the Australian Restructuring Insolvency and Turnaround Association (ARITA), which is supportive of the changes but is seeking more details regarding certain measures.

ARITA wants an actual “phoenixing” offence that would specifically apply to directors, advisers and facilitators. Currently, liquidators must pursue those under breaches of the Corporations Act 2001, such as breaches of director duties.

ARITA has also commented on the lack of adequate funding and documentary evidence available to liquidators, which it has noted continues to hamper the effectiveness of the reforms.

Ultimately, time will determine the effectiveness of any changes which become legislation, but it’s definitely a step in the right direction to reduce the amount of illegal phoenix activity.

If you’re facing insolvency and want to know your legal options, contact us for a free, no obligation discussion.