Phoenix for insolvent companies: It must be legal

It’s a fact of business life that some companies won’t make it past the first year. But just because a company has gone into liquidation doesn’t mean it was a failure. The owners can often learn from what went wrong and use that knowledge to build a better company.

But before they liquidate or otherwise wind up the old company, they may transfer its assets to the new one and then continue trading, a practice commonly known as “phoenix activity”.

Is this ‘phoenix activity’ legal? Well, that depends on various factors.

When phoenix activity is legal

Starting a company takes a lot of work and so few people will deliberately set one up to fail. Unfortunately, it can still happen despite all their great ideas and hard work.

If the failed company was properly managed by its directors then its business can often be transferred to a new company for fair value on commercial arm’s length terms.

Yes, this is technically ‘phoenix activity’. But providing the directors have acted in accordance with their duties, the transfer shouldn’t give rise to:

  • any claims against the directors or their new company by the liquidator appointed to the old one
  • any criminal conduct that could be investigated and prosecuted by the Australian Securities & Investments Commission (ASIC)

When phoenix activity isn’t legal

As we said earlier, few people will set up a company to fail. But some people do so they can get out of paying its liabilities. Or they may transfer the insolvent company’s business to a new one for less than fair value, or on uncommercial terms.

This is illegal phoenix activity.

The creditors most commonly affected by illegal phoenix activity are the ATO (for unpaid taxes) and employees (for unpaid superannuation).

The penalties for illegal phoenix activity

When a company engages in illegal phoenix activity, it gives rise to potential recovery claims that can be pursued by a Liquidator of that company, including claims against:

  • the company’s directors (for breaching their duties)
  • the entity that received the assets for less than fair value

Claims may also be made against those who:

  • advised the directors to engage in illegal phoenix activity
  • helped the directors illegally ‘phoenix’ the company

How ASIC and the ATO are dealing with illegal phoenix activity

ASIC makes the distinction between legal and illegal phoenix activity with regard to a number of factors, but primarily whether or not the sale adequately addresses the issues of value and commerciality for any asset transfer.

Because of a recent increase in illegal phoenix activity both ASIC and the ATO are cracking down on this practice.

In August 2016, the ATO and ASIC conducted raids on 13 businesses and residences in Brisbane, the Gold Coast and Melbourne. The raids targeted pre-insolvency advisors that ASIC and the ATO suspected were involved in facilitating illegal phoenix activity.

According to Deputy Commissioner of Taxation Michael Cranston:

These visits are part of an ongoing investigation into the activities of a firm of pre-insolvency advisors and their involvement in encouraging and facilitating illegal phoenix activity, evading GST, and failing to pay tax on $22 million of unreported income.

Unlike registered liquidators, these self-proclaimed ‘specialists’ operate in an unregulated environment. Tax professionals, liquidators and their professional associations have said they are also concerned about how the behaviour of a minority undermines the whole insolvency industry.

If you’re thinking of transferring assets from your insolvent company to a new one, don’t risk it being considered illegal phoenix activity. Get in touch with us today, and let us help you structure it properly so it doesn’t raise any red flags to ASIC or the ATO.

 

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