Government to Target Illegal Phoenix Activity

Government to Target Illegal Phoenix Activity
Posted on 10 Jan 2020

Are you a creditor that has been left high and dry by a trade debtor, only to discover the business has resurfaced under a different entity?

Or, perhaps you are setting up or restructuring your business and have been advised to set up a labour hire company, or to transfer the business assets to a newly established company and liquidate the old company.

You may be falling victim to or implementing illegal phoenix activity.

With the recent introduction of the ‘safe harbour’ defence for offences such as insolvent trading, which encourages external administration and turnaround and restructuring of businesses being implemented lawfully, and the impending illegal phoenixing laws, it is now more important than ever that directors and advisors understand the difference between what is legal and illegal phoenixing.

Here’s what you should know now.

Introduction

On 27 November 2019, the House of Representatives passed the Treasury Laws Amendment (Combating Illegal Phoenixing) Bill 2019 (Bill) and it will now handover to the Senate to consider.

The Bill introduces a number of new concepts to the Corporations Act 2001 and related legislation, in particular a new regime for combatting illegal phoenixing, called the ‘creditor defeating dispositions’, which may implicate directors, including shadow and de facto directors, pre-insolvency advisors, insolvency practitioners, lawyers and accountants working in the insolvency and restructuring space.  

The Bill was first introduced into Parliament in February 2019, but after lapsing was re-introduced on 4 July 2019. 

What is illegal phoenixing?

Phoenixing, in this context, is a term used to describe the liquidation of an insolvent company following the transfer of its assets to a related corporate entity in order to carry on the business of the first-mentioned company without the burden of the debts it carried.  Phoenixing can be done legally, or illegally.

Illegal phoenixing has been described as:

“…the deliberate and systematic liquidation of a corporate trading entity which occurs with the fraudulent or illegal intention to:

  • avoid tax and other liabilities, such as employee entitlements;
  • continue the operation and profit taking of the business through another trading entity.”[1]

The key factors indicating illegality include the use of liquidation to avoid debts with the full intention of continuing on the business after liquidation, or the intentional restructuring of a company that allows directors to avoid meeting their obligations to pay taxes, employee entitlements and debts owed to other businesses.[2]

Illegal phoenixing not only affects creditors; it also creates an unfair advantage to the business to trade without the burdens of tax and other operating expenses.

What will constitute illegal phoenixing?

The Bill has proposed a new section 588FDB in the Corporations Act 2001 which will provide the statutory definition of the targeted phoenixing activity to be known as ‘creditor defeating dispositions’.

A creditor defeating disposition is a disposition by the company where:[3]

1. the consideration paid to the company was less than the market value or the best price reasonably attainable for the property, whichever is less; and

2. the disposition has the effect of preventing the property from becoming available for the company’s creditors or hindering or delaying the process of making the property available for the company’s creditors.

A transaction involving company property at a time the company is insolvent or may become insolvent in the subsequent 12-month period, will require careful consideration of:

1. whether the transaction constitutes a disposition of company property;

2. the market value of the property;[4]

3. the best price that is reasonably attainable for the property at the time of the proposed disposition, including:

(a) whether market value is reasonably attainable;

(b) whether the company has taken reasonable steps to realise the value of the asset (such as advertising and public auction);

(c) whether there are any urgent cash-flow needs which would take the transaction outside of the circumstances required to obtain market value; and

(d) whether there are legitimate concerns that an urgent sale is required to prevent factors arising which would further reduce the attainable price.

4. whether the disposition could make the property unavailable to any subsequent liquidator to sell or apply for the benefit of the company’s creditors; and

5. whether the disposition could hinder or delay the availability of the property to any subsequent liquidator to sell or apply for the benefit of the company’s creditors.

It will be presumed that the consideration payable for the property is less than the market value and the best price that was reasonably attainable for the property where the company has failed to keep financial records in relation to the disposition, or has failed to retain financial records for 7 years after the disposition.  The usual exception to the presumption of section 588E will apply, being that the failure to retain financial records was solely due to someone destroying, concealing or removing financial records of a company other than the person whose rights or interests would be prejudiced by the presumption.   This presumption is necessary to:

1. deter officers of the company from committing further breaches by obscuring the company’s financial position;[5] and

2. ease the burden on liquidators pursuing illegal phoenix activity and recovering assets for the benefit of the company’s creditors, by reducing the cost and uncertainty of proving the company’s insolvency.[6]

Evidence of the market value of the property and the best price that was reasonably attainable for the property, together with records of the properly-documented agreement or transaction, will be essential to prove that a disposition does not constitute a creditor defeating disposition.

Combatting illegal phoenixing

In summary, the Bill proposes to create the following laws:

1. Voidable transactions

In certain circumstances, creditor defeating dispositions will become transactions voidable against the liquidator, entitling the liquidator to claw-back the company property that was transferred by the disposition pursuant to the existing section 588FF. 

Relevantly, the liquidator will not need to prove that the company was insolvent at the time of the disposition if the company is placed into external administration less than 12 months after the disposition or an act done for the purposes of giving effect to it.[7]

The transaction will not be voidable if it was:

(a) pursuant to a compromise or arrangement approved by the Court under section 411;

(b) under a deed of company arrangement (or DOCA) executed by the company; or

(c) by an administrator, liquidator or provisional liquidator of the company.

It is proposed that the following defences be available:

(a) safe harbor under section 588GA; and

(b) that the person was not a party to the disposition but later acquired the property in good faith under section 588FG.   A person who is not a party to the disposition but later acquires the property with knowledge that the original disposition was voidable, will not be able to rely on the ‘good faith’ defence.[8]

2. Director’s liability and accessorial liability

Directors and officers of the company will have a duty to prevent creditor defeating dispositions where the company is insolvent, becomes insolvent because of the creditor defeating disposition, or is placed into external administration (administration or liquidation, for example) or ceases to carry on business less than 12 months after the creditor defeating disposition. 

Further, there will be an obligation on any person not to engage in the conduct of procuring, inciting, inducing or encouraging a company to make a creditor defeating disposition in certain circumstances, including where the person knows, or a reasonable person in their shoes would know, that the transaction is a creditor defeating disposition.  Awareness of what constitutes a creditor defeating disposition is therefore essential.

The exception to liability for engaging in conduct in contravention of the aforementioned duty and obligation, is where the disposition was made:

(a) pursuant to a compromise or arrangement approved by the Court under section 411;

(b) under a deed of company arrangement (or DOCA) executed by the company, since this scheme of arrangement is made with approval of the company’s creditors and is subject to ASIC and judicial review;

(c) by a liquidator or provisional liquidator of the company, since liquidators are subject to appropriate remedies for misconduct.

However, conduct by the administrators of a company is not an exception.  This is to ensure administrators that are complicit in illegal phoenixing activity are exposed to civil and criminal penalties.[9]

3. ASIC’s powers

ASIC will have the quasi-judicial power to make orders, by request of a liquidator or on its own initiative, to:

(a) direct the recipient of the money or property to re-transfer the property back to the company;

(b) require the recipient of the money or property to pay to the company an amount that fairly represents the benefit that person has received from the transaction; and

(c) require the recipient of the money or property to pay to the company an amount that fairly represents the application of proceeds of the company’s property.

These powers enable ASIC to act where a liquidator is unfunded or not fulfilling its obligations properly.

Importantly, there will be an appeal mechanism whereby the person can appeal the ASIC order within 60 days from being served with the order or otherwise becoming aware of it.  The Court may set aside the order if it is satisfied, based on ASIC’s reasoning, that the conditions for making the order did not apply.

4. Debt recovery by a liquidator

A liquidator of a company will be able to recover the amount payable by a person pursuant to an ASIC order as a debt.  If the order is set aside it will be deemed never to have been made.  Accordingly, liquidators may be inclined to wait out the 60-day limitation period for any appeals before commencing recovery proceedings.

Further information

If you have any queries in relation to external administration, turnaround and restructuring, whether you are a debtor, creditor, advisor, administrator or liquidator, please contact the team at Cronin Miller Litigation for more information.

By Andrea Joyce, Senior Associate. 


[1] PriceWaterhouseCoopers (PwC), Phoenix activity: sizing the problem and matching solutions, Fair Work Ombudsman, June 2012, page ii.

[2] Ibid, page 9.

[3] Proposed section 588FDB.

[4] That is, the price that would be paid in a hypothetical transaction between a knowledgeable and willing, but not anxious, seller to a knowledgeable and willing, but not anxious, buyer, who transact at arm’s length.

[5] Explanatory Memorandum, Treasury Laws Amendment (Combatting Illegal Phoenixing) Bill 2019, paragraph 2.31.

[6] Ibid, paragraph 2.35-2.36.

[7] Ibid, para 2.39.

[8] Ibid, para 2.41.

[9] Ibid, para 2.48.

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