Corporate Insolvency Regime Reform: The ‘Combatting Illegal Phoenixing’ Bill
By Krisha Reddy, Law Clerk and Alicia Hill, Principal, MST Lawyers.
Illegal phoenix activity is a significant problem that affects the government, businesses and employees. A report conducted by PricewaterhouseCoopers in July 2018 for the Phoenix Taskforce estimated that the annual direct cost of illegal phoenix activity was between $2.85 billion and $5.13 billion in 2015/16. As a result, on 13 February 2019 the Treasury Laws Amendment (Combating Illegal Phoenixing) Bill 2019 (Cth) (Bill) was introduced into Commonwealth Parliament as part of the government’s reform of Australia’s corporate insolvency regime. The Bill intends to amend the Corporations Act 2001 (Cth) to introduce penalty provisions for individuals and officers who engage in phoenixing-related conduct. It also proposes to give ASIC the power to reverse such transactions.
These proposed amendments have received significant public interest, and no doubt insolvency practitioners are already keeping tabs on the progress of the Bill. This article summarises the background to the changes set out in the amendments as at 13 February 2019 and outlines this area of insolvency laws for business owners to increase their awareness of phoenixing and detail courses of action if they fall victim.
What Is Phoenixing?
Company phoenix activity refers to when a new company is registered to take over the failed/insolvent business of a previous company. There are two distinct types of phoenix activity:
- Legitimate business rescue activities (legal); or
- Deliberately using insolvency as a way to avoid paying debts (illegal).
The latter is an issue because of the costly effect on related parties. Illegal phoenixing activity occurs when the assets of an old company are transferred to a new company for little or no value. The old company is then handed over to a liquidator but no longer has any assets to meet its debts to creditors, employees and the government. The directors then continue to operate the same or similar business through the new company – without the burden of the old company’s liabilities but with the benefit of the old company’s assets.
For example, Mr Dubious operates a bakery under the name of Baker’s Dozen Pty Ltd. Due to an expansion of his bakery and purchase of new equipment he can no longer meet his debts to creditors and owes employees for a month of work. Mr Dubious then starts a new company called Baker’s Dozen Extra Pty Ltd and transfers all of the new equipment from Baker’s Dozen Pty Ltd for no consideration. Baker’s Dozen Pty Ltd is then left to be put into liquidation by the ATO for the unpaid tax liability. The creditors and employees are notified by the liquidator that they will be unable to recoup the amounts owing to them as Baker’s Dozen has little assets. Meanwhile, Baker’s Dozen Extra picks up where Baker’s Dozen left off.
This is a very basic example but illustrates how directors of a company can abuse the limited liability regime to get around debt. If you are concerned that illegal phoenix activity has occurred, you can call the ASIC Phoenix Hotline on 1800 807 875 or complete an online form on the ATO website.
Outlined below are the proposed amendments. It should be noted that the final version (if passed) may vary.
Creditor Defeating Disposition
The proposed s.588FDB sets out that disposition of property will be a ‘creditor-defeating disposition’ if:
- The consideration payable from the new company to the old company for the disposition was less than the lesser of (i) the market value or (i) the best price reasonably obtainable in the circumstances; and
- The disposition must have the effect of (i) preventing property becoming available to creditors during wind-up or (ii) hindering or delaying the process of making the property available to creditors during wind-up.
The proposed s.588E(6B) sets out that a transaction will be voidable if:
- It is a creditor-defeating disposition of property (per 588FDB); and
- The transaction was entered into while the company was insolvent and 12 months before winding up occurred or the transaction resulted in the company becoming insolent; but
- But EXCLUDES transactions: giving effect to Court approved arrangements under s.411, under a DOCA, or conducted by an administrator/liquidator/provisional liquidator of the company.
ASIC May Reverse Transactions
The proposed s.588FGAA gives ASIC the power, where there has been a voidable creditor-defeating disposition of property (per s.588E(6B)), to make orders upon request by the company’s liquidator or on its own initiative for the:
- Person to transfer back to the company the disposed property;
- Person to pay the company an amount which fairly represents the benefit they received because of the disposition; and
- Person to transfer to the company property which fairly represents the application of the proceeds of the property subject to the disposition.
ASIC must have regard to the conduct of the parties and the circumstances of the disposition before making such an order.
Officer’s Duty To Prevent Creditor-Defeating Disposition
The proposed s.588GAB provides that an officer of a company who engages in conduct that results in a creditor-defeating disposition may face criminal and/or civil penalties.
The proposed criminal penalty is imprisonment for 10 years and/or a fine of the greater of $725,355 or three times the sum of the total benefit received. The civil penalty will equal compensation for loss or damage.
Procuring Creditor-Defeating Disposition
The proposed s.588GAC provides that a person who engages in conduct of procuring, inciting, inducing or encouraging conduct that results in a creditor-defeating disposition may face criminal and/or civil penalties.
The proposed criminal penalty is imprisonment for 10 years and/or a fine of the greater of $725,355 or three times the sum of the total benefit received. This increases to $7,253,550 for a body corporate. The civil penalty will equal compensation for loss or damage.
Insolvency practitioners should keep an eye on the progress of the Bill as the amendments, especially the proposed s.588FGAA, provide them with greater power to recover property disposed of through phoenixing. Further, the harsh criminal and civil penalties should act as an effective deterrence against illegal phoenix activity if the Bill is passed.
Please subscribe to the MST Insolvency Newsletter for updates about the progress of this Bill.
If you have any questions about this article or the issues raised in it, please feel free to contact Alicia Hill of MST Lawyers’ Dispute Resolution and Litigation team by email or phone +61 8540 0200.