Illegal Phoenix Activity: Re Intellicoms (in liq)

By Alicia Hill, Principal and Harriette Singh, Law Clerk

The Supreme Court recently considered the application of provisions in the Corporations Act 2001 (Cth) (Act) relating to actions taken to defeat creditors and deprive them of a return in a winding up (otherwise known as phoenix activity) in Re Intellicoms (in liq) [2022] VSC 228.

This is one of the first authorities that deals with the operation of sections 588FDB and 588FE(6B) of the Act. The Court found that selling the assets of a company immediately before going into voluntary liquidation constituted ‘illegal phoenix activity’, and resulted in the relevant Sale Agreement being classified as a creditor-defeating disposition.

This article reviews the case and examines what the Court considered to constitute illegal phoenix activity and what relief was available.

Facts

On 8 September 2021, Ms Haynes, the sole director of Intellicomms Pty Ltd (Intellicomms), sold assets of Intellicomms to Tecnologie Fluenti Pty Ltd (Buyer Company) under a Sale Agreement.

Later that day, Ms Haynes convened a meeting of Intellicomms and placed the company into creditors’ voluntary liquidation.

Evidence showed that:

• the assets were sold to the Buyer Company at a much lower price than they had been valued at over multiple months;
• Ms Haynes was unhappy with early valuations, so had provided poor forecasts to valuers when they conducted further valuations of the business, resulting in an alleged decreased value of the assets.

Evidence adduced in trial showed that the Buyer Company was incorporated on 25 August 2021, only two weeks prior to the execution of the Sale Agreement. The sole director and shareholder of the Buyer Company was Ms Gigliotti, the sister of Ms Haynes.

The effect of the Sale Agreement between Intellicomms and the Buyer Company was that the assets sold were no longer assets of Intellicomms, and could not be realised in the winding up of the company, reducing the amount available to potentially return to creditors.

The appointed liquidator of Intellicomms, Mr Glenn Jeffrey Franklin (Mr Franklin), commenced action against the Buyer Company on the basis that the Sale Agreement was a creditor-defeating disposition under section 588FDB of the Act and a voidable transaction within the meaning of section 588FE(6B) of the Act.

Section 588FDB states:

• A disposition of property of a company is a creditor‑defeating dispositionif:
  1. the consideration payable to the company for the disposition was less than the lesser of the following at the time the relevant agreement (as defined in section 9) for the disposition was made or, if there was no such agreement, at the time of the disposition:
     1. the market value of the property;
     2. the best price that was reasonably obtainable for the property, having regard to the circumstances existing at that time; and
  2. the disposition has the effect of:
     1. preventing the property from becoming available for the benefit of the company’s creditors in the winding‑up of the company; or
     2. hindering, or significantly delaying, the process of making the property available for the benefit of the company’s creditors in the winding‑up of the company.

Section 588FE(6B) states that a transaction is a voidable transaction if it is a creditor-defeating disposition of property of the company.

In the explanatory memorandum introducing the relevant bill, limiting illegal phoenix activity was mentioned as one of the aims of each of the above sections. Illegal phoenix activity includes the ‘stripping and transfer of assets from a company to another entity’.[1]

Mr Franklin argued that the Sale Agreement constituted illegal phoenix activity, making the Sale Agreement a creditor-defeating disposition and a voidable transaction. Mr Franklin submitted to the Court that illegal phoenix activity occurred because the Intellicomms assets were sold such a short time before Intellicomms went into voluntary liquidation, and were sold to a company incorporated only two weeks before the Sale Agreement was signed controlled by a related party to the director of Intellicomms.

Mr Franklin sought that the alleged sold assets be returned to Intellicomms for realisation and potential distribution amongst the creditors.

Issues

The main issue for the Court to consider was whether the liquidator, Mt Franklin, had established that the amount payable under the Sale Agreement was less than the lesser of the market value or the best price reasonably obtainable for those assets.

If the amount payable under the Sale Agreement was less than either of these amounts, then this would mean the Sale Agreement was a creditor-defeating disposition and a voidable transaction, able to be reversed and for those assets sold returned to Intellicomms (and the liquidator).

Held

The Court held that the liquidator, Mr Franklin:

•   did not have to adduce evidence for the court to determine an actual monetary value for the market value of the sold assets;
•  only had to establish that, on the balance of probabilities, the consideration payable under the Sale Agreement was less than:
  •  the market value of the property sold; or
  •  best price that was reasonably obtainable for the property, having regard to the circumstances existing at that time.

Associate Justice Gardiner held that the Sale Agreement was a creditor-defeating position under section 588FDB and a voidable transaction under section 588FE(6B).

This was because the best price reasonably obtainable for the assigned assets was not less than the market value, and both were, on the balance of probabilities, significantly more than the consideration payable under the Sale Agreement.

Associate Justice Gardiner held that the ‘transaction constituted by the Sale Agreement was a blatant example of phoenixing’ due to various actions of Ms Hayes.[2] These actions included:

• Ms Haynes refusing to accept the July valuation of the business as a proper valuation;
• Ms Haynes intentionally providing valuers with negative forecasts which had not previously been provided by experts;
• Ms Haynes effectively decreasing three successive valuations of the company by providing an ‘increasingly pessimistic outlook’;[3] and
• Not treating an offer by another business, QPC, to buy the company for an increased price as a legitimate offer.

Takeaways

When selling assets of financially distressed companies, particularly where the sale is not as part of a formal restructuring plan implemented under the auspices of section 588GA of the Act, to avoid allegations that illegal phoenix activity (a creditor defeating transaction) has occurred assets:

• need to be sold at or above market value; or
• for the best price available at the time of sale in the specific circumstances.

The assessment of whether the sale price is either of these should be supported by evidence that demonstrates the sale price is the current market value, or that the sale price was the best available at the time of sale.

This is likely to include valuations from relevant valuers, details of the sale campaign and how the market was tested to verify the sale price was the best price available at the time (such as the type of sale process, offers made, opinions sought, other sale outcomes for similar assets).

Conversely, it is important to be aware that when establishing a creditor-defeating disposition (illegal phoenix activity) has occurred under section 588FDB, plaintiffs (usually liquidators) must establish, on the balance of probabilities, that the consideration payable under any sale was less than both of the limbs contained in the section. That is less than the lower of the market value, or the best price available at the time in the circumstances.

The assessment of whether the price paid is less will be based on the circumstances of the case, and may include evidence such as business valuations, offers from other companies and any changes directors have made to forecasts and valuations.

It will be critical to:

•  examine the documents generated to justify the sale of any assets, or which were in existence in respect of those assets immediately prior to the sale of the assets. Ensuring books and records of the company are obtained and reviewed prior to commencing any action is strongly recommended.
• examine, if there is no clear paper trail, the relevant actors in the sale of the assets. That being the director, solicitor, or accountant of the vendor company, or the valuer retained by the vendor company and the director or individual who is the purchaser.

If you have any queries about any of the matters raised by this case, then please contact Alicia Hill on (03) 8540 0292 or alicia.hill@mst.com.au.

[1] Explanatory memorandum to Treasury Laws Amendment (Combatting Illegal Phoenixing) Bill 2019 (Cth) [1.3].

[2] Re Intellicomms Pty Ltd (in liq) [2022] VSC 228, [244].

[3] Ibid [229].