Illegal phoenix activity broadly involves the transfer of assets between related companies to intentionally evade creditors. In October 2015 a comprehensive report in respect of the incidence, cost and enforcement of illegal phoenix activity was released by the Melbourne Law School and Monash Business School in Australia (Report) providing lawmakers and regulators with highly sought after data to assist them tackle illegal phoenix activity across Australia.
The Report comes at a time when the Australian government has undertaken a number of actions to address illegal phoenix activity, including the commencement of a Senate Inquiry, which released its final report on 3 December 2015 (Senate Report), and the establishment of a ‘Serious Financial Crime Taskforce’ (Taskforce) in July 2015. This paper examines the key findings of the Report, the recommendations of the Senate Report and the possible impact of the recently announced Australian insolvency legislative reforms on the incidence of illegal phoenix activity.
What is illegal 'phoenix activity'?
Illegal phoenix activity involves the transfer of the assets from an indebted company into a new company (often controlled by the same directors) with the intention of avoiding paying creditors. The indebted company is then placed into administration or liquidation leaving no assets to pay creditors. Meanwhile the new company continues to trade. Such activity continues to occur in a number of common law jurisdictions, including Australia, United Kingdom, United States, Canada and New Zealand.
How big is the problem?
The Report noted that while the Australian government and regulatory bodies recognise that illegal phoenix activity is a significant and increasing problem, no one has been able to accurately quantify its extent. The difficulty is due, in part, to the fact that ‘phoenix activity’ lacks a specific legal definition or legal offence in Australia and other jurisdictions. While an accurate estimate of the extent of illegal phoenix activity in Australia is not presently available, the Report provides that:
- The Australian Taxation Office (ATO) estimates that at any given time there are approximately 6,000 phoenix companies operating in Australia, run by between 7,500-9,000 directors. Many of these companies operate in the small to medium enterprise market (companies with a turnover of AUD$2 million to AUD$250 million) and the micro enterprise market (companies with below AUD$2 million turnover). The ATO believe that phoenix activity largely operates in these segments of the market because larger business cannot afford to risk their reputations, and
- The Australian Securities Investment Commission (ASIC) have identified 6,223 companies in the top five risk industries that may have the potential to conduct illegal phoenix activity (rather than confirmed cases).
What's the cost?
Quantifying the extent of illegal phoenix activity is difficult and accordingly, regulators also face difficulties calculating a figure that represents the true cost of phoenix activity. Nonetheless, the Report notes that the problem is significantly costly to justify the commitment of substantial government resources to it and, in particular, illegal phoenix activity may cost:
- The Australian economy between approximately AUD$1.78 billion to AUD$3.19 billion annually according to a report prepared by PwC in 2012 (PwC Report)
- Australian employees between approximately AUD$191 million to AUD$655 million annually according to the PwC Report, and
- The Australian government approximately AUD$600 million annually in relation to uncollected tax according to ATO estimates.
How have the regulators responded?
As there is no specific offence in relation to phoenix activity, regulators are left to resort to a quagmire of legislative provisions that may have not been drafted with the purpose of targeting illegal phoenix activity. Accordingly, enforcement of phoenix activity and the quantification of enforcement measures have proven difficult. Despite the significant incidence and cost of phoenix activity in Australia, there is real difficulty faced by regulators when combatting phoenix activity. For instance, the Report estimates that during a 10 year period between 2004 and 2014 only 51 directors were disqualified by ASIC in circumstances that involved illegal phoenix activity.
'Serious Financial Crime Taskforce' (Taskforce)
Going forward, the Australian government has enlisted the support of a number of agencies including the Australian Federal Police to tackle illegal phoenix activity. Earlier this year the government committed AUD$127.6 million over four years to fund the Taskforce to target (amongst other things) international tax evasion and criminality related to fraudulent phoenix activity. The Taskforce has recovered AUD$85 million since being operational on 1 July 2015.
The Australian government has also recently established a Senate inquiry into insolvency in the Australian construction industry and, in particular, the practice of phoenix companies within the industry. The Senate Report was released on 3 December 2015 and, in relation to phoenix activity, recommended that:
- ASIC require external administrators to indicate whether they suspect phoenix activity in their statutory reports
- Consideration be given to amending the statutory confidentiality requirements of certain regulators to permit regulators providing information to the ATO
- More resources be directed to strategies aimed at preventing, detecting and prosecuting instances of illegal phoenix activity and
- Section 596AB of the Corporations Act 2001 (Cth), which prohibits a person from entering into an agreement with the intention of preventing the recovery of employee entitlements, be amended to (among other things) remove the requirement that a person have a subjective ‘intention’.
Recent insolvency legislation reforms
In December 2015, the Australian Government announced that it would significantly reform Australia’s current insolvency laws by mid-2017. The reforms are intended to:
- Reduce the current default bankruptcy period from three years to one year
- Protect directors from personal liability for insolvent trading if they appoint a restructuring adviser to develop a turnaround plan for the company
- Make 'ipso facto' clauses, which allow contracts to be terminated solely due to an insolvency event, unenforceable if a company is undertaking a restructure.
If implemented, these reforms will significantly change the landscape in Australian insolvency law. While the proposed reforms do not directly tackle illegal phoenix activity, they may impact on the rates of illegal phoenix activity. The CEO of the Australian Restructuring Insolvency & Turnaround Association stated that “these reforms are more likely to preserve creditors’ money by finding better ways to turn troubled businesses around.” If the reforms have their desired affect and more businesses are able to be rescued, incidence of illegal phoenix activity and other drains on creditor and shareholder funds could conceivably decrease, enhancing Australian’s corporate environment for investment.
The current regulatory landscape appears to be failing to hinder phoenix activity and protect creditors. Arguably, this is partly because of the limited resources of regulators, the difficulty in quantifying what actions represent phoenix activity and the evidentiary difficulties in proving phoenix activity. However, the recent government investment in research into illegal phoenix activity, the establishment of the Taskforce and the Senate Inquiry may indicate that the government may be prioritising tackling phoenix activity going forward. Furthermore, while the position remains unclear, the recent Federal government’s insolvency legislative reforms may have an impact on illegal phoenix activity in the future.