It has long been the stance of the Australian Securities and Investments Commission (ASIC) to prevent the intentional transfer of assets by directors from an indebted company to a new company (with the same controllers) for the sole purpose of avoiding payment of creditors, tax or employee entitlements. This practice is referred to as illegal phoenixing, and stands in contrast to genuine company failures. Illegal phoenixing occurs when those in control of a company attempt to avoid the liabilities of the failing company, and start afresh with a new legal entity that runs a similar sort of business.
Often, the following signs will precede an illegal phoenix company rising from the ashes:
- the company is failing and unable to pay its debts;
- the company is acting in a manner that intentionally denies unsecured creditors equal access to the company’s assets to meet and repay debts;
- a new company commences shortly after (normally within 12 months) and uses some or all of the assets of the former business, while still being controlled by related parties.
ASIC has the power to take action over this alleged misconduct, but will normally only do so when it is likely to broadly benefit the market or public. Partner, Michelle Eastwell and Law Graduate, Felicity Dunstone consider how this is set to change following the Government’s announcement that it will crackdown on illegal phoenixing activities, which are reportedly estimated to cost the economy up to $3.2 billion per year.
The aim of the proposed reforms is to deter and disrupt illegal phoenix activity from occurring and remove the unfair competitive advantage that it creates. The proposed reforms start with the introduction of a Director Identification Number (DIN). This will allow Government agencies to seamlessly identify a company’s directors by their uniquely assigned DIN. The Government anticipates that tracking a DIN will allow regulators to easily map the relationship between individuals and entities, as well as the relationships between different entities. The Government has also proposed a consultation with industry members in order to better deter and disrupt other illegal phoenixing related activities by all operators (directors and non-directors) in a two-part reform.
Part 1: Broad Reforms
1. Establishing a dedicated phoenix hotline for public notification of these activities
2. Implementing a ‘phoenixing offence’
It is proposed that the Corporations Act will be modified to address the current deficiency in the legislation caused by the absence of a specific offence for illegal phoenixing activities. The offence, intended to operate in a similar manner to section 121(1) of the Bankruptcy Act 1966 (Cth), will prohibit the transfer of property from company A to company B, where the main purpose of such a transfer was to prevent, hinder or delay the process of that property being divisible between creditors. Contravention of this would give creditors and liquidators (as well as ASIC) a right to sue for compensation of the loss caused under the claw-back provisions in the Corporations Act and Property Law Act (in each state).
Where ASIC (or a liquidator) suspects that illegal phoenixing has occurred due to a transfer of assets for less than market value, ASIC may issue a notice to company B to certify the worth of the property. The recipient of the notice may apply to court for it to be set aside. Similarly, remedies concerning these matters will also be reviewed for their effectiveness as a deterrent.
3. Addressing directorship issues
Under the proposed regime, directors will not be allowed to back-date their resignation date to avoid personal liability attaching to them-an action that is intended to shield the real controller from liability. In practical terms, the reform would amend the Corporations Act to impose a rebuttable presumption so that where a director’s notice is lodged more than 28 days after the date of that director’s resignation, the director may still be held liable for misconduct up until the point of lodgement. Additionally, the Government intends to restrict a sole director resigning from office without finding a replacement director, or taking steps to wind up the company.
4. Restricting voting rights
Currently, phoenix operators have the ability to “stack” votes through the voting power of related creditors, allowing them to exert their influence to prevent the removal of undesirable liquidators. A streamlined process has been proposed, whereby an external administrator is required to disregard any “related creditor” votes received in relation to a resolution to remove and replace an external administrator.
5. Implementing wider promoter penalties
Introduced in 2006, promoter penalty laws were intended to deter the promotion of tax avoidance and evasion schemes. The proposed extension of the scheme is intended to disrupt the business model and facilitators alike who advise or aid and abet illegal phoenixing activity. For instance, through enforceable voluntary undertakings, advisers may be required to provide a full disclosure of their activities to ensure their advice complies with the law.
6. Extending the Director Penalty Notice regime to GST
The proposed change to the regime would catch companies’ with outstanding GST obligations. The Australian Tax Office (ATO) would therefore be authorised to recover penalty amounts from the directors’ equivalent to the amount of unpaid GST. The underlying premise of the change is to create a strong financial disincentive to engage in illegal phoenixing activities.
7. Security deposits
Under this reform, the ATO would be entitled to recover any security bond via a garnishee notice to a third party. This would cover either part, or the full amount of the requested security.
Part 2: Dealing with higher risk entities
8. Targeting higher risk entities
The Government has suggested commencing a risk measuring mechanism, in order to properly classify those entities who have adopted phoenixing into their business model. These entities will be assessed as either a “Higher Risk Entity” and/or “High Risk Phoenix Operator”.
9. Appointing liquidators on a cab rank basis
When an entity is designated as a “High Risk Phoenix Operator”, an independent registered liquidator (from a panel) or a Government liquidator may be appointed to that entity. There would be a minimum level of funding for those companies with little to no assets. This is intended to operate in a similar manner to the role of the Official Trustee in Bankruptcy. This approach will target facilitators that have cultivated a relationship with an individual liquidator who would facilitate their client’s interests to the detriment of creditors.
10. Removing the 21 day waiting period for a Director Penalty Notice to facilitate quick recovery
11. Providing the ATO with the power to retain funds so as to disrupt a phoenix business model and protect tax revenue