September 2018

Illegal phoenix activity – proposed reforms to affect directors and facilitators

Last month, ASIC disqualified Jason Hammond from managing companies for the maximum period of five years. The reason? Mr Hammond’s actions regarding three failed companies.

Among numerous other things, ASIC found that Mr Hammond had engaged in illegal phoenix activity by transferring the business of an indebted company to a new company, leaving the initial company with no assets to pay creditors while continuing what was essentially the same business using the new company.

Illegal phoenix activity is estimated to cost the country between around $3 billion and $5 billion annually.[1] 

The five year ban is a salutary caution. For many years, the government has struggled to deal with illegal phoenix activity. This ASIC decision, and proposed reforms discussed below, signal a renewed effort by the regulator and legislature; those who engage in such behaviour can expect to be dealt with harshly.

Proposed reforms should give directors and others pause

The Government recently announced a package of reforms to corporation and tax laws that will have significant impact on directors, pre-insolvency advisers and businesses.

The Treasury Laws Amendment (Combatting Illegal Phoenixing) Bill 2018 introduces civil and criminal offences for directors, pre-insolvency advisors (such as lawyers or accountants) and individuals who facilitate illegal phoenix activity.

If passed into law, the reforms will also include measures such as:

  • preventing a director’s resignation from being backdated to avoid liability or when this would result in a company having no directors;

  • making directors personally liable for GST liabilities; and

  • extending the ATO’s existing power to retain refunds where there are outstanding tax lodgements.

Those for whom the reforms are intended ignore them at their peril. The proposed penalties for individuals are 4,500 penalty units ($945,000) or three times the benefit gained by the illegal transaction, or imprisonment for 10 years, or both.

For corporations, the penalties are 45,000 penalty units ($9,450,000) or three times the benefit gained by the illegal transaction, or 10 per cent of the annual turnover of the entity.

A director who commits (or person who facilitates them to commit) an illegal phoenixing transaction may also be subject to compensation orders.

What is illegal phoenix activity?

Illegal phoenix activity at its simplest is when a new company is created to continue the business of a company that has been deliberately liquidated to avoid paying its debts.

Let’s say, for example, that the director of a labour hire company called Labour to You engages other parties to provide labour hire services. Labour to You has few physical assets; its main assets are its business relationships with its customers and its labour hire service contracts, which are informal and oral.

Over time Labour to You incurs debts to employees, trade creditors and the ATO. The director wants to avoid paying the liabilities, so changes the company name to its ACN and establishes a new entity called Labour for You.

The name of the new company is chosen to be similar to allow it to continue conducting the business activities of Labour to You as normal, but through Labour for You. This way, Labour for You gets the benefit of the existing labour hire arrangements and generates income effectively through the existing business that was previously conducted by Labour to You.

The liabilities, however, remain with Labour to You, which has no means to pay them.

The director’s next step is to resign as director of Labour to You (now known by its ACN) and leave the company dormant. None of its trade creditors, employees or the ATO can access any revenue from the labour hire arrangements, because they are effectively housed in the new company, Labour for You.

Should you be nervous about restructuring your business?

The short answer is no. The reforms are not intended to hinder legitimate commercial transactions, such as business restructuring, transactions approved by creditors under a DOCA, or transfers for market value.

For this reason, under the proposed illegal phoenixing reforms, the transfer of a company’s assets will be voidable, and thus recoverable by a liquidator, if made:

  • by a company while it is insolvent; or

  • up to 12 months prior to the company entering into external administration.

The offences will be supported by an extension of the existing liquidator asset clawback powers to cover illegal phoenix transactions. ASIC will also be granted specific powers to recover property that has been transferred under an illegal phoenix transaction for the benefit of the creditors.

The Safe Harbour, discussed in a recent Bartier Perry article,[2] is available to directors as a defence to allegations of illegal phoenix activity. The director must show that the transfer of assets was part of a course of action reasonably likely to result in a better outcome for creditors than liquidation.

Public consultation for the Bill closes on 27 September 2018.

Contact us

For further information or advice on potential liability, please contact our commercial disputes team.

   

 Authors: Gavin Stuart & Phoebe Martin

 

[1] Pricewaterhouse Coopers Consulting (Australia), Economic Impacts of Potential Illegal Phoenix Activity, June 2018.

[2] https://www.bartier.com.au/insights/articles/an-insolvency-safe-harbour-for-company-directors/