25 September 2009
Phoenix Rising - Advisors to directors of phoenix company burned
ASIC v Somerville & Ors  NSWSC 934
In ASIC v Somerville the Supreme Court of New South Wales has found a solicitor guilty of aiding and abetting directors to breach their duties by engaging in so-called "asset stripping" or "phoenix" activity. The case serves as a warning to all those advising directors on business restructuring to take especial care not to overstep the bounds of legitimate financial and legal advice. Where exactly that boundary is, remains to be fully explored.
Mr Somerville is a solicitor. He and his incorporated legal practice advised directors of companies facing financial difficulties. Eight of the other defendants had sought such advice from Mr Somerville. Some came back two or three times. In each case, Mr Somerville gave advice to restructure the failing company so that:
The failing company ("oldco") ceased to trade
a new company ("newco") was formed
oldco sold its assets to newco on terms which included:
the transfer of assets from oldco to newco
the issue by newco of 100 "V" class shares to oldco as consideration for the transfer of the assets. V class shares entitled oldco to all dividends declared by newco up to an amount equivalent to the purchase price
employees of oldco were terminated and offered employment by new company
newco took over essential property, plant and equipment leases
pre-transfer debtors and all outstanding liabilities remained with oldco
The same strategy was adopted in relation to each of the companies under consideration by the Court, and in none of them was a dividend ever paid on the "V class" shares issued to oldco by newco. In practice, the assets were transferred for no consideration at all.
In all cases almost all procedural matters including documentation, required to give effect to this 'phoenix' arrangement were undertaken by Mr Somerville. In one case there was evidence that the director thought a second restructure "sounded a bit rich" but was assured by the solicitor that it would be "alright" (at ).
The duties of directors include the statutory obligations set out in s181, 182 and 183 of the Corporations Act 2001 (Cth) which require them to act in good faith and not to misuse their position or information obtained by them to gain personal advantage or inflict a disadvantage on the corporation.
Acting Justice Windeyer also noted that in the face of insolvency the interests of creditors "had to be taken into account by the directors in dealing with the assets of the company in question" (at ).
Section 79 of the Corporations Act imposes liability on those "involved in" breaches of the Corporations Act, including by aiding and abetting and otherwise being knowingly concerned in such breaches.
The Directors' Liability
The Court had little difficulty finding breaches by each of the directors of s181, 182 and 183 of the Corporations Act. Windeyer AJ found:
- there was no proper purpose in the phoenix transactions other than to preserve the assets in a new company without the liabilities of the old company;
- in each case the directors used their position to obtain an advantage for themselves and the new company, in preserving the assets, whilst inflicting a detriment on the old company by leaving the liabilities behind;
- in each case the directors acted knowing the old company was insolvent, and acted to prefer their own interests in favour of creditors of the old company.
The Adviser's Liability
The Court was also satisfied in all the circumstances that Mr Somerville had aided and abetted the breaches by the directors. In each case he had been heavily involved in recommending and implementing the transactions. The Court was satisfied that there was a direct causal link between the solicitors' conduct and the directors' breaches and that the transactions would not have occurred but for his involvement.
The Court noted arguments of senior counsel for Mr Somerville that it would be extraordinary if liability was imposed for "just giving advice". However, Windeyer AJ observed that:
"That of course may be the normal case, but that depends upon what advice was given." (at )
In this matter, Mr Somerville had given advice to carry out an improper activity and had done substantially all of the work involved in carrying it out "apart from signing documents". In such circumstances "there can be no question as to liability".
The Court concluded:
"What has really happened here is that a scheme has been devised to bring about asset stripping but to attempt to make this seem legitimate by providing for "V" class shares" (at ).
In one sense this judgment is a triumph of the obvious. If you advise people to breach the law, you will be guilty of aiding and abetting that breach.
On the other hand, whilst the conduct in question might be readily seen as going too far, at what point would an advisor have avoided liability?
- What if he advised against the transactions but did the work to implement the transactions if the client nevertheless decided to proceed? Would this apply to a liquidator who advises the director that such arrangements may breach the Act, but still accepts appointment as liquidator of oldco?
- What if the advice was to place the company into liquidation and buy the assets from the liquidator for their auction realisable value including by payment over time? Would the liquidator be liable if he agreed to payment out of profits on trading of newco?
- What if the advice included obtaining a formal valuation; actual finance; and physical payment of real money for the assets? Surely this could not be in breach of a director's duties to its shareholders and creditors, even in the face of insolvency?
- What if the same proposal had involved vendor finance for some (or all) of the purchase price, but the sale was otherwise for market value and such amounts as were paid did involve real money?
- And what if the purchaser then found itself in its own financial trouble and sold the assets to a third company, this time for cash?
"Phoenix activity" is not a term of art. There is nothing inherently illegal about "phoenix activity" as such. Each case needs to be considered in light of how and why assets have been transferred, and the advantages and disadvantages for those affected, including creditors.
At the very least this case is a reminder of the dangers involved for advisers of "business restructuring", "turnaround" and "asset protection", and a warning that to the extent that this advice facilitates directors "behaving badly", the adviser too may be in breach of the Corporations Act.
Author: Stephen Mullette