Parliament enters the ring to combat illegal phoenixing

Articles, Restructuring + Insolvency

The introduction of the Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020 (Cth) sees a new arsenal of tools available to the Australian Securities and Investments Commission (ASIC), the Australian Taxation Office (ATO) and insolvency practitioners dealing with illegal phoenix activity.

What is illegal phoenix activity?

The concept of phoenixing reflects the mythological nature of the phoenix, which rises from the ashes of its predecessor. In a corporate context, phoenix activity occurs when a company is incorporated with the intention to continue the business of a failed company using the same controllers and assets. Where valuable consideration is provided for the business and assets of the predecessor company, including provision for outstanding entitlements and debts, the business of a company can legitimately continue with the new entity. However, such conduct will be characterised as illegal phoenixing where there is a deliberate liquidation of a company with the intention of avoiding paying liabilities and the new entity enjoys the benefit of the business without having provided any, or having provided nominal, consideration.

Commonly, illegal phoenix activity will have the following characteristics:

  • A company with significant debts will transfer most or all of its assets to a secondary company that is trading with substantially the same controllers and corporate purpose for little to no consideration;
  • The “old company” maintains all of the incurred debts, without assets or ongoing business to meet those liabilities;
  • The purpose of the transfer of assets was to avoid payment of the debts of the “old company’”.
  • Proceeds from the transfer of assets are dissipated to avoid the payment of creditors.

It is estimated that illegal phoenix activity results in costs of between $1.8 and $3.5 billion in lost gross domestic product to the Australian economy annually. The direct costs from illegal phoenix activity can be summarised as follows:

  • Cost to business from unpaid trade creditors of between $1.162 – $3.171 billion;
  • Cost to employees due to unpaid entitlements is between $31-$298 million; and
  • Cost to the Government due to unpaid taxes and compliance costs is approximately $1.166 billion.

Addressing the rising economic impact of illegal phoenix activities has been fraught with issues. Creditors who suspect illegal phoenix activity have limited remedial options with no standing to bring proceedings. Additionally, directors rarely hold assets in their own name (thereby reducing the prospects of substantive recovery). Moreover, the costs of bringing and litigating proceedings are significant and generally not appealing to creditors who have already lost significant sums as a result of the insolvent company’s failure to meet its debts. Similarly, liquidators of companies which have been the subject of illegal phoenix activity are usually without funds to pursue claims (whether against directors or their advisers).

Summary of amendments 

Whilst there has bee recent judicial response to the issue of illegal phoenix activity, Parliament has introduced the Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020 (Cth) (which received Royal Assent on 17 February 2020) to address the economic impact of illegal phoenix activity on the Australian economy and the difficulty of its enforcement. The legislation specifically amends the Corporations Act 2001 (Cth) (Corporations Act) and Taxation Administration Act 1953 (Cth) (Tax Administration Act).

Corporations Act

The following amendments have been made to the Corporations Act :

  • Section 588FDB – provides a definition of “creditor-defeating dispositions”, being transfers of company property for less than market value (or less than the best price reasonably obtainable) that prevents, hinders or significantly delays access to property by creditors at liquidation.
  • Section 588FE(6B) – extends the powers of the court to order a particular transaction found to be a creditor-defeating disposition to be voidable if the transaction was entered into when the company was insolvent, the company became insolvent because of the transaction or the company enters external administration as a direct or indirect result of the transaction.
  • Section 588GAB – introduces a statutory duty on officers to prevent creditor-defeating dispositions.
  • Section 588GAC – inhibits a person from engaging in any conduct that procures, incites, induces or encourages a company to make a creditor-defeating disposition;
  • Sections 588J(1A) and 588K(2) – introduces new criminal offences and civil penalties for officers that fail to prevent creditor-defeating dispositions and other persons that facilitate a company making a creditor-defeating disposition subject to certain safeguards;
  • Section 588FGAA – empowers ASIC to make orders to recover assets for the benefit of creditors.
  • Section 588FGAA(2) – empowers liquidators to request ASIC make an order to recover assets  for the benefit of creditors.
  • Sections 588M(1) and 588R(1A) – empowers liquidators, and in some instances creditors, to recover compensation from officers and other persons responsible for creditor-defeating dispositions.
  • Sections 203AA-203AB and 203CA – prevents the backdating of director resignations or the abandonment of companies by resigning directors (i.e. so there is no director).

Tax Administration Act

 The Tax Administration Act has been amended as follows:

  • Section 268-10 – empowers the Commissioner to collect estimates of anticipated GST liabilities, Luxury car tax (LCT) liabilities and Wine equalisation tax (WET) liabilities;
  • Section 269-30 – empowers the Commissioner to issue director penalty notices to company directors in respect to unpaid GST, LCT and WET liabilities and estimates of those liabilities.
  • Section 8AAZLG(1)(b) – empowers the Commissioner to retain a refund to a taxpayer who has outstanding lodgements or information.

The future for illegal phoenix activity 

Although the amendments to the Corporations Act will result in a wider arsenal of actions available to insolvency practitioners, in our view the introduction of director penalty notices in respect to GST will have the biggest short term impact. In industries where systemic illegal phoenix activity has seen common directors proliferate for decades, second thought will be given to liquidating companies and incorporating new entities to continue the common business. This will be particularly so in the building and construction industry where special vehicle companies are incorporated for a specific development (whether commercial or residential), the relevant lots are sold, GST is not remitted (or only partially remitted) on those sales, and the directors either liquidate or abandon the special vehicle company with significant GST liabilities and incorporate a new entity to undertake the next project utilising the profit obtained from the previous project (which would not have existed had the GST been remitted).

In addition to the above, it will be interesting to monitor the impact of the amendments on industries which operate without significant tangible assets, such as labour hire, and which engage in illegal phoenixing. In so far as these types of industries are concerned, the extension of powers to make compensation orders against directors are likely to be the common tool to discourage / minimise the effect of illegal phoenix activity.

 

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