The Treasury Law Amendment (Combating Illegal Phoenixing) Bill 2019 (the Bill), after initially being introduced in February 2019, has now re-surfaced.
In its current form, the Bill is slated as a countermeasure to increasingly common illegal phoenixing activities. It is the position of the Government that illegal phoenixing activities cause serious harm to our economy – being estimated that the direct costs to Australian businesses, employees and governments are between $2.85 and $5.13 billion in years past.
What is Phoenixing?
”Phoenixing” or any similar terms in this context adopts a colloquial meaning – it is not defined in any current Australian legislation. The phrase takes its meaning from the Greek mythological bird – the one that is born again from the ashes of its predecessor. In a business context, phoenixing is essentially the ‘rebirthing’ of an enterprise by transferring one company’s assets to a new entity.
It is essential to understand that phoenixing can be legal, and moreover, for businesses in financial distress, legal phoenix business rescue is a viable option you should speak to an experience legal expert or insolvency practitioner about immediately. Legal phoenixing by a regulated practitioner is also the subject of relevant ASIC and ARITA guidelines. At the core of legal phoenixing is the protection and preservation of business value for valuable and commercial consideration in periods of financial distress. It also takes into consideration the “better off” test and should be considerate of creditor positions rather than seeking to defeat creditor claims.
What is *Illegal* Phoenixing?
Unlike legal phoenix business rescue, illegal phoenixing is often characterised by deceit, fraud and dishonest intentions.The Australian Securities and Investments Commission (ASIC) defines illegal phoenixing as ”a transfer of assets (often below market value) to a new company, and the old company deliberately liquidated with the intention of defeating the interest of creditors (such as the ATO and employees and suppliers).”
In doing so, the first company is commonly rendered asset-less and unable to meet its obligations to creditors (ATO, employees, suppliers, subcontractors, etc) and the new company commonly becomes rich with assets and unencumbered by any pre-existing liabilities.
Phoenixing activities rely on our judicial bodies being reluctant to ”pierce the corporate veil.” The notion of a corporate veil is underpinned by the Legal Entity Doctrine, which recognises an incorporated entity as a separate legal entity from its director(s). The corporate veil refers to the invisible barrier separating a company and its directors/shareholders. As such, piercing the corporate veil refers to the Court’s deciding to hold a corporation’s directors/shareholders personally liable for the corporation’s actions or debts. While it may be argued that the corporate veil enables illegal phoenixing activities, it is essential to remember that the Legal Entity Doctrine is instrumental to the health of our economy as it inherently promotes and protects those that decide to go into business.
Seeking to better define and profile the difference between legal and illegal phoenixing, a Monash Business School research team defined phoenixing in these 5 categories:
1. Legal phoenix: also known as ‘business rescue’, where directors have no intention to defraud creditors, and saving the business (but not the company) is the best course of action for all stakeholders and the economy in the current circumstances.
2. Problematic phoenix: technically legal, where there is no evidence of directors intending to defraud creditors, but the net effect of the phoenixing is not beneficial to creditors or wider society (may involve director/s who have had past business failures).
3. Illegal type 1: where a company was set up with the best intentions, but finds itself in financial difficulty, whether by bad practice or unfortunate circumstances. An intention to defraud creditors is then formed at or immediately before the time of business failure.
4. Illegal type 2: phoenix as a business model, where the company is incorporated and designed for the sole purpose of engaging in personally profitable phoenix activity (i.e. the business was never operated so as to succeed).
5. Complex illegal: phoenix as a business model which also coincides with and occurs alongside more serious crimes perpetrated by the same individuals within the same framework, involving practices such as creating false invoices (e.g. GST fraud), false identities, fictitious transactions, money laundering, visa breaches, and misusing migrant labour
Current Countermeasures for Illegal Phoenixing Activities:
Although there is no offence relating to illegal phoenixing activity, there are some ways in which the existing law prohibits it.
Liquidators of companies that have plausibly engaged in illegal phoenixing activities are able to pursue legal actions against directors and/or their associates for uncommercial transactions, insolvent trading and unreasonable director-related transactions.
ASIC, often on referral of Liquidators, can take action against the director(s) for breaches of duties (namely the duties to act in the interest of the company and to act for a proper purpose).
The ATO may fund a Liquidator to pursue the above legal actions. Importantly, these actions do not help creditors. These actions target the directors and/or associates, rather than return assets/funds to the company in liquidation.
The most aggressive countermeasure has very recently developed through cases such as Yeo v Alpha Racking  FCA 1338, where illegal phoenix companies have been wound up by the Court under the ”just and equitable” clause found in section 651(1)(k) of the Corporations Act 2001 (Cth).
Notably, all these countermeasures are reactive.
Potential Regulations under the Bill:
The Bill intends to combat illegal phoenixing activity by:
1. Introducing new duties for directors to not dispose of assets in a manner that appears to defeat creditor interests;
2. Limiting director resignations to avoid instances where companies are left with no directors and consequently nobody to take action against; and
3. Introducing a broad recovery power for ASIC under which they may order a person to return assets/funds to the company in liquidation for a Liquidator to sell and distribute to the creditors. This power is intended to apply to land and other assets. In circumstances where an asset has been immediately sold by the illegal phoenix company, ASIC may order they pay the company in liquidation a sum equal to the market value of the asset at the time of sale.
The Bill will most likely be passed in early 2020. Legal phoenixing will remain an accessible and viable possibility for struggling businesses.
With the Bill’s passing, insolvency practitioners can expect more tools in their pursuit of directors of illegal phoenix companies. ASIC’s broad new recovery power will render them a powerful guardian against illegal phoenixing activity.
With the goal of eradicating the practice of illegal phoenixing, the Bill is a strong step in the right direction.