Phoenix Activity – Sizing the Problem and Staying Legal

phoenix activity insolvency accountants

By Nick Combis 

Phoenix activity is increasingly common in companies facing financial distress and is often presented by pre-insolvency advisors as a scheme to evade creditors.  Misuse of the company structure is not always illegal and in some cases may save a business from its downfall, however in other cases involves a fraudulent scheme involving breaches of directors’ duties and potentially criminal offences.  The end result in both cases is creditors are left unpaid and with a feeling of injustice.

The typical phoenix activity seen by many insolvency practitioners involves a company entering into a transaction / sale agreement with another related company for the sale of its business and or assets which allows the business to continue without interruption and also debt-free.  The sale of business may occur more than once between a number of companies.  The directors are protected by the limited liability of the company and in some cases the sale / restructure has been a last resort without any intention to defraud creditors.

The various legislation that captures conduct associated with illegal phoenix activity will depend on the circumstances and conduct of those involved.  To some extent fraudulent activity is curbed by regulation and enforcement by the Australian Securities and Investments Commission (“ASIC”).  ASIC will rely on investigation and reporting of insolvency practitioners of failed companies when considering prosecution for breaches of the Corporations Act 2001.  The effectiveness or success of the phoenix may also be curbed by the Director Penalty Regime set out in the Taxation Administration Act 1953.  The Director Penalty Regime serves to capture some of the outstanding taxation liabilities of the company by imposing those liabilities personally upon the directors in certain circumstances.  This affects the ability for the director to avoid the company’s tax and may eventually be burdened by the phoenix activity in any event.  Directors should also be wary of the potential breaches of the Fair Work Act 2009 in any phoenix arrangement that involves avoidance of employee entitlements.

Insolvency practitioners are involved in the wind up of the left over shell-company once the business has been transferred.  It is the Liquidator’s duty to investigate the company’s affairs which includes the conduct of its directors and report his or her findings or suspicions to ASIC.  This will involve an assessment of whether or not he or she believes there has been illegal phoenix activity and the extent of breaches of the Corporations Act 2001 and of directors’ duties.  The Liquidator’s investigation of phoenix transactions may also reveal recoveries under the voidable transaction provisions of the Corporations Act 2001, for example, for undervalued transactions or unreasonable director-related transactions.  Recovery of these transactions may result in funds for the benefit of creditors however in many cases the recovery is insufficient to enable payment of a dividend large enough to pay out all creditor debts.

Unfortunately the likely eventuality is the phoenix will fail over again.  As notwithstanding the business is owned by a new entity, the management and trading has not changed.  Often because the company has a similar name and address, creditors mistake it for the old company and by the time the creditor realises it is too late as its debt is caught up in the liquidation.

The lesson for creditors is to be wary of the signs or indicators of financial distress including inadequate financial records and poor management and to also be wary of a change in ABN.  Directors need also be cautious of pre-insolvency advice and the potential offences and penalties they may be subject to if engaging in illegal phoenix activity.

Want to know more?

If you would like to know more about the issues raised in this article, please contact Nick Combis our Insolvency & Reconstruction Director for assistance.

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