Increasing Measures to Combat Illegal Phoenix Activities

As coronavirus fear is causing disruption to the global economy with the risk of recession rising, global stock markets plummeting and tumbling of the Australian dollar, businesses have seen a decline in revenue and disruption to supply chains.

Prolonged disruption to a business can cause solvency concerns, and in such circumstances, directors will need to carefully consider activities to rescue their businesses.  In these conditions, directors should be vigilant in ensuring that they do not engage in or facilitate illegal phoenix activities.

In our article issued in October 2019: we observed a trend by ASIC in pursuing officers and directors personally for contravention by their company.  The campaign to hold directors accountable is further demonstrated by the recent Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2019 (Cth) (Illegal Phoenixing Act) which introduced amendments to the Corporations Act 2001 (Act) to deter and penalise illegal phoenix activities.

What is illegal phoenixing activity?

Phoenix activities are activities which involve the liquidation of one company, establishing a new company with substantially similar name, and transferring the assets of the old company to that new “phoenix company”.  Phoenix activities are not inherently illegal where they are legitimate business rescue activities. Phoenix activities are illegal where company directors deliberately and intentionally strip the company of all valuable assets with nothing or little remaining to pay the company’s liabilities such as tax, employee entitlements and creditors – by transferring the company’s assets to the phoenix company for no or little value before handing the company over to an external administrator.

A recent example of a director engaging in illegal phoenix activities is a director who, on 24 March 2020, ASIC disqualified from managing corporations for four years following ASIC’s findings that he, amongst others things, transferred the business to another company, leaving insufficient assets to pay creditors.

Illegal Phoenixing Act

The Illegal Phoenixing Act introduces the following 4 measures to combat illegal phoenix activities:

  1. Credit-defeating disposition – Introducing a new voidable transaction for “creditor-defeating dispositions”.
  2. Director and facilitator accountability and penalties – Creating new offences that target those who conduct and facilitate illegal phoenix transactions and preventing directors from improperly backdating resignations or ceasing to be a director when this would leave the company without a director.
  3. Increasing powers – Extending the powers of ASIC and liquidators to intervene to recover property received in a voidable creditor-defeating disposition.
  4. Empowering regulators – Empowering regulators such as the ATO to retain tax refunds and collect GST liabilities.

We have provided a summary of the measures below.

Creditor-defeating dispositions

The Illegal Phoenixing Act introduced a new voidable transaction for “credit-defeating dispositions”, which are transactions that dispose of company property:

  • for less than the market value of the property or best price reasonably obtainable for the property; and
  • that have the effect of preventing, hindering or significantly delaying the property becoming available to meet the demands of the company’s creditors in winding up.

The transaction may be voidable if it is a creditor-defeating disposition and it is made when the company is insolvent or, because of the disposition, the company:

  • immediately becomes insolvent; or
  • enters into external administration within the following 12 months; or
  • ceases to carry on business altogether within the following 12 months.

Director Accountability

New Director Offences

The Act imposes duties on directors and company officers (officers) to act in the best interests of the company. Officers are subject to civil and criminal offences when they are found to have acted for an improper purpose or fail to prevent the company from trading while insolvent.

The amendments to the Act introduce new criminal offences and civil penalties for officers who engage in conduct that results in a company making a disposition.

The central mental element of the criminal offence is recklessness and is assessed according to the officer’s conduct, being the acts and omissions of that officer.  An officer is reckless if that officer is aware, or ought to have been aware, of a substantial risk that the transaction is a prohibited creditor-defeating disposition, having regard to the circumstances known to that officer and it is unjustifiable for that officer to take such risk.

To establish contravention of a civil penalty provision, it is sufficient to establish that a reasonable person would know that the transaction would be a creditor-defeating disposition that prevents, hinders or significantly delays the disposed property from becoming available to creditors.

Safe Harbours

The safe harbour provisions are extended to ensure the amendments do not affect legitimate business transactions, and transactions made with the creditor, or court approved transactions under a deed of company arrangement or scheme of arrangement.

With the Government directions caused by COVID-19, many businesses have been required to cease operations in the short term resulting in liquidity issues. The Government responded by introducing an additional insolvent trading safe harbour and rapidly passed the amendments to the Act on 23 March 2020.  These changes provide for a six-month moratorium on insolvent trading liability in respect of debts incurred:

  • in the ‘ordinary course of the company’s business’;
  • during the six-month period (starting on 24 March 2020); and
  • before any appointment of an administrator or liquidator during the temporary safe harbour application period.

The temporary relief also:

  • increases the minimum debt which can form the basis for a statutory demand from $2,000 to $20,000; and
  • extends the period within which the debt must be paid from 21 days to 6 months.

However, this temporary safe harbour does not offer directors carte blanche with respect to their general director’s duties, and illegal phoenix activity will remain subject to penalties.

Accountability of Resigning Directors

One of the principal objects of the Illegal Phoenixing Act is to prevent directors from shifting accountability to other directors by improperly backdating resignations or ceasing to be a director when this would leave the company with no directors.

Company directors who have engaged in phoenixing activities may resign and transfer accountability to a “straw director” who has no real involvement in the company, little to no knowledge of his/her directorship or employment and may have limited assets.  As a result, the Act now provides that if a resignation of a director is reported to ASIC more than 28 days after the purported resignation, the resignation takes effect from the date it is reported to ASIC.

The Illegal Phoenixing Act also prevents directors from abandoning the company by resigning or ceasing to act as a director where this would leave the company without a director so that any purported resignation would be ineffective (unless the company is being wound up).

Extending Directors’ Personally Liability

The Illegal Phoenixing Act also extends the personal exposure of directors under the Director Penalty Notice regime to include GST liabilities (and estimates of those liabilities) so that directors will be personally liable for GST liabilities in certain circumstances

Alfonso Grillo

Ashleigh Le

Senior Associate