From the Ashes: Understanding the Crackdown on Phoenix Activity

New laws under consideration could expose company directors to jail terms of up to ten years for engaging in ‘Phoenix activity’ – the practice of closing down an enterprise, shifting its assets then re-starting it to avoid creditors.

The new measures, which must now await the formation of a new federal parliament, are contained in the Treasury Laws Amendment (Combating Illegal Phoenixing) Bill 2019 (Cth). The Bill is part of a rush of activity in this area over recent years, including amendments to the Treasury laws and the Insolvency Practice Rules, and the establishment of a range of federal bodies targeting the black economy, serious financial crime and phoenix activities.

The Bill seeks to address a form of corporate misbehaviour that is widely recognised but, until recently, rarely sanctioned. It defines “illegal phoenixing” as “the use of serial deliberate insolvency as a business model to avoid paying company debts.” The point is made in the explanatory memorandum that phoenix activity “can encompass both legitimate business rescue activities and the use of serial deliberate insolvency as a business model to avoid paying company debts.” Whilst the former must be allowed to take its course, the latter requires intervention.

The Bill arose from the work of a Senate Inquiry into this area, and also in response to an ATO report on phoenixing, which estimated the total cost of the practice at somewhere between $2.85 and $5.13 billion annually. The brunt of those losses, according to the ATO, is borne by other businesses in the form of unpaid commitments. Government losses in the form of taxes and compliance costs are also significant, with lost employee entitlements, perhaps surprisingly, coming a distant third.

“The total cost of the practice is estimated at somewhere between $2.85 and $5.13 billion annually. The brunt of those losses, according to the ATO, is borne by other businesses…”

The main lines of attack under the Bill will be:

    • the prohibition, under Schedule 1, of suspect transfers of company property. For example transfers at less than market value (referred to as “creditor-defeating dispositions”) will be outlawed, and criminal penalties created for those doing it. Liquidators will have extended powers of recovery over transferred assets;
    • banning, under Schedule 2, the practice of directors dodging accountability by back-dating resignations (or ceasing to be a director when this would leave the company with no directors). A director’s resignation date, if notice is received more than 28 days after the claimed date, will be deemed to be the date that notification was received by ASIC. And a director will not be able to resign (or be removed by resolution) if doing so would leave the company without directors (except in the case of winding up of a company); 
    • Schedule 3 enables the Commissioner to “collect estimates of anticipated GST liabilities and make company directors personally liable for their company’s GST liabilities in certain circumstances”; and
    • tax return practices will be tightened by Schedule 4, which will work in conjunction with Schedule 3. Under this provision, the Commissioner will be able to withhold a refund from a taxpayer who has any outstanding lodgements or information required by the ATO.

Conducting phoenix activities, or “procuring, inciting, inducing or encouraging” them, will become criminal offences, carrying penalties for individual directors of up to ten years’ jail, and/or fines approaching $9.5 million. All those extra verbs are on the menu because the Bill makes a point of drawing in professional advisers: the Explanatory Memorandum says “Such transactions are also facilitated by others, including unscrupulous pre-insolvency advisers, accountants, lawyers or other business advisers, who advise companies on how to engage in illegal phoenix activity.”

“The Bill makes a point of drawing in professional advisers…”

ASIC will have powers under the new laws to make orders to recover company property that’s been disposed of – or benefits that have been received – in the course of a creditor-defeating disposition. Such recoveries, commenced either on ASIC’s own initiative or at the request of a liquidator, would be carried out for the benefit of a company’s creditors.

A further measure worth noting is the clampdown on the voting rights of related creditors. The exposure draft, Insolvency Practice Rules (Corporations) Amendment (Restricting Related Creditor Voting Rights) Rules 2018 makes good on a promise from the 2018 Federal Budget: to prevent related creditors supporting phoenix activity by influencing the removal or replacement of external administrators. This measure, delivered via amendments to the Insolvency Practice Rules (Corporations) 2016, came into effect in December last year.  

It is worth reiterating that a distinction can be made between legitimate activities aimed at rescuing a business in distress, and those which seek to evade obligations to creditors. Once the Bill becomes law, expert advice will be vital to eliminate any risk of falling foul of these new measures.