This is a short, informal article on phoenixing activity and the risks associated with restructuring an insolvent business. Admittedly, it pokes fun at what is a very serious issue that costs the Australian economy literally billions of dollars.
“Phoenixing” is terms adopted by the insolvency industry to describe rebirthing a business. Historically, this rebirthing can be achieved in many creative (and illegal) ways, but to broadly summarise, a director/owner of a company cycles the assets (the good parts) of the company to a clean entity so as to continue to trade the business, but at the same time, leave the debt and liabilities of the company (the bad parts) in the old entity to be wiped by an insolvency event (usually a voluntary liquidation).
In the insolvency game, we see this practice time and time again in relation to tax debts and employee entitlements, but there is no limit to mischief.
Notwithstanding the industry wide acknowledgment of the term “phoenixing”, there are no express definitions found in any Australian laws at the time of writing.
The conduct that amount to phoenixing has been taken before the court and pressed in different ways, via different causes of action. Without going into too much detail on this point, effectively, ASIC or the liquidators pursue directors, their advisors on the new company for breaches of directors’ duties, knowing receipt by the related new company, uncommercial transactions and unreasonable director related transactions.
However, a transition of assets from an insolvent company to a new entity (whether related or not) is not necessarily illegal.
Herein lies the issue. Which transactions are illegal or voidable and which are not?
In asking that question the can of worms is officially opened, however, the simple answer is… simple.
The transaction needs to be arm’s length, market value and better or the same as the insolvency practitioner would achieve upon their appointment. In other words, it needs to be transparent and in the best interests of the creditors of the insolvent company.
This process also has a cute name recognised by the industry, “pre-packaged insolvency”.
Given the scrutiny and the risk to directors and stakeholders, an pre-packaged insolvency needs to be well considered. Without question, a business owner considered such a transaction should speak with a solicitor or accountant before and assets change hands. A quick google of the phrase pre-insolvency advisor will bring up references to recent raids by ASIC (the regulators of companies) and the ATO (the tax man) on unregulated advisory businesses preying on uneducated business owners in financial trouble.
Penalties and Liability
The best case scenario is the director or new entity returns the assets or pays market value for them. However, this alone is unlikely if a matter proceeds to trial.
The remedies that can be claimed against the director are varied. These include, damages, compensation, an account for profits, tracing, or a constructive trust whereby the director or new company holds the benefit of the phoenixing activity on behalf of the creditors.
The director may be liable for the breaches of the civil penalty provisions which the court can order a penalty up to $200,000 per infringement. Additionally, if the breach is reckless or dishonest, criminal liability can be imposed upon which further fines can be ordered, even imprisonment. Recently, a pre-insolvency advisor from the Gold Coast was found criminally liable for this type activity (he even created false directors).
Also, a director can be banned from managing a company for a period of up to ten (10) years (please note this include being a shadow director of a company – so please don’t think you can just pop your wife in), which probably doesn’t bother someone in prison, however, can be devastating to a small business operator. Given you are banned from managing a company, it covers circumstances in which a business operator is a shadow director. That is to say, acts as though they were a director notwithstanding they are not directors (usually, the spouse is!).