New laws passed to tackle illegal phoenix activity

A 2018 report prepared for the Phoenix Taskforce (a coalition of 37 federal, state and territory government agencies established to combat illegal phoenix activity), estimated that the direct cost of illegal phoenix activities to the Australian economy is between $2.85 billion – $5.13 billion per annum (April 2018, The economic impact of potential illegal phoenix activity, PricewaterhouseCoopers).

What is illegal phoenix activity?

Illegal phoenix activity involves the deliberate and systematic transferring of assets from one entity to another to avoid paying liabilities such as tax, employee entitlements and debts owed to creditors. The original entity is liquidated by the directors, who then recommence with either the same or a very similar business through a new corporate entity – often using the same customers and employees.

Not all phoenix activity is illegal. A legitimate business rescue conducted within the confines of the law, and with the directors acting bona fide, is not illegal. As a rule of thumb, the course of action must be reasonably likely to lead to a better outcome for the company than the immediate appointment of an administrator.

The reforms at a glance

The reforms address the following key areas:

• Creditor-defeating dispositions: These reforms introduce new phoenixing offences, with civil penalties and criminal offences for contraventions by directors, pre-insolvency advisers and other facilitators. Directors’ duties have also been expanded to include a duty to prevent creditor-defeating dispositions.

• Leaving the company without a director: Directors will now be prohibited from improperly backdating resignations, or ceasing to be a director, when this could leave a company with no director.
• GST liabilities: The Commissioner of Taxation (‘Commissioner‘) now has the power to collect estimates of anticipated GST liabilities. Company directors are also personally liable for a company’s GST liabilities in certain circumstances.
• Retention of tax refunds: The Commissioner is authorised to retain tax refunds where a taxpayer has failed to lodge a return or provide other information which may affect the amount that the Commissioner refunds. This ensures taxpayers satisfy their tax obligations and pay outstanding amounts of tax before being entitled to a tax refund.

Creditor-defeating dispositions: New phoenixing offences

Schedule 1 of the Phoenixing Bill amends the Corporations Act 2001 (Cth) (‘Corporations Act‘) to improve the mechanisms available to combat illegal phoenix activity, specifically targeting creditor-defeating dispositions.

A creditor-defeating diposition is a disposition of company property for less than its market value (or best reasonably obtainable price) that has the effect of preventing, hindering or significantly delaying the property becoming available to meet the demands of the company’s creditors in winding-up.

A transaction may be voidable if it is:

• a creditor-defeating disposition made by a company at a time when the company was insolvent; or
• where the company became insolvent because of the disposition.

Recovery of voidable credit-defeating dispositions may be allowed and, where necessary, the provision of compensation from company officers and other persons responsible for a company making a creditor-defeating disposition.

Courts have been granted powers to both void a transaction and restore the parties to the position that they would have been in but for the transaction.

Schedule 1 of the Phoenixing Bill makes it an offence for a company officer or a facilitator such as a pre-insolvency adviser to cause a company to make a creditor-defeating disposition.  The new offence regime will target asset stripping behavior designed to avoid a company paying creditors’ entitlements.  The amendments allow liquidators and in some cases creditors to recover compensation from officers and facilitators who have contravened a creditor-defeating disposition offence or civil penalty provision.

The new law introduces four offences resulting in penalties for prohibited creditor-defeating dispositions, including:

• Officers that engage in conduct that results in the company making a prohibited creditor-defeating disposition; and
• Persons that incite, procure, induce or encourage a company to engage in a prohibited creditor-defeating disposition.

To be held criminally liable the officer must be reckless as to the result of their conduct, i.e. the officer is aware of the substantial risks and intentionally engaged in the conduct.

The civil penalty provision applies generally in the same terms as the offence, however liability is assessed using the reasonable person yardstick to establish that a reasonable person would know, or should have known, that the result of their conduct would be the company making a creditor-defeating disposition.

Penalties for contravention of the new offence provisions are:

• Individual: 4,500 penalty units or three times the benefit obtained (and detriment avoided) or imprisonment for 10 years, or both;
• Body Corporate: 45,000 penalty units or three times the benefit obtained (and detriment avoided) or 10 per cent of the annual turnover of the entity.

Once a declaration has been made that a person has breached a civil penalty provision, ASIC may seek a pecuniary penalty order (s 1317G) or a disqualification order (s 206C) for individuals.

Directors’ duties have been expanded to include a duty to prevent creditor-defeating dispositions.

ASIC will now have powers to take effective action against illegal phoenix activity in order to protect the interests of legitimate creditors, and to make orders and recover (for the benefit of the company’s creditors) company property disposed of, or benefits received, under a voidable creditor-defeating disposition.

However, where a company undertakes a legitimate restructure, the safe harbour provisions contained in s 588GA of the Corporations Act protect directors and officers from liability for debts incurred by an insolvent company in connection with a course of action that is reasonably likely to lead to a better outcome for the company than the immediate appointment of an administrator.

Accountability of resigning directors

Schedule 2 of the Phoenixing Bill ensures that directors are held accountable for any misconduct by preventing directors from:

• backdating resignations; and
• resigning if the resignation would leave the company with no directors (unless the company is being wound up).

GST estimates and director penalties – personal liability

Schedule 3 of the Phoenixing Bill allows the Commissioner to collect estimates of anticipated GST liabilities (and other taxes) and makes company directors personally liable for the company’s GST and other tax liabilities.

A director penalty regime applies with respect to a company’s liabilities to pay the following:

• PAYG withholding amounts;
• superannuation guarantee charges; and/or
• estimates of PAYG withholding liabilities and superannuation guarantee charges.

Directors are under a general obligation to ensure that the company satisfies the above liabilities, and may be subject to a penalty equal to the company’s unpaid obligations, if those obligations are breached.

Retention of tax refunds

Schedule 4 of the Phoenixing Bill authorises the Commissioner to retain tax refunds where a taxpayer has failed to lodge a return or provide other information to the Commissioner, which may affect the amount the Commissioner refunds. These provisions ensure that taxpayers satisfy their tax obligations and pay outstanding amounts of tax before being entitled to a tax refund.

Personal liability of company directors and pre-insolvency advisors

Given the breadth of penalties for non-compliance with the new legislation, it is incumbent upon all companies, company directors and relevant facilitators such as (but not limited to) insolvency practitioners, lawyers and accountants to familiarise themselves with the provisions of the new phoenixing laws, as a failure to do so may result in civil penalties and criminal offences.

Danny Adno is a partner at Holman Webb Lawyers.