Illegal phoenix activity has long been on the radar of regulators in Australia. The impact of this activity has been particularly severe on owners of negligently built properties and, in particular, apartment developments.

In response, the government has now moved to tighten up the rules around illegal phoenix activity.  In particular, the new rules will extend to not only the directors themselves, but also those professionals advising them.

Definition and impact

Illegal phoenix activity is when a company transfers assets to a new company with the intention of defeating the interests of creditors.

While particularly prevalent in the construction industry (although not limited to it), this conduct has an impact across the economy. In 2018, the Phoenix Taskforce (made up of agencies including the Australian Taxation Office (ATO) and the Australian Securities & Investments Commission (ASIC)) commissioned PwC to measure the economic impacts of illegal phoenix activity. Their report, The Economic Impacts of Illegal Phoenix Activity, found a direct annual cost to the economy of up to $5.13b.

These losses to creditors, employees and the government provide some context to the recent laws and the federal government’s push to crack down on this conduct.

Previous regulatory approach

Prior to the recent amendments there was no specific regime to combat illegal phoenix activity. Instead, the conduct was caught under a range of laws by various regulators:

  • ASIC targeted cyclical offenders through administrative disqualification orders, or by bringing actions for breach of directors’ duties and uncommercial transactions;
  • The ATO penalised fraudulent tax avoidance through its director penalty notice scheme; and
  • The Fair Work Ombudsman (FWO) brought action against facilitators of illegal phoenix activity for breaches of the Fair Work Act 2009.

However, these measures had various limitations that impacted their effectiveness in both deterring and punishing illegal phoenix activity.

What has changed?

The Treasury Laws Amendment (Combating illegal Phoenixing) Act 2020 (the Act) has now introduced a number of targeted measures with the intention of:

  • Providing increased powers to the courts, ASIC and liquidators to combat illegal phoenix activity; and
  • Prescribing greater duties on directors, officers and professional advisors to ensure that they are not engaging in illegal phoenix activity.

The laws are subject to a number of safeguards that look to ensure that legitimate business and commercial transactions are not caught under the Act. This includes maintaining the safe harbour for legitimate business restructuring and permitting transactions made with creditor or court approval.

Practically, this represents a significant increase of the powers and obligations in place previously:

Following the Act Prior to the Act
Directors and officers face civil penalties and criminal offences for engaging in a “creditor defeating disposition No equivalent.
Professional advisors (including accountants and lawyers) face civil penalties and criminal offences for engaging in a “creditor defeating disposition No equivalent.
ASIC can order void transactions that are deemed a “creditor defeating disposition No equivalent.
Liquidators can request ASIC to make an order to void transactions that are deemed a “creditor defeating disposition No equivalent.
The safe harbour is available to directors as a defence against a contravention of the insolvent trading prohibition and the contravention of the creditor-defeating disposition prohibitions The safe harbour is available to directors as a defence against a contravention of the insolvent trading prohibition

 

Creditor-defeating dispositions

The Act allows action to be brought against individuals who have engaged in conduct that has resulted in a “creditor-defeating disposition”. This is now defined in the Corporations Act as a disposition where:

  1. The consideration provided is lower than the market value of the property; and
  2. The property is then prevented, or significantly delayed, from being available for the company’s creditors in the winding up of the company.

Actions can be brought even if a company ceases to conduct business up to 12 months following a creditor defeating disposition.

Fulfilling directors’ obligations

Any transactions made by companies that are insolvent, or on the brink of insolvency, will set off red flags for ASIC. However, it is important to note that the Act does not prohibit good faith restructuring measures implemented by struggling companies.

Directors and officers should then ensure that any dispositions of company property are supported by independent valuations and appropriate due diligence.

Additionally, directors should remain diligent in respect of their general duties to act in their role with care, diligence and good faith.

Obligations of professional advisors

In addition, the Act imposes offences and penalties on any person that engages in conduct that procures, incites, induces or encourages a creditor defeating disposition. This will extend to professional advisors such as lawyers and accountants.

As such, it will be necessary for advisors to remain vigilant when advising clients in relation to dispositions of property to or from a distressed company. Careful consideration will be necessary to ensure that any such transaction will not be in breach of the Act.

Practical impact

The practical impact of the Act can be considered using the hypothetical example provided in the Act’s explanatory memorandum. Consider:

  • Company ABC sells a commercial property to Alexia who wants to set up a dancing studio. They agree the purchase price of the property is $500,000. Let’s assume this is market value.
  • During the transaction Company ABC instructs Alexia to pay the $500,000 to Company XYZ. Ronie is the sole director of both Company ABC and Company XYZ.
  • Six months after the sale, a liquidator is appointed in the winding up of Company ABC. The company has insufficient assets to meet the demands of its creditors.

Here Company ABC has made two dispositions:

  1. The transfer of the property to Alexia, and
  2. The deemed transfer of $500,000 to Company XYZ.

Regulators will look to assess whether market value consideration was provided in return for the disposition of property. The test is applied at the time of the relevant agreement or, otherwise, at the time of disposition.

The transfer of the property was at market value and is not of itself a creditor-defeating disposition. However, the transfer of the $500,000 was for no consideration and so will be a creditor-defeating disposition.

As a result, the disposition of the $500,000 will be voided and the money made available to the liquidator to allow them to repay Company ABC’s creditors. Civil penalties and criminal offences can also be brought against Ronie and any other individual that procured, incited, induced or encouraged that conduct.