NEWSLETTER | July 2018

Phoenix Activity – An Update

Broadly speaking, illegal phoenix activity refers to the creation of a new company to take over from the business of an existing insolvent company. Often, assets of the insolvent company are transferred to the new company without paying fair consideration, if any at all, leaving no assets to pay outstanding taxes, creditors and employee entitlements. Effectively, the company is “arising from the ashes” leaving a trail of destruction behind. This illegal phoenix activity is estimated to be costing each individual Australian tax payer approximately $100 per person according to a 2017 report authored by academics from the University of Melbourne and Monash University.

The primary indicator of a phoenix operation is that directors of the company have deliberately attempted to avoid paying creditors through illegal conduct. Genuine company failures do occur. In these instances, where directors have conducted a failed business responsibly, the business may continue to trade subsequent to liquidation under a new legal entity without involving illegal phoenix activity.

So how can one distinguish illegal phoenix activity from a genuine company failure? The key characteristics of illegal phoenix activity may include:

· the company fails and it cannot pay its debts;

· the company changes its name (typically to its ACN) and a new company is registered, typically with a similar name to the failed company;

· the assets of the failed company are transferred to the new company for little or no consideration at all;

·the new company continues to operate the same business using the assets of the failed entity; and

· the directors of the failed company control the new company.

The Federal Budget released by the Turnbull Government in May 2018 included a number of reforms to corporations and tax laws, providing regulators with additional tools to assist them to deter and disrupt illegal phoenix activity. The package includes reforms to:

· introduce new phoenix offences to target those who conduct or facilitate illegal phoenixing;

· prevent directors improperly backdating resignations to avoid liability or prosecution;

· limit the ability of directors to resign when this would leave the company with no directors;

· restrict the ability of related creditors to vote on the appointment, removal or replacement of an external administrator;

· extend the Director Penalty Regime to GST, luxury car tax and wine equalisation tax, making directors personally liable for the company’s debts; and

· expand the Australian Taxation Office’s (ATO) power to retain refunds where there are outstanding tax lodgements.


Existing anti-phoenixing measures

The Government has previously established the following taskforces to focus on combatting illegal phoenix activities:

· Phoenix Taskforce; and

· Serious Financial Crimes Taskforce.

Phoenix Taskforce

The Phoenix Taskforce, which was established in 2014, comprises over 20 Federal, State and Territory government agencies including the ATO, Australian Securities & Investments Commission (ASIC), Department of Employment, and the Fair Work Ombudsman. This taskforce provides a whole-of-government approach to combating illegal phoenix activity, using data matching tools to identify, manage and monitor suspected illegal phoenix activity.

In the first half of 2017-18 the Phoenix Taskforce conducted 187 audit and review cases involving illegal phoenix behaviour, raising $214.4 million in liabilities, with recoveries of $72.8 million.

Serious Financial Crime Taskforce

The Serious Financial Crime Taskforce was established in 2015 and is part of the Australian Federal Police-led Fraud and Anti-Corruption Centre. The Taskforce, which includes the ASIC, the Australian Transaction Reports and Analysis Centre, the ATO and other Commonwealth agencies, is responsible for investigating and prosecuting those involved in serious and complex financial crimes including illegal phoenix activity.


ASIC’s approach to illegal phoenix activity

Currently, the ASIC are reliant on liquidators to report cases of illegal phoenix activity and will generally only take action in instances where it can be demonstrated that directors intentionally misused company assets or acted in a way that is contrary to the company’s best interests. The ASIC are currently penalising directors who engage in illegal phoenix activity through:

a) enforcement action – the ASIC takes this action against those who facilitate or aid and abet illegal phoenix activity, including against directors who breach their duties; and

b) disqualification of directors – where a director has been involved in multiple liquidations over a seven year period, the ASIC may disqualify that director from managing corporations.

Some recent case studies

1. Ms Amy Timko, the sole director of a company which operated a number of Noodle Box franchises, was issued a two-month suspended jail sentence by the Local Court and is disqualified from managing corporations for five years. Ms Timko re-assigned leases for the Noodle Box stores of her failed company (Company A) to another company (Newco), and “sold” the plant and equipment of Company A to Newco, without Company A actually receiving any payment. Company A was then placed into liquidation.

2. Mr James Meaden, the sole director of a manufacturing company, was convicted and fined by the Magistrates Court for dishonestly using his position as a director of a company. Mr Meaden was also automatically disqualified from managing corporations for five years. An ASIC investigation found that Mr Meaden engaged in illegal phoenix activity by transferring $34,800 from his failed company to a related company one day prior to a court hearing to wind up the failed company. As a result of the transfer, the company had no assets available to pay creditors, totalling in excess of $2 million.

3. Ms Sheila Anne McAuley, a director of a company, pleaded guilty to dishonestly using her position as a director of a company in the Magistrates Court, after an ASIC investigation found that her failed company sold its assets to a related company (of which she was also the director) for $20,000. However, no independent valuation of the assets had been conducted nor had any consideration actually been paid by the related company. This resulted in no assets being available for the liquidator to pay creditors of the failed company.

4. Mr Peter Kalos was disqualified from managing corporations for a period of five years as a result of his involvement in nine failed companies. The ASIC found that Mr Kalos, inter alia, engaged in phoenix activity by transferring the business of a failed company to a new company leaving no assets to pay creditors, whilst the new company continued operating the same business. The total amount of debts owed by the nine companies to creditors was almost $8 million.

Taking the right steps

While there are clear benefits to creditors for a company to legally undertake a sale of its business to a related party, it requires accurate and professional advice to ensure the transaction is done safely, to minimise the risk of directors breaching their duties. Any director of a company experiencing financial difficulty should obtain advice from their accountant, lawyer or contact the team at DW Advisory on (02) 9234 0444.