The dangers of illegal “phoenixing”

In Greek mythology, the phoenix is a bird that goes through constant renewal. It dies in flames, only to be reborn from the ashes. It is a term that is used when a new business is created to continue trading, whilst leaving the flaming remains of the previous business and its bad debts behind. It has long been a problem in Australia and is illegal with serious personal ramifications for the directors of the failed company. New legislation has been passed that give liquidators of failed companies greater power with respect to recovery of assets.

1. What is illegal phoenxing?

Illegal phoenixing is the removal of a valuable assets from one company to gift to a new company (either for no payment or at significant undervalue) so that the proceeds of the sales of those assets are not available to pay the debts owed to the creditors.

Removal of the business to a new entity has been associated with illegal phoenix activity in Australia, where a new company is incorporated to run the existing business without an amount paid (or a significantly lesser amount than fair value) to the company for that asset.

The assets of the company include hard assets, such as plant and equipment and inventory. However, it also includes the “soft” assets such as client data base, the name and logo of the business, the domain name and website, email addresses, telephone numbers and social media sites. The assets of a company include the business itself.

A very important issue in determining if a transfer is illegal phoenixing, is the valuation of the assets and the price paid by the purchaser. To avoid the allegation, it is best practice to get a formal valuation of the asset and to agree the price for the asset at or about that sum.

2. Prosecution of directors

Under the Corporations Act, ASIC can prosecute a director for illegal phoeixing activity. Penalties range include large fines and up to 15 years imprisonment. This applies to directors (including shadow directors) and secretaries.

3. Power of liquidator to recover assets

Directors owe a duty to the company to act in good faith and also to consider the creditors when approaching insolvency. This includes ensuring that any assets of the company are not transferred for less than market value. Use this link to read more about director duties.

A liquidator appointed to the company is able to take action against the directors personally and against the company to which the assets were transferred. This has often proved difficult and expensive for a liquidator to successfully recover the assets or compensation under the existing law.

In addition to the duty of directors to deal with the assets of a company in good faith, and in response to the difficulties to recover assets or compensation, two new pieces of legislation have recently been passed in Australia that have greatly increased a liquidators ability to recover those phoenixed assets or obtain fair value payment for them. They can be summarsied as:

· dispositions of assets of a company for the purpose of taking those assets out of the hands of the liquidator so they cannot be sold and the proceeds split amongst creditors; and

· prohibiting directors resigning that would leave the company without a director.

4. Creditor defeating disposition

The concept of “creditor-defeating dispositions”, was introduced in 2020 to deal with this issue to give liquidators greater power to recover assets removed or the loss caused by that removal. In that situation:

· a liquidator can seek to set aside the transaction removing the assets and take possession; and

· ASIC can make an order directing that the third party delivers the asset back to the company or pays “fair value” — not abiding by that order can lead to substantial fines.

A significant change in the new legislation is that the directors and/or the party receiving the assets now have to prove that the transfer was not a creditor defeating disposition. It is far more difficult to have to positively prove that the transaction is not a creditor defeating disposition than having to defend that allegation on a reasonable basis.

5. Directors ability to resign from a company in liquidation

The new legislation, introduced in 2021, is designed to ensure that a company is not left without a director. This is so directors do not avoid responsibility.

A person’s resignation as a director of a company takes effect on the day that written notice is lodged with ASIC. This stops a common practice of directors lodging a resignation that is dated a significant period of time before it is lodged.

Further, a director may not now resign, or be removed by resolution of the owners of the company, if it would result in the company not having a director.

6. Alternatives?

Illegal phoenxing activity of small-business owners has very serious consequences. The new powers to deal with this issue have made it even more difficult for owners to get away with it. But, the reason that many owners of small business (which are often the directors) will continue to engage in illegal-phoenixing activity is because of a feeling of helplessness. They feel that there is no alternative to cutting and running either because:

· they do not understand the processes available for a company in financial distress; or

· they do understand the processes under the Australian insolvency regime and they think that the process is too expensive and/or will not result in a positive outcome.

Use this link to read more about the Australian insolvency regime.

Getting early advice about options when financial difficulty arises is very important to ensure that the situation does not get worse and there is a business to save. However, small-business owners will be less likely to seek advice if they think that it will be too expensive to save their business. The temptation to just shut down and start again with essentially the same assets just looks too enticing.

If small-business owners protected the often-significant personal investment they make in their business as a secured loan registered on the PPSR, they would be more confident to get early advice because the chance to recover their company is significantly enhanced. This is because having that protection in place raises the chances that a business restructure can be done quickly and for far less money without losing control of the business. Use this link to read how this protection works.