How the Crack Down on Illegal Phoenixing Increases Director Accountability

In an effort to avoid paying tax debts, businesses too often turn to illegal phoenixing. This exposes directors to liability, and poses a threat to the integrity of the tax system.

Enacted in February 2020 as part of a suite of reforms, the Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020 (Cth) (the Phoenixing Act) empowers regulators to combat illegal phoenixing by company directors and other professional advisors.

This article explores the legislative measures introduced by the Phoenixing Act, as well as the significant risks directors face if they pursue the path of illegal phoenixing.

Key takeaways 

• Directors and professional advisors, such as pre-insolvency advisors, must be mindful of the civil and criminal penalties for illegal phoenixing

• The legislative reforms were designed to stamp out illegal phoenixing, and protect the interests of legitimate creditors

• There is a difference between legal phoenixing, involving a genuine restructure, and illegal phoenixing

What is illegal phoenixing?

The practice of illegal phoenixing involves a company deliberately stripping and transferring its assets to a new company in order to avoid paying outstanding debts owed to creditors. Illegal phoenixing ultimately hinders the liquidation process and denies creditors access to assets to satisfy the outstanding debts.

It is important to note that legal phoenixing, where companies restructure as a new entity with the intent to remain willing and able to meet outstanding company debts, may not fall foul of the legislation.

Key reforms contained in the Phoenixing Act

The reforms introduced new phoenixing offences with two key purposes:

1. To prohibit creditor-defeating dispositions of company property and penalise individuals that engage in or facilitate such dispositions; and

2. To ensure directors are held accountable for misconduct, preventing them from improperly backdating resignations or abandoning the company.

We will discuss how the legislative regime implements these purposes below.

Creditor-defeating dispositions

Under the provisions, company officers can be penalised for engaging in creditor-defeating dispositions, a new class of voidable transaction added to the Corporations Act 2001 (Cth).

According to section 588FDB of the Corporations Act 2001 (Cth), creditor-defeating dispositions are transfers of company assets for less than market value, or the best price reasonably obtainable, that prevent, hinder or significantly delay access to company assets by creditors in the winding up. 

However, the Phoenixing Act imposes safeguards to protect legitimate restructuring activity. A transaction is not voidable as a creditor-defeating disposition if:

• The transaction was under a restructuring plan made by the company;

• The transaction was by a restructuring practitioner, administrator, provisional liquidator or liquidator; or

• The transaction was under a deed of company arrangement executed by the company.

The power of ASIC to undo the effect of creditor-defeating dispositions

A novel feature of the legislative regime is the quasi-judicial power granted to ASIC. The scheme empowers ASIC to make orders, either on request of a liquidator, or on its own initiative, to:

• demand the return of property received as a result of a voidable creditor-defeating disposition; or

• demand payment of compensation of the value of the property subject to the creditor-defeating disposition.

Importantly, the limitation period for a liquidator to request an order by ASIC ends the later of 3 years after the relation-back day, or 12 months after the first appointment of a liquidator to wind up a company.

The expansive powers granted to ASIC under the Phoenixing Act were introduced with two overarching aims:

1. To overcome the difficulties encountered by liquidators, who are often hampered by inadequate funding; and

2. To permit intervention in circumstances where a liquidator is failing to fulfil his or her obligations to recover company property.

Whilst it is yet to be seen whether ASIC actively exercises this power, it remains a powerful instrument available to ASIC.

The Phoenixing Act also imposes significant criminal and civil penalties on company officers who fail to prevent the company from making creditor-defeating dispositions. Individuals that procure or encourage creditor-defeating dispositions, such as lawyers and other advisors, also face potential criminal offences, civil penalties and liability to creditors or the company.

Resignation of company directors

The Phoenixing Act also prevents company directors from improperly backdating their resignation more than 28 days, a common tactic adopted by company directors to engage in illegal phoenixing.

Under the legislative scheme, the resignation of a director takes effect on the day when the person stops being a director of the company, provided that ASIC is notified of the day within 28 days. In any other case, resignation take effect on the day the written notice is lodged with ASIC.

If a director resigns from their role and leaves the company with no directors, the resignation will fail to take effect.

Conclusion

Undertaking a business restructure can often be complicated, especially when it involves the sale of assets.

This article highlights the requirement for both directors and professional advisors to be aware of the new reforms which have been implemented to combat illegal phoenixing activity.

It is imperative that directors and professional advisors seek appropriate advice before embarking on business activity which could fall foul of the new anti-phoenixing regime, especially given the new powers provided to ASIC to recover property and/or seek compensation.