Illegal phoenix activity (phoenixing), the practice of selling a distressed company under value to a related party in order to leave debts with the old company, has significant negative effects across the entire economy. When phoenixing occurs, creditors, employees and/or subcontractors are left unpaid, and the liquidation of the old company is unlikely to generate funds given the disposition of assets to the new. Additionally, phoenixing leads to economic damage on a broader, societal level, in circumstances where companies avoid paying tax and governments are often required to subsidise the outstanding employee entitlements of liquidated companies.
Phoenixing generally occurs in 3 stages:
- company directors transfer the assets of a struggling or near-insolvent company to a new entity without paying true or market value, leaving the debts with the old company;
- the directors continue operating the company through the new entity, now free of debt and with lower operating costs, providing unfair advantages; and
- the old company is placed into liquidation with no remaining assets owned in its name with which to satisfy creditors.
The Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020 (Cth) (Phoenixing Reforms) was enacted in order to amend the Corporations Act 2001 (Cth) (Corporations Act) to provide additional protections and enforcement methods against phoenixing.
The Explanatory Memorandum to the Phoenixing Reforms states that, “the scale of illegal phoenix activity ranges from the opportunistic to the systemic, a common characteristic is the stripping and transfer of assets from a company to another entity. Such transactions are carried out by a company’s directors or other controlling minds with the intention of defeating the interests of the first company’s creditors in that company’s assets.”
Under the Phoenixing Reforms introduced s 588FDB of the Corporations Act, the disposition of property of a company is a creditor-defeating disposition if:
- the consideration paid for the property was less than the lesser of the market value of the property or the best price that was reasonably obtainable for that property; and
- the disposition of the property has the effect of preventing the property becoming available for the benefit of the company’s creditors during the winding-up, or hindering or significantly delaying the process of making the property available for the benefit of the company’s creditors during the winding-up.
The Phoenixing Reforms constitute a stronger legislative approach to tackle phoenixing by:
- providing that any person involved in conduct that results in a company making a creditor-defeating disposition will be exposed to civil and criminal liability;
- granting ASIC the power to make orders against a person who has received property the subject of a creditor-defeating disposition to return the property or pay compensation; and
- creating criminal offences for those who procure or incite creditor-defeating dispositions.
Statistics
A 2018 report prepared by PricewaterhouseCoopers for the ATO, “The economic impacts of potential illegal phoenix activity,” found that phoenixing costs employees between $31 and $298 million in unpaid entitlements, and the government around $1.6 billion in unpaid taxes and compliance, per year.
In 2014, the ATO established the Phoenix Taskforce, which brings federal, state and territory agencies together to combat phoenixing. Up until 31 December 2023, the Phoenix Taskforce raised more than $2.18 billion in liabilities from audits and reviews of illegal phoenix activities, and returned more than $986 million to the community. The Phoenix Taskforce's results from the 2022-2023 financial year included:
- completing 2,967 audits and reviews;
- collecting more than $107 million in cash;
- receiving more than 2,500 referrals of suspected phoenixing through the Tax Integrity Centre; and
- banning or disqualifying 5 directors from being involved in the management of a corporation.
Case study
The Victorian Supreme Court considered the Phoenixing Reforms in the 2022 case of Re Intellicomms Pty Ltd (in liq) [2022] VSC 228.
Introduction
Intellicomms Pty Ltd (Intellicomms) was a company providing translation services to commercial enterprises under the trading name “ezispeak” and was placed into creditors’ voluntary liquidation on 8 September 2021.
The liquidators of Intellicomms made an application for relief in respect of a sale agreement dated 8 September 2021 (Sale Agreement) between Intellicomms and Tecnologie Fluenti Pty Ltd (TF) involving certain business assets of Intellicomms. The liquidators invoked the Phoenixing Reforms by seeking to establish that the Sale Agreement was a creditor-defeating disposition within the meaning of s 588FDB of the Corporations Act.
Facts
The salient facts are as follows:
- the Sale Agreement was entered into on the same day that Intellicomms was placed into liquidation;
- TF admitted the Sale Agreement prevented the assets of the company from becoming available for the benefit of creditors;
- Intellicomms was insolvent at the time of entering into the Sale Agreement;
- TF was a related entity of Intellicomms by reason that its sole director was the sister of the sole director of Intellicomms, its employees included several relatives and both companies shared an identical registered office;
- The purchase price under the Sale Agreement was $20,727.17;
- Prior to the Sale Agreement, Intellicomms received a number of increasingly pessimistic valuations:
- 3 February 2021 valuation of $11,277,346 as at 30 June 2020;
- 26 July 2021 valuation of between $117,456 and $683,559 as at 30 June 2021;
- 30 August 2021 valuation of $101,000; and
- 8 September 2021 valuation of $57,000.
- The largest creditor, Callscan Australia Pty Ltd, which trades under the name QPC (QPC), informed the liquidators that QPC would be interested in participating in any sale process for the sale of the assets of Intellicomms.
- An expert report was prepared by a chartered accountant and forensic consulting partner at Grant Thornton (Grant Thornton Report) for the purpose of the proceedings who assessed the market value of the assets the subject of the Sale Agreement to be $22,925.
Considerations
The Court was faced with the following considerations:
- whether the purchase price under the Sale Agreement was less than the market value of the assets;
- whether the purchase price under the Sale Agreement was less than the best price that was reasonably obtainable; and
- in light of questions a. and b. above, did the Sale Agreement constitute a creditor-defeating disposition within the meaning of s 588FDB of the Corporations Act, and if so, should the Court void the transaction pursuant to s 588FF?
Decision
The Court held that the Sale Agreement had “all the features of what has become known as a phoenix transaction; indeed, it is a brazen and audacious example.” In coming to its decision, the Court noted the following points:
- the effect of the Sale Agreement was to strip Intellicomms of the assets it had to satisfy creditors and to transfer them to a new entity closely associated with its director;
- no explanation was given as to why it was necessary to urgently sell the business rather than leave the process of the sale of the remaining assets to the liquidators;
- the director of Intellicomms had, with the assistance of advisors, executed a plan to place the assets of Intellicomms beyond the reach of creditors;
- numerous valuations were commissioned with the aim of lowering the company’s value in order to minimise the consideration paid under the Sale Agreement
- TF was established shortly before the liquidation in order to prevent QPC from having the opportunity to purchase assets;
- the Grant Thornton Report failed to take into account aspects of Intellicomm’s New Zealand revenue that, if considered, would have significantly increased the valuation;
- there was no attempt to put the sale of Intellicomms to the open market, having regard to the second limb of s 588FDB(1) (obtain the best price reasonably possible); and
- the director of Intellicomms was aware of QPC’s interest in the company and knowingly put in place a plan to frustrate the legitimate motives of QPC in retrieving its commercial position.
The Court held that the Sale Agreement was a creditor-defeating disposition within the meaning of s 588FDB of the Corporations Act and that an order for the Sale Agreement to be declared void was warranted with the necessary ancillary orders.
Key takeaways
When a business is in distress it is a challenging and worrying time for all involved. Directors seeking to continue trading often make the error of re-arranging their affairs in such a manner as to be in breach of the Phoenixing Reforms. The consequences of this may be particularly serious, given that persons who engage in the procuring, inciting, inducing or encouraging of the making by a company of a creditor-defeating disposition may be guilty of a criminal offence that, for an individual, may result in fines of up to $1.05 million, or three times the benefit derived or detriment avoided due to the contravention, or up to 10 year’s imprisonment.
Directors looking to continue trading should instead look to less risky restructuring methods. Company restructures can involve the transfer of assets to a new entity, but to minimise any risk of the transfer being defeated they should consider:
- having the assets independently valued;
- having the business/goodwill independently valued;
- paying fair market value for the company;
- marketing the company on the open market; and
- engaging with a liquidator to conduct the sale process.
For businesses with total liabilities not exceeding $1 million, it may also be possible to access the simplified debt restructuring process which allows small businesses to access a single, streamlined process to restructure their debts, while allowing the owners to remain in control of their business under the supervision of a restructuring practitioner. This process allows directors to maintain greater control of their companies when dealing with economic stress and enables them to put forward a plan to pay creditors within a period not exceeding 3 years.
