Rising from the ashes - Treasury seeks input on combating illegal phoenix activity

In brief

Keeping up the momentum from the recent passing of its insolvent trading safe harbour and ipso facto legislation, the Federal Treasury has released a consultation paper containing a package of reforms to 'deter and disrupt illegal phoenix activity'. Partner Alf Pappalardo and Lawyer Belinda Hennessy report.

Background

'Phoenixing' is an activity whereby a company (often newly incorporated) seemingly rises from the ashes of an insolvent or abandoned company. The controllers and the business apparently remain unchanged; however, the liabilities are left in the old company. While it's sometimes difficult to distinguish it from a legitimate business rescue, illegal phoenixing occurs when the controllers intend to abuse the corporate form in order to defraud the company's creditors.

Unsurprisingly, a number of the proposals in the Treasury consultation paper centre around protecting the Australian Taxation Office, often the greatest victim of phoenix behaviour. However, this Client Update will cherry-pick proposals that have a bigger impact on other creditors.

Restrictions on voting rights

Creditors have always enjoyed the fundamental protection of being able to remove 'friendly liquidators' who they perceive not to be representing the interests of the creditors as a whole. However, currently this right is enjoyed by all creditors, and phoenix operators are able to effectively 'stack the vote' through the voting power of 'related creditors' to prevent the removal of often undesirable liquidators.

Although section 600A of the Corporations Act 2001 (Cth) allows creditors to ask the court to review such a practice, the consultation paper proposes streamlining this process by requiring the external administrator to disregard any 'related creditor' (as defined in the Corporations Act) votes received in relation to a resolution to remove and replace an external administrator.

A phoenixing offence

The paper further proposes amending the Corporations Act to 'specifically prohibit the transfer of property from Company A to Company B if the main purpose of the transfer was to prevent, hinder or delay the process of that property becoming available for division among the first company's creditors'. The proposal is designed to operate in a similar manner to s121(1) of the Bankruptcy Act 1966 (Cth), which states that the main purpose in making the transfer will be taken to be the prescribed purpose:

if it can reasonably be inferred from all the circumstances that, at the time of the transfer, the transferor was, or was about to become, insolvent.

 

 
Contravention of this provision would give rise to a right for the creditors, liquidators (and ASIC) to sue for compensation for the loss caused by the contravening conduct. It is worth noting that this remedy would be in addition to those already available to liquidators under the claw-back provisions in the Corporations Act and by creditors under s 228 of the Property Law Act 1974 (Qld)¹. However, the proposal goes further than these protections and provides that where ASIC (or a liquidator) suspects that illegal phoenix activity has occurred and the assets of Company A have been transferred to Company B for less than market value, then ASIC can issue a notice upon Company B requiring them to deliver up the property or monies worth (similar to the regime in s139ZQ of the Bankruptcy Act. The recipient would then have the right to apply to the court to set aside the notice. However, the paper leaves open what enforcement options would be available to ASIC if the notice is not complied with.

High risk entities – a cab rank rule or a government liquidator?

Part 2 of the consultation paper specifically targets phoenix operators who have 'adopted phoenixing into their business model' or who are active facilitators of phoenixing. Two of the noteworthy proposals to target 'friendly liquidators' (who may facilitate the directors' interests to the detriment of the creditors) are as follows.

Next cab off the rank

A registered liquidator would be chosen from a regionally based panel on a 'next-cab-off-the-rank' basis. In order to combat the instances of low- or no-asset companies, the proposal provides that liquidators would receive some minimum level of funding to ensure the proper performance of their duties.

This option is currently only designed to apply where an officer of the company is deemed a 'High Risk Phoenix Operator' (under a process set out in the consultation paper) but the paper does question whether it should apply more broadly, to all external administrations.

Government liquidator

This proposal is not dissimilar to the appointment of the Official Trustee in Bankruptcy for an individual. However, the proposals paper is light on detail, and seeks input into how such a measure would be funded and what external administrations the 'government liquidator' should conduct. The proposal does recognise the need for a private registered liquidator in certain circumstances, which may be necessary with complex liquidations.

Next steps

Feedback is due by 27 October 2017 and can be provided directly to the Treasury.