Clipping the wings of the Phoenix: Insolvency laws are changing

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This article was written by Tim Klineberg, Samantha Kinsey, Sam Dundas and James Nagle.

Australia's corporate insolvency laws are in a process of significant change.

The latest proposed reform concerns the controversial practice of "phoenixing". In recent months and years, phoenixing has attracted attention from a wide band of Australian regulators.

The Phoenixing Bill

On 13 February 2019, the Treasury Laws Amendment (Combating Illegal Phoenixing) Bill 2019 (Phoenixing Bill) was introduced into Parliament proposing to give ASIC, liquidators and the ATO significant new powers designed to help curtail phoenixing activity and prosecute culpable directors and associated persons.

The Phoenixing Bill forms part of a tranche of recent reforms to Australia's corporate insolvency regime that have included:

  • the safe harbour reforms, which has reduced the scope of the insolvent trading prohibition on directors (amendments to Part 5.7B, Corporations Act 2001 (Cth) (Corporations Act);

  • reforms making certain "ipso facto" clauses unenforceable in contracts signed after 1 July 2018 (amendments to Parts 5.1, 5.2 and 5.3A, Corporations Act); and

  • new restrictions on the use of related party votes at creditors' meetings, including:

    • new court powers to set aside deeds of company arrangement voted through using the votes of related parties (section 75-41, Insolvency Practice Schedule (Corporations) introduced under the Insolvency Law Reform Act 2016 (Cth)); and

    • restricting the value of related party votes where debt assignments have been used to transfer claims to related parties (new rules 75-95(1A) and 75-110(7), Insolvency Practice Rules (Corporations) 2016 (Cth)).

What is "Phoenixing"?

"Phoenixing" is not a technical legal term. It is used generally to describe the stripping and transfer of assets from a distressed company to another entity with the intention of defeating the interests of the distressed company's creditors in those assets.

Stripped of its assets, the distressed company then stops trading and is ultimately liquidated, with insufficient assets available for creditors left behind. The "phoenix" is the new company which "rises from the ashes" to continue trading the business.

Government creditors have suffered losses on a number of unfunded liquidations which are understood to have been "phoenixes". The government estimates that the cost of illegal phoenixing activity to businesses, employees and government is very significant, in excess of $2 billion per year.

Phoenixing has attracted significant regulatory attention in recent months and years, particularly from Government creditor bodies like the Australian Taxation Office (ATO), which is commonly a creditor of companies liquidated as part of "phoenixes", and the Fair Entitlement Guarantee (FEG) which pays out stranded employee entitlements and subrogates into the employees' position.

Key proposed amendments to address asset stripping

Combatting creditor-defeating dispositions

The Phoenixing Bill proposes a number of amendments to the Corporations Act aimed at combatting "creditor-defeating dispositions", which are dispositions of property that:

  • are for less than market value (or the best price reasonably obtainable); and
  • have the effect of preventing, hindering or significantly delaying property becoming available to meet the demands of the company's creditors in a winding-up.

Amendments would add a new voidable transaction aimed specifically at phoenix-style transactions, targeting creditor-defeating dispositions within 12 months of the company entering an insolvency procedure. This supplements the existing voidable transactions which in theory apply to creditor-defeating dispositions, but in practice are rarely used by liquidators to unwind apparent phoenixes.

New ASIC powers

The Phoenixing Bill would grant ASIC additional powers to make administrative orders and intervene where it considers that a liquidator is not fulfilling its obligations to recover company property. Under the new powers, ASIC may order a person to:

  • return the property to the company for distribution to its creditors;
  • pay an amount equal to the benefit the person received from the creditor-defeating disposition; or
  • transfer any subsequent property that was purchased with the proceeds of sale of a creditor-defeating disposition.

The Phoenixing Bill would also create new criminal offences and civil penalty provisions for company officers that fail to prevent the company from making creditor-defeating dispositions and other persons that facilitate such conduct.

The introduction of these new phoenixing offences is consistent with a broader legislative push to introduce a stronger penalty framework for corporate and financial sector misconduct more generally (eg see the amendments outlined in the KWM alert: Towards a stronger penalty framework for corporate and financial sector misconduct).

Consequences of the proposed amendments

While ASIC has been afforded substantial new powers to curtail phoenixing, it remains to be seen whether those new powers will actually translate into significant additional regulatory activity. ASIC has limited resources and is unable to pursue all of the reports of corporate misconduct that it presently receives from administrators and liquidators pursuant to sections 438D and 533 of the Corporations Act. Without additional funding, it is difficult to see how ASIC will, practically speaking, be able to pursue its new powers to their full potential.

Even so, one of the risks with increasing ASIC's "armoury" in this way is the perception that it may lead to increased regulatory activity and inadvertently discourage persons from engaging in legitimate restructuring activities. This risk is arguably heightened in circumstances where there is no clear definition in the Phoenixing Bill of what comprises a "phoenixing", and therefore what comprises legitimate and illegitimate activity. To alleviate this risk, the Phoenixing Bill proposes to protect genuine restructuring activity by maintaining a safe harbour for legitimate restructures and by respecting transactions made with creditor or court approval (eg under a DOCA or scheme of arrangement). Having said that, if a restructure involves a liquidation with unsatisfied creditors, then the persons involved with that transaction appear to be at risk under the new laws.

Additional tax recovery reforms

The Phoenixing Bill also introduces additional measures that are designed to improve the accountability of culpable directors and increase the prospect of the ATO recovering unpaid tax liabilities, summarised as follows:

Reform focus

Legislation  The reform would
Regulating "backdated" director resignations

Corporations Act, Part 2D.3

make it more difficult for directors to "backdate" their resignations seeking to "obscure" their role in phoenixing. 

Extending prospective director personal liability to unpaid GST

Taxation Administration Act 1953 (Cth)

extend existing director liability provisions for unpaid PAYG withholding amounts and superannuation guarantee charges to GST. An additional disincentive to directors to defer GST payments. 

ATO power to withhold tax refunds

Taxation Administration Act 1953 (Cth)

empower the ATO to withhold tax refunds if a taxpayer has other outstanding ATO lodgements or disclosures. Delays in lodgements can be part of a phoenix where tax liabilities are not crystallised until assets (including tax refunds) have been stripped.

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