Making the right decisions when rescuing a business

Say “No” to illegal phoenix activity!

OTP readers would be familiar with the concept of “phoenix activity”, which typically involves the failure of one company (Oldco) and a second company (Newco) being set up by the same owner and conduct essentially the same business, leaving debts in Oldco unpaid. The key distinction between legal and illegal phoenix activity is that: 

• Legal phoenix broadly refers to the owner starting a new company to genuinely rescue the failed business.

• Illegal phoenix activity happens when a new company is created to continue the business of a company that has been deliberately liquidated to avoid paying its debts.   

Illegal phoenix activity is not a legally defined term and is almost impossible to define because illegal phoenix activity can take many forms and how it is being conducted is constantly changing. Further to that, it is practically difficult to draw a distinction between illegal phoenix activity and a legitimate business rescue.

The main victims of illegal phoenix activity include the government, employees, creditors, competing businesses, and the public at large. Illegal phoenix activity costs the Australian economy billions of dollars each year. Those who suffer most from illegal phoenix activity are the Australian Taxation Office (ATO) and the respective state revenue offices.

A typical illegal phoenix activity usually involves the following: 

• Newco operates a business under the same or similar name to retain customer goodwill.

• Oldco’s employees continue to be employed by Newco.

• Oldco's assets were transferred to Newco with no or nominal consideration paid.

• Oldco’s tax affairs and liabilities are left behind. 

Existing law combatting illegal phoenix activity

Several provisions in existing laws prevent illegal phoenix activities. Primarily in the Corporations Act 2001 and the Taxation Administration Act 1953 (TAA) such as director duties breaches , voidable transactions, and the director penalty provisions.

In addition, the general public can report suspicions of phoenix activity to the ATO through the 1800 Hotline.

The director identification numbers (DINs) aims to help prevent straw directors being used and to help the regulators to identify directors’ involvement in unlawful activity such as illegal phoenix activity.

Further to that, the Phoenix Taskforce (established in 2014) unites government entities to prevent fraudulent phoenix behaviour.

Issues with existing system 

Despite the above measures, several deficiencies prevents the laws being enforced effectively, namely: 

• Unbalanced recovery power among creditors—the ATO or the Fair Entitlements Guarantee scheme (FEG) is empowered with various legislation and are funded to pursue recoveries against illegal phoenix activity but a normal supplier does not have the same power or level of funding.

• Lack of effective cooperation between government agencies—legislation preventing Taskforce members from sharing some information.

• Insufficient punishment for those non-compliance activities.  

• Insufficient funds to meet the cost of enforcements—small business liquidations usually have insufficient assets to fund the liquidator for further investigation or recovery actions.

• Late detection—illegal phoenix activity victims have moved on from the losses.  

• Under-utilised law, for example, section 5 of the Crimes (Taxation Offences) Act 1980 provides a potential 10-year jail term and $180,000 fines however, it has not yet been used for illegal phoenix activity.

• Difficulties establishing a case—the onus of proof is on the liquidator and the Australian Securities and Investments Commission (ASIC) but it is difficult to prove when the company does not maintain proper bookkeeping.

That said, the government’s efforts to combat illegal phoenix activity is continuing through law reforms, so we should expect to see more effective ways preventing illegal phoenix activity in the future. 

What should be considered when rescuing a business?

Phoenix activity can be legal when it arises from a genuine business failure, or it is part of a legitimate business rescue. 

Here are some tips: 

• Consider using small business restructuring or voluntary administration to achieve a formal restructuring through a Deed of Company Arrangement, where the Oldco can continue to exist.

• Obtain a valuation before disposing company assets/business.

• For medium-to-large-size businesses, consider Safe Harbour advice to ascertain that the restructuring is reasonably likely to lead to a better outcome for the company and its creditors. 

Related article: The effectiveness of the safe harbour regime

----

1. Anderson, H., O’Connell, A., Ramsay, I., Welsh, M., & Withers, H. (2015). Profiling Phoenix Activity: a new taxonomy. Company and Securities Law Journal, 33(2), 133–137.

2. Anderson et al, Defining and Profiling Phoenix Activity (n 74) 1; Anderson et al, ‘Profiling Phoenix Activity’ (n 74) 133.

3. Australian Taxation Office, Illegal Phoenix Activity [Internet], available from https://www.ato.gov.au/general/the-fight-against-tax-crime/our-focus/illegal-phoenix-activity/

4. Treasury, Australian Government, Action against Fraudulent Phoenix Activity (Proposal Paper, November 2009) 6 [2.3]

5. Parliamentary Joint Committee on Corporations and Financial Services 2004, Corporate Insolvency Laws: A Stock Take [Internet], available from https://www.aph.gov.au/binaries/senate/committee/corporations_ctte/completed_inquiries/2002-04/ail/report/ail.pdf 169.

6. Anderson, H., Hedges, J., Ramsay, I., & Welsh, M. (2017). Illegal phoenix activity: is a “phoenix prohibition” the solution?(Australia). Company and Securities Law Journal, 35(3), 203.

7. PricewaterhouseCoopers, The Economic Impacts of Potential Illegal Phoenix Activity, July 2018, p. ii. [internet], available from https://www.ato.gov.au/uploadedFiles/Content/ITX/downloads/The_economic_impacts_of_potential_illegal_Phoenix_activity.pdf.

8. Welsh, M., & Anderson, H. (2016). The Public Enforcement of Sanctions against Illegal Phoenix Activity: Scope, Rationale and Reform. Federal Law Review, 44(2), 206.

9. Anderson, H., O’Connell, A., Ramsay, I., Welsh, M., & Withers, H.(2014) Defining and Profiling Phoenix Activity 2 [Internet], available from https://law.unimelb.edu.au/__data/assets/pdf_file/0003/1730703/Defining-and-Profiling-Phoenix-Activity_Melbourne-Law-School.pdf.

10. Auditor-General Report No.32 2018-19 Addressing Illegal Phoenix Activity 7 [internet], available from https://www.anao.gov.au/work/performance-audit/addressing-illegal-phoenix-activity [accessed September 2020].

11. Christine Parker and Vibeke Lehmann Nielsen, What Do Australian Businesses Really Think of the ACCC, and Does It Matter? (2007) 35 Federal Law Review 187, 192.