How are pre-insolvency advisers regulated in Australia?

Estimated reading time: 8 minutes Other

Pre-insolvency advice is an area that is relatively under-regulated in Australia. While there is a range of Codes of Ethics and professional standards that may apply, they will only apply where an individual is a member of that specific profession or association (e.g. ARITA, CPA Australia or ABRTC).  

How are pre-insolvency advisers regulated in Australia?

While insolvency in Australia is a heavily regulated industry, historically, there is one segment of the industry that has had little oversight: pre-insolvency advisers. Arguably, this has been a detriment to the broader industry because the highly trained work in competition with snake oil salesmen. As the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) Insolvency Inquiry put it: 

“The word adviser can be misleading as there are no requirements to be licenced, no regulation of their practises and no dispute resolution process if things go wrong” (p 15). 

In this article, we look at the definition of pre-insolvency advisers, how they are regulated and where there might be room for improvement. 

What is the definition of a pre-insolvency adviser?

The term in Australia is not defined in any statute or regulations. However, commonly this term is used to refer to any individual who helps business owners understand why their business is failing, and comes up with a strategy for turning it around, or winding it up.  They are also commonly known as ‘pre-insolvency consultants’. 

There is no single profession or training that pre-insolvency advisers have, but they are usually: 

  • Public practice accountants (i.e. an accountant that works in a traditional accountancy firm)
  • Chief financial officers or finance managers on contract (i.e. financial accountants who work within a general business)
  • Insolvency practitioners or liquidators (i.e. registered liquidators, voluntary administrators, receivers and managers, and restructuring practitioners)
  • Lawyers who specialise in insolvency 
  • Generic financial advisers 

For more information on pre-insolvency advisers generally, read our long post: What should a Pre-Insolvency Adviser (a lawyer, accountant, or other professional) do to help a financially troubled small or medium-sized business?

There is a general reluctance on the part of insolvency practitioners to offer pre-insolvency advice. This is because it would undermine the perceived independence of the insolvency practitioner if later appointed to the external administration. Insolvency practitioners would prefer to get a high fee appointment such as a voluntary administration rather than undertake significant pre-appointment advice that would preclude them from later becoming a voluntary administrator.

A competent pre-insolvency adviser looks at both the personal position of the business owner (asset protection) and the viability of the business before coming up with a strategy. This is a multi-disciplinary exercise including law, accounting and general entrepreneurial expertise. 

Unfortunately – there aren’t many dedicated professionals in this area. This is perhaps the reason that illegal phoenix operators have been able to step in to fill the void.

Are pre-insolvency advisers phoenix operators? 

An illegal phoenix operator is an individual who advises struggling businesses to transfer assets out of their business into a new company, for less than market value, before winding up the original company. This has the effect of defeating creditors of what they are legally entitled to. 

This is nothing new and Australia has a history of advisers who find ways of hiding assets from creditors. One example is the struck off barrister Peter Clyne, who, during the 1970s, ran conferences from the posh Sibel Hotel in Sydney. The conferences and consultations included plans to hide money from creditors and how to frustrate tax collection and insolvency professionals. Mr Clyne also published a series of books including ‘How not to pay your debts: a handbook for scoundrels’, ‘Adventures in tax avoidance: with 120 practical tax hints’ and ‘How to survive a financial crisis: and then make more money than ever!’. 

Some pre-insolvency advisers are illegal phoenix operators. Those who are, tend to be of the ‘generic financial adviser’ mould. Often, the phoenix operator takes advantage of naïve company directors who are not aware that this practice is generally illegal. Unfortunately, it is more likely to be the directors, rather than the phoenix operator, who is the subject of enforcement action. This is because the obligations that directors have under corporate and tax law are personal and their phoenix operator adviser has no enforceable retainer with their client.  

Phoenix operators are often former liquidators and one common thread of their approach is to interlace sham or fraudulent transactions into their work. This distinguishes them from other pre-insolvency advisers such as lawyers and insolvency practitioners. Ultimately, they rely upon lax enforcement standards by liquidators and governmental bodies (such as the ATO and ASIC) to achieve success. 

We discuss the tools that have been implemented to crack down on illegal phoenix activity below. For more general information on the phenomena check out The Complete Guide to Illegal Phoenix Activity.

How are pre-insolvency advisers regulated?

As mentioned, it is rare for insolvency practitioners to offer comprehensive pre-insolvency advice. However, even where they do, many of their obligations under the Corporations Act 2001 (Cth) (henceforth, ‘the Act’) and the Insolvency Practice Rules (Corporations) 2016 will not apply. That is because the obligations there primarily apply to formal insolvency appointments. However, they will still be bound by a range of ethical obligations that apply either through their membership of the Australian Restructuring, Insolvency and Turnaround Association (ARITA) or as professional accountants (through the APESB Code of Ethics).

For example, under the ARITA Code of Ethics, all ARITA members (whether acting in an insolvency appointment or not) must act with integrity, impartiality, competence and professionalism. 

More specifically, clause 5.10 explicitly prohibits ARITA members from illegal phoenix activity:

“Members must not advise a financially distressed Entity (nor, if the Entity is a company, its directors) on how to cause assets to be unavailable in an Administration or to otherwise avoid the consequences of the insolvency.”

From a lawyer’s point of view, this ethical obligation is somewhat problematic because this may encompass transactions that, of themselves, are legal but result in less assets becoming available for creditors in a liquidation scenario. One example would be transfers of key business assets to related parties. It may be that the transactions are for fair value and therefore are not ‘uncommercial’ or ‘undervalued’ so they are not subject to claw-back by a liquidator. The valuations of the assets could be low and it would have been in the interests of creditors for the assets to be retained so that the going concern of the company is preserved. 

Under the APESB Code of Ethics, professional accountants must act with integrity, objectivity, professional competence and due care, and according to standards of professional behaviour. 

Those professional accountants who are not also registered as insolvency practitioners will be similarly covered by these general standards when giving pre-insolvency advice. 

Insolvency lawyers are regulated by strict professional standards set out primarily (but not solely) in the Legal Profession Uniform Law Australian Solicitors’ Conduct Rules 2015 (‘Conduct Rules’). This includes an obligation to: 

  • act in the best interests of a client;
  • be honest and courteous in all dealings;
  • deliver legal services competently, diligently and promptly; and
  • avoid compromising their integrity and professional independence.

The Association for Business Restructuring and Turnaround (ABRT) has a robust Code of Ethics and set of professional standards that apply to any individual who becomes a member. The Code of Ethics encompasses five key values: 

  • Integrity & Professionalism 
  • Objectivity & Independence
  • Competence & Diligence
  • Fairness & Trustworthiness
  • Confidentiality & Security 

The agency problem has been widely analysed in industries such as financial planning and stockbroking. It is the idea that agency problems arise when there is a conflict of interest between an adviser and their client. Where there are no regulations or dispute resolution avenues then there are no external factors that can ameliorate situations where the agent (i.e the adviser) has an incentive or motivation not to act in their best interests of their principal (i.e. the client). The agency problem is compounded in insolvency matters because the clients are often desperate and may be more susceptive to snake oil salesmen offering a solution of setting traps and hiding assets from creditors.

To put the lack of regulation in perspective if anyone provides a consumer with advice about how to structure their finances, such as refinancing car loans, then that person will need to hold a credit licence (see ASIC Regulatory Guide RG203.61). This has the effect that an ASIC registration is required to make a ‘suggestion’ to an individual that they need to refinance their Toyota hatchback but that no registration is required for a pre-insolvency adviser taking conduct of a business that has numerous employees, large tax debts and obligations to suppliers and customers. 

Are pre-insolvency advisers affected by the prohibition on creditor-defeating dispositions?

Illegal phoenix activity is prohibited in the Act primarily through the recent prohibition on ‘creditor-defeating dispositions’. A creditor-defeating disposition is defined in section 588FDB(1) as “a disposal of company property that prevents, hinders or significantly delays that property from becoming available for the benefit of creditors in the winding up of the company”. 

Under section 588GAC of the Act it is illegal for any person to procure, induce, incite or encourage a creditor-defeating disposition. This is linked to stiff criminal and civil penalties. The reference to “any person” would clearly cover phoenix operators. 

It remains to be seen whether ASIC will use its powerful new tools to track down and take enforcement action against illegal phoenix operators.

Conclusion

Pre-insolvency advice is an area that is relatively under-regulated in Australia. While there is a range of Codes of Ethics and professional standards that may apply, they will only apply where an individual is a member of that specific profession or association (e.g. ARITA, CPA Australia or ABRTC). 

Hopefully, ASIC’s new powers to take on illegal phoenix operators will go some way to cracking down on the rogues and encouraging the professional pre-insolvency advisers to adhere to professional norms.

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