Creditor-defeating dispositions occur when a company transfers property for less than its reasonable market value.
- A liquidator now has the power to claw back creditor-defeating dispositions by suing both the director and any professional advisor.
- ASIC has been granted new powers to intervene to recover property received in a voidable creditor-defeating disposition on its own initiative or at the request of a liquidator.
What are creditor-defeating dispositions?
A creditor-defeating disposition occurs when a company transfers property for less than its reasonable market value. This process typically occurs during the winding up of a company, and may take place as part of a broader process of illegal phoenixing. This has the effect of preventing, hindering or significantly delaying the company’s assets from becoming available to meet the demands of creditors. The implementation of creditor-defeating dispositions into Australian law works to deter potential promoters of phoenix activity and provides a new mechanism that liquidators can use to claim assets.
What is phoenix activity?
Whilst there is no universally agreed upon definition of phoenix activity, it is accepted to be the process of ‘rebirthing’ an enterprise by stripping one company of its assets and transferring them into a new entity which becomes essentially the same business. Creditor-defeating dispositions are one type of phoenix activity used to prevent assets from becoming available to creditors. Phoenix activity is often, though not always illegal and can have significantly detrimental impacts on creditors and the Australian economy more broadly. Whilst there is no offence specifically targeting phoenix activity, there are a range of ways in which the law prohibits this activity and might be used to take action against directors. Despite such measures, throughout recent history creditors have often complained that regulatory bodies and liquidators do not undertake serious investigations or initiate adequate enforcement action. This has paved the way for a range of reforms.
For more information, read our article: What is phoenix activity and how does the law (attempt to) regulate it?
Why have creditor-defeating dispositions been introduced into Australian law?
Creditor-defeating dispositions have been introduced to give liquidators another arrow in their quiver. The reforms were introduced in February 2020 within the Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2019 (Cth) as part of a widespread attempt to crack down on illegal phoenix activity across Australia. Alongside creditor-defeating dispositions, reforms were instituted concerning the backdating of director resignations, GST liabilities and the retention of tax refunds. These reforms were driven by the perceived inadequacy of the previous legal framework to deal with illegal phoenix activity.
The need for reform has been further brought to light by the work of the Phoenix Taskforce. The Phoenix Taskforce comprises 38 federal, state and territory government agencies, and aims to take a holistic approach to combating illegal phoenix activity. The collective work of the Taskforce has demonstrated that illegal phoenix activity poses a serious threat to revenue, employee entitlements and the integrity of the Australian corporate system. As such, the provisions have been brought in to remedy what has long been recognised as a serious issue across the Australian commercial landscape.
What are the details of the new provisions?
The Treasury Laws Amendment Act amended the Corporations Act 2009 (Cth) to create a new definition for creditor-defeating dispositions, to impose duties to prevent such dispositions, to provide for remedies and to bolster ASIC’s powers.
Definition of creditor-defeating dispositions
Creditor-defeating dispositions are outlined in s 588FDB of the Corporations Act. The section dictates that a disposition of property is a creditor-defeating disposition if:
- The consideration payable to the company for the disposition was less than the lesser of the following at the time the relevant agreement for the disposition was made or, if there was no such agreement, at the time of the disposition:
- the market value of the property; or
- the best price that was reasonably obtainable for the property, having regard to the circumstances existing at that time.
- The disposition has the effect of:
- preventing the property from becoming available for the benefit of the company’s creditors in the winding‑up of the company; or
- hindering, or significantly delaying, the process of making the property available for the benefit of the company’s creditors in the winding-up of the company.
The legislation further extends the concept of a disposition by providing that:
- If a company does something that results in another person becoming the owner of property that did not previously exist, the company is taken to have made a disposition of the property.
- If a company makes a disposition of property to another person and the other person gives some or all of the consideration for the disposition to a person (third party) other than the company, then the company is taken to have made a disposition of the property constituting so much of the consideration as was given to the third party.
A creditor-defeating disposition will be voidable under s 588FE(6B) of the Corporations Act if three criteria are met:
- The transaction is a creditor‑defeating disposition of property of the company.
- At least one of the following applies:
- the transaction was entered into, or an act was done for the purposes of giving effect to it, when the company was insolvent, during the 12 months ending on the relation‑back day or both after that day and on or before the day when the winding up began;
- the company became insolvent because of the transaction or an act done for the purposes of giving effect to the transaction during the 12 months ending on the relation‑back day or both after that day and on or before the day when the winding up began;
- less than 12 months after the transaction or an act done for the purposes of giving effect to the transaction, the start of an external administration of the company occurs as a direct or indirect result of the transaction or act; and
- The transaction, or the act done for the purpose of giving effect to it, was not entered into, or done:
- under a compromise or arrangement approved by a Court under s 411; or
- under a deed of company arrangement executed by the company; or
- by an administrator of the company; or
- by a liquidator of the company; or
- by a provisional liquidator of the company.
The Corporations Act also sets out a range of new duties to prevent creditor-defeating dispositions. In particular it sets out that:
- An officer of a company must not engage in conduct that results in the company making a creditor‑defeating disposition of property of the company.
- A person must not engage in conduct of procuring, inciting, inducing or encouraging the making by a company of a disposition of property that results in the company making the disposition of the property.
The key takeaway here is that liability now extends to other persons who facilitate a company making a creditor-defeating disposition, including professional advisers such as solicitors. This widens the scope to better deter phoenix activity and provides greater recourse for liquidators to receive compensation.
Remedies and penalties
If a creditor-defeating disposition has occurred, and that disposition is determined by a court to be voidable, a range of remedies will be available to creditors and liquidators. The primary remedy is the recovery of the property that has been transferred, which intends to restore the parties to the position they would have been in but for the disposition. In addition, a court may also provide that compensation be paid to creditors or liquidators where necessary. It would be expected that liquidators would prefer a claim for cash compensation.
Furthermore, the new regime introduces criminal and civil penalties for individuals and corporate bodies that contravene the duties outlined above. To be held criminally liable, the individual or body must have been reckless as to the result of their conduct. To be held civilly liable, the individual or body must have been unreasonable in their conduct. If such a standard is proven, hefty penalties can be enforced by the court including fines of up to 4,500 penalty units for individuals and 45,000 penalty units for corporations. Individuals can also be imprisoned for up to 10 years and corporations can be fined up to 10% of their annual turnover.
Powers for ASIC
Finally, the reforms have bolstered ASIC’s ability to combat illegal phoenix activity and protect legitimate creditors by enforcing the creditor-defeating disposition provisions. ASIC now has the ability under s 588FGAA to make an administrative order at the request of a liquidator or on its own initiative stating that the property involved in a creditor-defeating disposition be returned, that the amount representing the benefit be paid or that an amount that ‘fairly represents’ the proceeds be paid. Any failure to comply with the order, is an offence which carries a fine of up to 30 penalty units or imprisonment of up to six months, or both. This extends the recovery provisions available to liquidators and improves their ability to recover assets lost through illegal phoenixing.
- Creditor-defeating dispositions occur before an insolvent liquidation, when the company transfers property for less than its reasonable market value.
- When developing a restructuring plan, directors and their professional advisors need to make sure that value is paid when any asset is transferred or they may face a civil or criminal action brough by a liquidator or ASIC.