- Phoenix activity occurs when a ‘new’ business rises from the ashes of a debt-burdened business, leaving creditors stranded
- The directors will abandon a company without properly winding it up and transfer the assets of that company to a new company (usually with a similar name) to avoid paying liabilities
- It is an area where the lawmakers haven’t implemented effective regulation to date and the reader should note that a “phoenix transaction” isn’t specifically illegal under Australian law
- It has become more complex in recent years because some phoenix operators are becoming more aggressive with regular liquidations of payroll entities.
Listen to our podcast for Taxtalks on Phoenix Activity
Ben Sewell of Sewell & Kettle Lawyers is interviewed in this podcast by Heide Robson from Tax Talks (https://www.taxtalks.com.au/). This podcast is a good introduction to help professional advisers understand phoenix activity and the legal background.
Podcast on the phoenix activity hyperlink – https://www.taxtalks.com.au/phoenix-activity/
You can listen and subscribe to this podcast on iTunes or listen on Sticher.
Click on the play button below to listen to the podcast
Click on the play button below to listen to the podcast.
Topics of podcast and discussion below:
- What is phoenix activity?
- Is phoenix activity illegal?
- What reforms are proposed?
- What are examples of phoenix activity?
- What has the Phoenix Research Team found out about phoenix activity?
- Using the same name for successor businesses
- Liquidator claims for uncommercial transactions, insolvent trading and unreasonable director-related transactions
- What are the current techniques of phoenix activity?
- How does the Fair Entitlement Guarantee fit into phoenix activity?
- Who is the regulator or pursuer of phoenix activity?
- Can phoenix activity be specifically pursued?
- Is there a legal phoenix transaction that can be utilised by company directors?
- What do insolvency lawyers do?
What is the legal definition of phoenix activity?
There is no definition in the Corporations Act for phoenix activity or any single definition that is accepted in the insolvency industry. The precise definition of phoenix activity is still a matter of academic debate but the current thinking is best represented by Professor Helen Anderson and the Phoenix Research Team.
Phoenix activity is also known as:
- Asset stripping
- Phoenix transactions
- Phoenix companies
- Payroll phoenixing
Phoenix activity involves:
- An insolvent company (Oldco);
- The transfer of Oldco’s assets for inadequate consideration to a related entity (Newco)
- The result is detrimental for creditors, employees and other stakeholders as they receive less than what they would have received from a voluntary administration
- or liquidation scenario.
Another methodology of phoenix activity is to use the liquidation of successive payroll entities to retain PAYG and other taxes rather than remit these monies to the ATO.
The most up-to-date research on the definition of phoenix activity was undertaken by the Phoenix Research Team in its 2014 report, “Defining and profiling phoenix activity”. In that report, the researchers asserted that phoenix activity was distinguished by the intention of the directors and their advisers. They argued that there were five types of phoenix activity:
- Legal phoenix
- Problematic phoenix
- Illegal type 1
- Illegal type 2
- Complex illegal
There is no current legislative or policy movement by the Federal Government to develop a more sophisticated understanding of phoenix activity to match the academic research. There is also no serious thought being given by the Federal Government to specifically defining phoenix activity.
The problem that we face as lawyers is that strictly, phoenix activity, in itself is not illegal unless it breaches either the common law, tax laws or the Corporations Act.
How much does phoenix activity cost the economy?
It is estimated that phoenix activity costs Australia between $1.78 billion and $3.19 billion per year (PricewaterhouseCoopers report to the Ombudsman in July 2012.). And chances are if you’re a small-to-medium sized business you’ll be affected. Research carried out by the Australian Securities Commission regulator in 1996 found that 18% of small to medium-sized businesses had been exposed to phoenix company activity.
However, the most up-to-date research of the Phoenix Research Team in its 2015 report, “Quantifying phoenix activity: Incidence, cost and enforcement” found that there was no way to measure phoenix activity costs. The firm conclusion is that every report prepared that puts forward an estimate, is at best only a guess.
Another key economic cost of phoenix activity is the externalities it causes. The external cost of phoenix activity is undermining competition because of the competitive advantage a debt-free company can have. This may lead to significant underpricing in certain industries and an expectation that phoenix activity is necessary to compete.
The 2003 Final Report of the Royal Commission into the Building and Construction Industry (Cole Report) devoted an entire chapter to phoenix activity and it gave the overwhelming impression that it was part of hard-wired illegality in the industry. Since then, not a lot has changed other than the introduction of One Touch Payroll and measures to limit money laundering.
Why do company directors undertake phoenix activity?
Phoenix activity occurs for a broad range of reasons. These include:
- It may be a temporary solution to a crisis – i.e. disaster recovery, such as from losing a principal customer or the sickness of the main proprietor
- Directors may be trying to finance drug, gambling or alcohol problems
- Businesses with unsustainable business models looking for a ‘quick fix’ – in some industries it may even be expected that phoenix activity is priced into quotes
- The business that has a long history of being cash (black economy)
- A response to insolvency caused by normal issues like poor management, a big project that lacks sufficient working capital and/or poor accounting systems
Who is organising phoenix activity?
There is no empirical evidence to draw upon but it may be promoted by accountants and former liquidators as well as lawyers. There is no empirical evidence because, firstly, there are few criminal prosecutions against phoenix operators and secondly, there is no academic research into the organisers of phoenix activity. Many of the examples given by the ATO regarding gaoled phoenix operators relate to tax fraud rather than phoenix activity. This follows the main criticism of the regulation of the area by the Phoenix Research Team who argue that phoenix activity itself is actually illegal, and that it is distinguishable from tax fraud.
The most recent story of a phoenix operator in the media involved the public examinations of Philip Whiteman. It was alleged that Mr Whiteman conducted his business through both an accounting and legal practice that he controlled.
Receiving a DPN will be a confronting experience for any company director. The director’s personal assets are at risk and if it is a “lockdown” DPN then the problem won’t be solved through a voluntary administration appointment.
Much has been written in the media about the unmasking of “phoenix operators”. These are the people that are the co-ordinators of phoenix activity and may represent a number of clients. The ATO is part of an interagency Phoenix Taskforce and it has stated that it is targeting both “high risk” and “medium risk” phoenix operators with strong scrutiny and legal sanctions [hyperlink https://www.ato.gov.au/General/The-fight-against-tax-crime/Our-focus/Illegal-phoenix-activity/Phoenix-Taskforce/].
The Phoenix Research Team lists several cases of specific phoenix operators including a solicitor, management consultant, barrister, insolvency practitioner, and a few company directors. However, none of these examples illustrates the “high risk” offenders that are currently being targeted by the ATO. The best example of this targeted type of organised phoenix model is the case of Plutus Payroll. It is estimated that the ATO lost an amount in excess of $100 million due to non-payment of tax. The best article on this alleged ring is ‘How the alleged $165 million tax scam worked’, SMH May 2017 (https://www.smh.com.au/national/how-the-alleged-165-million-tax-scam-worked-20170518-gw7wuz.html).
What types of businesses undertake phoenix activity?
There is no empirical evidence to draw upon but industries that have a significant incidence of phoenix activity include:
- Building and construction subcontractors
- Hospitality including nightclubs and restaurants
- Human resources including payroll and outsourcing of labour
It is not possible for a large company to undertake phoenix activity because of ASX listing requirements, auditors, public investors and independent directorships so the prevalence of phoenix activity is limited to small-to-medium sized enterprises with closed shareholdings.
What legal actions can be taken to police phoenix activity?
There are legal avenues that can be followed against the directors of a phoenix company such as insolvent trading actions by liquidators. However, liquidators are under no obligation to take this action if they have no funds in their administration account.
The persons or bodies that can pursue directors who undertake phoenix activity include:
- Liquidators: Commencing claims for uncommercial transactions, insolvent trading and unreasonable director-related transactions against directors and their associates
- ASIC: Taking action against directors for breaches of duties and appointing their own liquidators
- ATO: Appointing liquidators and funding liquidators to take actions
- Prosecutors: Accepting prosecution briefs where there is an element of dishonesty and taking action in the criminal courts
The main complaint of creditors is that if the liquidator of the phoenix company has no funds, they do not undertake serious investigations and take action.
What has the Federal Government announced it would do to stop phoenix activity?
The Federal Government announced in August 2018 that they would get tough on phoenix activity (Announcement: Legislation to combat illegal phoenix activity). The
measures announced included:
- Create new phoenix offences to target those who engage in and facilitate illegal phoenix transactions;
- Prevent directors from backdating their resignations to avoid personal liability;
- Prevent sole directors from resigning and leaving a company as an empty corporate shell with no directors;
- Restrict the voting rights of related creditors of the phoenix company at meetings regarding the appointment or removal and replacement of a liquidator;
- Make directors personally liable for GST liabilities, as part of extended director penalty provisions;
- Extend the ATO’s existing power to retain refunds where there are outstanding tax lodgements.
The main criticism about these measures is that they do not address the issue of enforcement and the costs of enforcement. There are already significant powers that liquidators have (including clawing back phoenix transactions and claiming compensation from parties that benefit) that aren’t enforced.
After these measures were announced, the Minister retired and the legislation was put on the backburner because the May 2019 Federal election took priority.
For more information on the government and potential phoenix activity legislation, read our article on what phoenix reform would look like under a Labor government [hyperlink: https://sklawyers.com.au/phoenix-activity-reform-labor-government/].
What can creditors do to protect themselves?
Nonetheless, from a creditor’s point of view, it is better to take risk minimisation steps to avoid exposure to phoenix company activity rather than fund liquidator litigation or hope ASIC will put the company into liquidation and support action.
The key techniques for risk minimisation are:
Having credit limits on goods and services contracts;
Reviewing contracts and making sure they are up to date with the latest developments in the law;
Taking security and utilising the PPSR to become a secured creditor; and
Avoiding unethical businesses.
Further reading and information
The temptation to engage in phoenix activity is exacerbated in small-to-medium sized businesses and we have created materials to help other professional advisers steer clients away from phoenix activity and towards legitimate restructuring work.
You can watch, listen to or read the following to help develop a better knowledge about the area:
Read our whitepaper: What you need to know before you pre-pack (to avoid phoenix activity)
Watch our video: What is phoenix activity and how does the law (attempt to) regulate it?
Watch our video: Interview on the safe harbour from insolvent trading
Read our blog post: What are the success rates of voluntary administration?
Read our blog post: Insolvency lawyers: What do they do and how do you pick the right one?
Read our blog post: When shouldn’t you appoint a voluntary administrator?
Post updated 15 May 2019