Changes to company laws have tightened the regulation of Australia’s company law landscape, targeting illegal phoenixing and extending director liabilities.
It’s estimated that the annual direct impact of phoenixing activity costs the Australian economy between $2.85 and $5.13 billion. Recently, the Commonwealth Government passed new laws (the Act) to assist in dealing with this issue. Most of the laws are now in force, but some of the taxation amendments will come into force on 1 April 2020.
How will illegal phoenixing laws apply to company activities?
Among other things, this reform aims to stop the disposition of a company’s assets to avoid the company’s obligations to its creditors – this activity is commonly known as illegal phoenixing. An example is when directors remove cash and assets from a company, which is then liquidated and restarted under a different name.
The Act targets company officers (including directors, shadow directors and de facto directors) as well as anyone else who procures, incites, induces or encourages a phoenixing transaction.
The Act has both civil and criminal consequences, and breach of certain provisions could result in a prison sentence of up to 10 years, fines of up to nearly a million dollars and or having to pay compensation.
How the concept of creditor-defeating disposition applies to illegal phoenixing
The new legislation introduces the term creditor-defeating disposition. This happens when:
- The company’s assets are sold for less than market value or for less than what would reasonably be considered to be the best possible price; and
- This prevents or delays the property from being used to pay off the company’s creditors.
A further extension of the concept could occur if a company does something that results in another person becoming the owner of property that did not previously exist.
This could occur when a construction company director uses the business’s resources to build a house for himself without payment.
A creditor-defeating disposition could also occur where, for example, a company sells a property for market value, but the selling company directs the buyer to pay the purchase price to a third party and it is not received by the seller.
What are the consequences of making a creditor-defeating disposition?
In some circumstances, a creditor-defeating disposition may be a voidable transaction, allowing a liquidator to claw back assets.
Where a person has received any money or property as a result of the disposition, the company’s liquidator (or ASIC of its own volition) can ask ASIC to order the receiving person to:
- Transfer the disposed property to the company;
- Pay the company an amount that, in ASIC’s opinion, fairly represents some or all of the benefits that person has received; and or
- Transfer to the company any property that, in ASIC’s opinion, fairly represents the application of the proceeds of the property that was the subject of the disposition.
There are strict time limits within which a liquidator can make such a request to ASIC.
These amendments represent an increase in ASIC’s quasi-judicial powers. ASIC’s power to issue orders is not unfettered. The Act imposes on ASIC a duty to have regard to various factors and restricts it from making an order where it has reason to believe that a Court would be prevented from making a corresponding order.
It is an offence to fail to comply with an ASIC order. This said, a person subject to such an order may apply to a Court to have the order set aside – although it must be noted that strict time limits apply to set aside the order.
Civil and criminal liability
Officers of a company and persons who engage in procuring, inciting, inducing or encouraging the making of a creditor-defeating disposition may be liable to civil and criminal sanctions. The ambit of the accessorial liability is wide and includes, but is not limited to, pre-insolvency advisors, accountants and other professionals.
Resigning directors: How are they accountable?
The Act has also amended the Corporations Act to prevent directors from backdating their resignations to avoid liability or from leaving a company without a director.
GST and director liability to meet GST obligations
The Act has also increased the liability of directors to personally meet company GST obligations. Directors can avoid liability by ensuring the company meets its obligations or promptly placing it in voluntary administration or liquidation.
Things to keep in mind
Where there’s a risk of insolvency, company directors (and their advisors) must seek urgent legal advice to reduce the risk of civil and or criminal penalties.
Since the Financial Services Royal Commission, ASIC has been more active in taking enforcement action. With its new powers to issue orders without starting Court proceedings, it can be expected that ASIC will be even more active in investigating companies and wrongdoers and taking action. This said, those subject to ASIC action should carefully scrutinise the lawfulness of its actions.
Companies should ensure that their directors are covered by a suitable directors’ and officers’ insurance policy, which includes, at least does not exclude, cover for shadow and de facto directors.
For more information about illegal phoenixing activity, insolvent trading or director liability, contact Trevor Withane: