Phoenix companies arise from the ashes of collapses that leave creditors, customers and tax authorities owed money, but new moves to stop the serial offenders are being planned.
Each year in Australia, around 9000 companies go to the wall. In many cases, these are legitimate failures by honest people who then, in good conscience, apply those learnings to their next venture in the hope of making it a success.
In some cases, however, the story is not about redemption and renewal. These failures are less well intentioned, with company directors deliberately liquidating the company to avoid paying debts, leaving behind a trail of creditors, and transferring the business to a new entity known as a “phoenix” company.
Regulators have increased their focus on phoenix activity because of the huge financial losses in its wake, and the Regulating Fraudulent Phoenix Activity project funded by an Australian Research Council Discovery Grant recommends a multi-faceted counterattack.
The research team was led by University of Melbourne Law School professor Helen Anderson, who will tell the CPA Australia Public Practice Conference in May how public practitioners face greater regulator scrutiny because of phoenix activity.
Who are the victims of phoenix activity?
Anderson looked at the strategies used by some directors to rebirth their business activities and avoid creditors and tax liabilities.
She says the aim was not to understand the prevalence of phoenix activity, but to recommend any regulatory or policy changes that could minimise the practice. As Anderson says, it’s not clear if this is a “A$100 million or A$1 billion” problem.
What she does know is that since her study started she has been flooded with calls from victims of phoenix scenarios, who have googled “phoenix companies” and seen her name associated with the study. Typically these people are creditors who have seen directors move from one company structure to another to avoid their liabilities.
“These are all victim calls, and I get about one a week,” says Anderson.
“They are often people whose own businesses have collapsed because they haven’t been paid by these people. They are angry because they have done the right thing, and they see the person who didn’t pay them still in their nice house, thriving and often still running a business, often from the same premises but with a new business name.”
Types of phoenix activity in Australia
Anderson and her team identified five types of phoenix business activity in Australia, three of which are illegal.
The first – legal – type of phoenix is often termed “business rescue.” This is when a company is in financial trouble and is placed in liquidation or administration, and the same controllers transfer the assets to a new entity and carry on the business. In this type there is no intention to defraud creditors, including employees, and the action is taken to save the business, and not the company.
The second legal phoenix is called “problematic” because it is technically legal but involves the repeated resurrection of the business by inept entrepreneurs at the expense of creditors.
The difference between the business rescue and problematic phoenix example is that in the problematic case the impetus for liquidating the company could be for the director to avoid liability for a breach of duty, and while there may no intention to avoid the debts of the old company, in practice many creditors and employees are hurt in the process.
In the third illegal example, a person sets up a business intending it to be a success but is persuaded by an adviser – usually an accountant or lawyer – that they can purchase the company assets for an undervalue by a new company. This is illegal because the directors have breached their duty to the failed company.
In this example the business is founded and operated legally and then runs into financial difficulties. As a solution to this the business owner then forms a second, new company which purchases the assets of the original company at below fair value. This is illegal because the owner, as a director, has breached a duty of care.
A fourth example is an escalation of the above, but a major difference is that the business person deliberately sets up the company to fail, and uses the failure as a way of avoiding tax liabilities and employee wages and entitlements.
The fifth example is the most extreme, involving illegal activity such as GST fraud, the misuse of migrant labour, and underpayments.
“This is complex and illegal,” says Anderson. “Just about every rort in the book is being employed.”
While difficult to quantify the incidence of each type of phoenix, a 2015 submission from the Australian Taxation Office to the Senate Standing Committee on Economics Inquiry into Insolvency in the Australian Construction Industry sheds some light on the extent of the problem.
The ATO reported it had identified 3355 people who controlled over 13,000 companies with a history of insolvency in the construction industry. This group had more than A$2 billion in debt written off and claimed A$1.3 billion in GST credits in the four years from 2010.
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Getting away with phoenix activity
While all three types involve some form of illegal activity, they are hard to detect and prosecute. The wrongdoers rely on their ability to hide behind what Anderson calls the “corporate veil” and bank on law enforcement and regulators lacking the resources to uncover what they have done.
In many cases, the businessperson has been led into one of these illegal phoenix activities by an adviser, and the current focus of the Australian Securities and Investments Commission (ASIC) and the Australian Taxation Office (ATO) is on the so-called pre-insolvency adviser or business restructuring experts.
In early April 2017, 80 officers from the ATO conducted raids on two Melbourne premises as part of the pressure being applied to the pre-insolvency industry. The ATO is taking the issue seriously enough to have created a special investigative Phoenix Taskforce.
With their promises to, as Anderson describes, “wave a wand and make business problems go away,” some unscrupulous pre-insolvency practitioners are leading otherwise honest businesspeople down an unethical path.
Regulators’ current fixation on the advisers, she says, is only one part of the issue. Instead of recommending a raft of legal fixes to the phoenix problem, Anderson and her team’s recommendations are taking a “lateral approach which is not front on, but through multiple mechanisms.”
How to stop phoenix activity
One of the major recommendations is to have a director identity number which will follow a person through all their corporate incarnations.
Currently, directors are able to move from one company to another under a cloak of virtual invisibility. No one, not even the regulator, can know if someone is a serial user of phoenix entities.
“We feel that if we shine a light so that when someone creates company number 10 they know that ASIC will realise what they are doing,” says Anderson.
“If ASIC knows this, then they can let others know they have this person and this company under surveillance, and that may cause some change in their behaviour.
“At the moment you can literally have 50 companies with no additional paperwork, so we feel that better detection and information sharing can have a major impact.”
Liquidators’ reports need to improve
Anderson is also calling for changes to liquidators’ reports, which she says are “greatly deficient”.
They give no scope for qualitative comment on whether phoenix activity is suspected, and do not ask if there has been a contribution from a pre-insolvency adviser.
While ASIC is right to have its suspicions about some of these advisers, Anderson says the majority of them are honest and professional but are being alienated by the regulator’s attitude.
“The tension between ASIC and the liquidators needs to be resolved, in my view,” she says.
“We feel there needs to be an attitude change between ASIC and the liquidators so that they are treated as allies, not purely as a regulated population who might be suspected of colluding with a few directors.”
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