New laws to fight phoenix activity

In late 2017, the Australian Government confirmed its commitment to tackling illegal phoenixing, announcing a director identification number (DIN).

The Australian government's proposed director identification number is just one weapon in the war against company phoenixing.

By Michelle Lindsay

In December 2013, Australian designer jeans label Ksubi was placed into receivership after 13 years in business, putting around 60 employees out of work. While on the surface this was simply a story of a local brand failing to survive in a competitive market, the truth was murkier. Three years earlier, the Ksubi brand had been sold to clothing manufacturer Bleach Group after going into administration. Then, in August 2013, it was sold again – this time to a company called Mentmore.

Investigation by liquidators, assisted by the Assetless Administration Fund section of the Australian Securities and Investments Commission (ASIC), found that Mentmore director Mark Byers had been involved in four failed companies associated with the Ksubi brand – transferring the assets of the failed companies into a new company, while leaving the failed company with insufficient assets to pay its creditors.

As a result, Byers was banned for five years from managing a company – for failing to discharge his duties as a director and engaging in what is recognised as illegal phoenix activity. This was the maximum penalty ASIC could apply, effectively giving the director little more than a slap on the wrist.

Now, a big change is coming. In late 2017, the Australian Government confirmed its commitment to tackling illegal phoenixing, announcing a director identification number (DIN) as part of a package to make it easier to identify and prosecute the individuals involved.

Problems with the phoenix fight

Phoenixing is currently not defined in legislation, so while it usually incorporates various illegal activities, it’s not technically illegal on its own. However, the practice of stripping a failing company of its assets in an attempt to defeat creditors is a significant problem, which the government says costs the Australian economy up to A$3.2 billion each year.

One of the main obstacles to preventing and penalising phoenix activity is that, on the surface, it can look remarkably similar to a genuine business rescue. The activities involved in helping to save a failing company – halting trading, setting up a new company and selling off assets at a fair value – are perfectly legal and, with the right intentions, even desirable.

The University of Melbourne’s Professor Helen Anderson led a three-year research project into phoenixing in Australia, which released its final report in 2017. She explains, “One of the complexities is that you don’t want to deter a legitimate business rescue – but you want to catch people who are doing it for the wrong reasons.” 

Anderson says the fact that phoenixed businesses have little money left to pay the liquidator hampers proper investigation and prosecution, even when illegal activity is suspected to have taken place.

“It’s harder to get a card at a library than it is to be registered as a director at ASIC.” John Winter, ARITA

“There is often little money left to do the investigations, [and] the liquidator simply has the obligation to report, not to investigate beyond the available resources. So the liquidator does a minimal investigation, sufficient for the reporting obligation, and that’s the end of it.”

This leads to difficulty in enforcing laws that already exist, according to John Winter, chief executive of the Australian Restructuring Insolvency and Turnaround Association (ARITA).

“The problem isn’t a lack of law – it’s a lack of enforcement,” he says. “The lack of prosecution, and very low-level penalties, can lead business directors to make a value judgement that the cost of being found to have broken the rules is so low that they’d be mad not to phoenix the business. This is being picked up and used in a number of businesses, to the point that they’re factoring phoenixing in as part of their return on investment.”

Unblurring the line

Dr John Purcell FCPA, CPA Australia’s policy adviser – corporate regulation, says that with the new insolvent trading provisions in the Corporations Act, which took effect in January 2018, the line between business rescue and illegal phoenixing is becoming much clearer.

“The government has made reforms to the insolvent trading provisions to make pursuit of those strategies easier and more clear-cut for directors that can demonstrate they’re executing a turnaround strategy,” he says.

“What the law now does say quite clearly is that if [your action] is designed to defeat creditors, then you are operating outside of the law. If you are seeking to defeat creditors, that has nothing to do with seeking to turn the business around.

“Given the positive obligation to show pursuit of a turnaround strategy, if these reforms are effective no one should be confused as to what the distinction is.”

Tracking directors’ movements

Anderson says introducing the DIN is a key step in preventing and penalising illegal phoenix behaviour. Regulators will be able to identify individuals involved in failed companies, and flag higher-risk individuals and entities. (In 2009, research by Dun & Bradstreet revealed that a company is eight times more likely to fail if one of its directors has a court action against them.)

“One of the reasons that people get away with [illegal phoenix activity] is that when they set up company number 25, they list a slightly different name or fudge their bare facts. They don’t need to even to put their correct name,” she explains.

Winter agrees that a regime for identifying directors is well overdue. “The DIN is one of those things that is almost impossible to argue against, and it makes you wonder how we allowed this situation to evolve.

“It’s harder to get a card at a library than it is to be registered as a director at ASIC; there is no need to even show your licence. That means we don’t have a reliable list of what companies a director is involved in or has been involved in. That’s a loophole that desperately needs to be closed.”

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Australia’s Minister for Revenue and Financial Services, Kelly O’Dwyer, confirmed in September 2017 that the federal government would support the introduction of a DIN, although it’s not yet clear when it will happen, or which agency would be responsible for administering it.

A spokesperson for O’Dwyer said the government’s approach goes further than simply issuing a number and verifying director identity. 

“We will adopt a whole-of-government approach which will enable identification of directors and others, and increase regulators’ ability to track the relationships between them over time. This will be a far more effective tool than a simple identifier number in exposing, deterring and punishing those involved in illegal phoenixing activity.”

Making directors liable for unpaid GST

In addition to the DIN, the government’s Combatting Illegal Phoenixing consultation paper, released in September 2017, outlines a range of proposals designed to prevent, identify and penalise illegal phoenixing.

These are intended to work within existing legislation to make it harder for individual directors and pre-insolvency advisers to misuse the corporate form to the detriment of taxpayers, employees and creditors. 

One proposal that could reduce the financial appeal of phoenixing, as well as its impact on the Australian Taxation Office (ATO), is removing the ability for directors to take advantage of the GST (goods and services tax) rules.

Currently, it’s possible for companies to fall behind in paying GST by exploiting the lag in its collection and payment. Phoenix operators can claim GST input credits for their costs and expenses, and collect GST from customers, then liquidate the company and pocket the GST themselves.

To prevent this, the government is proposing to extend the director penalty notice (DPN) regime to make directors liable for unpaid GST – in the same way they are currently liable for pay-as-you-go (PAYG) tax and superannuation guarantee contributions (SGC).

This proposal has the potential to not only minimise losses to the taxpayer, but also remove the advantage that phoenix operators have over their law-abiding competitors. It’s a re-levelling of the playing field.

A cab-rank system for liquidators

One of the more controversial items in the federal government’s consultation paper is the proposal that liquidators would be appointed on a next-cab-off-the-rank basis, with the potential for funding to be provided for investigations of higher-risk entities.

The intention of the proposal is to thwart directors from selecting friendly liquidators, who may be inclined to turn a blind eye to untoward or illegal behaviour, or facilitate their clients’ interests to the detriment of creditors.

The Governance Institute of Australia’s national director, policy and advocacy, Catherine Maxwell FGIA, believes that this could be an effective solution.

“The next-cab-off-the-rank proposal could be effective in cases of lower or no-asset companies. It would prevent cherry-picking a liquidation firm that is known for liquidating certain types of situations,” she says. 

Maxwell also supports one of the paper’s other proposals – setting up a government liquidator that could conduct streamlined administration of small-to-medium businesses – similar to what is operating for personal insolvency.

“This could facilitate the winding up of businesses in a cost-effective manner. While there is not a lot of detail at this stage, we think in principle it’s a good idea.”

However, Winter believes that such a solution would undermine the reputation and professionalism of the majority of liquidators, who abide by clear and robust ethical standards, in line with the organisation’s code of conduct.

“There are about 706 registered liquidators in Australia, and ASIC receives substantial funds each year to review those people. If there’s a problem with how an individual liquidator is operating, ASIC should investigate,” he says.

“There can be good reasons for accountants to appoint a liquidator they know – for example, those who specialise in certain types of businesses, such as farming. In those cases, [a particular liquidator may be] in a better position to help trade the business through, and recover more for creditors.”

Despite this, he believes that the proposals are a step in the right direction.

“Liquidators are at the front line of identifying phoenixing and director offences, and offences are reported in vast numbers to ASIC every year. We’re all in favour of it being easier to prove [wrongdoing] when the evidence is there,” says Winter.

“It’s very hard to prove right now, but if the proposals make it easier it will be better for everyone, especially the creditors caught out in a phoenix situation.” 

What are the proposals? 

The Australian Government’s proposed anti-phoenixing actions include: 
  • Company directors must obtain a director identification number (DIN), using 100 points of identification
  • Creating specific phoenixing offences
  • Establishing a hotline to report illegal phoenix activity
  • Extending the penalties that apply to people promoting tax avoidance schemes, to capture advisers who assist phoenix operators
  • Giving the Australian Taxation Office (ATO) stronger powers to recover a security deposit from suspected phoenix operators to help cover their tax liabilities
  • Making directors liable for unpaid GST 
  • Preventing directors from backdating their resignations to avoid liability, leaving a company with no directors
  • Prohibiting related entities to the phoenix operator from appointing a liquidator
  • Identifying high-risk individuals who will be subject to new prevention tools, including a next-cab-off-the-rank system of appointing liquidators, and allowing the ATO to retain tax refunds and commence immediate recovery action following a director penalty notice.

Phoenixes and vultures

Australia’s regulators are looking into the activities of unqualified pre-insolvency advisers in promoting illegal phoenixing. A joint government Phoenix Taskforce has found these advisers deliberately target companies in difficulty. They then help directors to sell assets or restructure the business, and install dummy directors, before appointing friendly liquidators to wind up the business.

In these scenarios, it’s not only creditors and employees who have something to lose: hapless company directors may find themselves exposed to claims of breaches in their director’s duty – and worse.

For example, in 2017 a businessman appeared in the Melbourne Magistrates Court over almost A$100,000 in traffic fines incurred after he transferred 20 business vehicles registered in the name of his wife’s company to business adviser Philip Whiteman. Whiteman is accused by liquidators acting for the Australian Taxation Office of helping struggling companies avoid paying tax on more than A$20 million in income. 

The man said Whiteman advised him to hide the cars to avoid them being repossessed, then refused to return them. After hearing the evidence, the court waived the fines.

The anti-phoenixing proposals seek to address the role of unethical advisers by extending any phoenixing offences and remedies to include both those who engage in it, and those who facilitate it. 

In the meantime, business owners should take care to avoid dodgy operators, says John Winter, CEO of the Australian Restructuring Insolvency and Turnaround Association.

“If you’re at a point you can’t pay your bills, you need to meet with professional liquidators with appropriate qualifications. They can look at your business and advise whether you can turn it around, or whether you need to go down the insolvency path – and, importantly, the first meeting should be free.

“A dodgy adviser will say, ‘pay me A$10,000 and I can help save your house, and make sure the liquidators don’t get anything’. 

“Remember, at the end of the day, the buck stops with the director. You carry that responsibility and can be pursued for insolvency and other financial crimes.” 

Read next: New moves to stop illegal phoenix company activity


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