Regulators disrupt phoenix companies’ flight plans

In recent years, regulators, legislators and law enforcement agencies have joined forces to make it more difficult for phoenixing to occur, and they are claiming some success.

New reforms, enhanced data analysis and co-operation between agencies are set to clamp down on directors trying to re-birth phoenix companies and clip the wings of unscrupulous pre-insolvency advisers.

The Australian economy loses about A$3.2 billion a year through illegal phoenixing activity, and much of this is facilitated by unscrupulous pre-insolvency advisers.

In many cases, these advisers hold no professional qualifications and their only expertise is that they have operated their own failed companies, joining the 9000 or so which go to the wall each year in Australia.

These advisers assist businesses faced with significant unpaid taxes, employee liabilities and debts to exploit loopholes in laws and regulations and enable them to rebirth their companies as new, shedding their liabilities and starting over again, rising from the ashes like the mythical phoenix.

Struggling companies prime phoenix targets

A typical scenario is this: an adviser approaches a company it knows is struggling and has received a wind-up notification from the Australian Taxation Office (ATO), and for an agreed payment promises to make the problem “go away”.

As John Winter, chief executive of the Australian Restructuring Insolvency and Turnaround Association (ARITA) puts it, “some people just look at this as the cost of doing business.”

A 2017 survey of ARITA’s 700 members, all registered liquidators, gives some idea as to the size of the problem.

Asked if they had seen the influence of pre-insolvency advisers in cases they had worked on, 40 per cent said they had observed this in more than 10 per cent of cases.

Among law firms the figure was even higher, with 83 per cent saying that more than 10 per cent of their cases showed evidence of pre-insolvency advice.

Regulators join forces on pre-insolvency advisers

In recent years, regulators, legislators and law enforcement agencies have joined forces to make it more difficult for phoenixing to occur, and they are claiming some success.

In the last five years the Australian Securities and Investment Commission (ASIC) claims 60 enforcement outcomes in cases concerning registered liquidators, compared with 12 in the previous five years.

While most of these outcomes have involved directors, action has also been taken against advisers and liquidators.

Queensland-based adviser Stephen Charles Hall was fined A$6600 and disqualified from managing a corporation for five-years in 2016 for “dishonestly aiding, abetting, counselling or procuring another director to breach their director duties”.

In a typical tactic, Hall cold-called the company director who had received a wind-up notice from the ATO.

New Safe Harbour legislation

On the legislative front, new Safe Harbour legislation takes effect on July 1 2018.

A key intention of the legislation is to help foster a culture of innovation and entrepreneurship by creating a soft landing for companies which fail and might be restructured, by limiting directors’ personal liability for insolvent trading. 

The hope is also that some of the directors who may previously have engaged unscrupulous pre-insolvency advisers might enter the Safe Harbour instead and try to turn the company around or, if this cannot be achieved, ensure employee entitlements and tax obligations are met.

The bigger changes, however, are yet to come in the form of more regulatory and legal reform to combat illegal phoenixing.

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A new Director Identification Number

ASIC, the ATO, the Fair Work Ombudsman and Victoria Police are among 20 government agencies which are part of the Phoenix Taskforce.  Their work data matching to identify and monitor suspicious activity has supported recent enforcement outcomes.

The Taskforce’s recommendations also led to Revenue and Financial Services minister Kelly O’Dwyer announcing reforms in September 2017, such as introduction of a Director Information Number (DIN), through which regulators will be able to spot suspicious director behaviour.

The DIN will go beyond the current 100 point identity test and into the area of digital identity, including biometrics.

Other proposed measures include a specific offence for phoenixing, the creation of a dedicated phoenix reporting hotline, and rules to prevent directors from backdating resignations to avoid personal liability.

A cab rank for liquidators

A more contentious proposal is to create a “cab rank” system to appoint liquidators to work on cases where high-risk individuals have been identified.

ASIC insolvency expert Adrian Brown says this measure is intended to break the “sometimes collusive relationship between some directors, untrustworthy advisers and liquidators.

“It’s a push back against that sharp practice where they collude and a friendly liquidator then facilitates the interests of people other than the creditors,” says Brown, who joined ASIC in 2011 as senior executive leader of the insolvency practitioner team after two decades as an insolvency practitioner. He now works in a part-time role with the regulator focusing largely on illegal phoenix activity.

“This can also deal with other illegal activities which come from the wilful blindness of some liquidators, such as money laundering.”

Should phoenixing be an offence?

At ARITA, Winter is a supporter of the DIN but is wary of other measures, such as the specific phoenixing offence, because “we believe there are already sufficient tools in the regulatory toolbox”.

ARITA is particularly at odds with the cab rank system, which he says ignores the fact that many liquidators have built up expertise in particular industries which can be used to benefit any outcome.

“This is a bizarre situation, because liquidators are one of the most highly qualified professions in the country,” says Winter.

“To then suggest that they de-professionalise a profession where their service is made vanilla is completely at odds with the definition of a profession.”

The cornerstone of the changes, however, is a focus on directors, and ARITA agrees with this.

“If directors know they can’t get away with it then they are less likely to accept the overtures of dodgy advice practitioners,” he says.

Pre-insolvency advisers will not be regulated because so many are unqualified and would never operate inside the system. Rather, the approach is to disrupt the illegal phoenix pathway.

ARITA offers a post-graduate qualification in turnaround and insolvency, currently held by about 2500 accounting, financial planning and legal professionals. This looks to the reform measures and the Safe Harbour legislation as a way of encouraging directors to engage this group, rather than take the cold call from an insolvency cowboy.

Message for accountants on insolvency

Brown represents ASIC on the Phoenix Taskforce which made the reform recommendations to the government, but says that ultimately this is also a cultural issue.

“It is a disgrace that some accountants, advisors and liquidators see fit to conduct this illegal activity and are seriously disengaged with what the law requires of them,” he says.

“There are some who simply don’t want to work within the rules. They want to take funds which don’t belong to them, funds which should to go creditors including the Commonwealth for the benefit of all Australians.”

Read next: New laws to fight phoenix activity

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