Combatting illegal phoenixing activity

Combatting illegal phoenixing activity

Illegal phoenix activity has been the subject of extensive government and industry activity and investigation. The most recent and potentially significant measure is in the introduction of the Treasury Laws Amendment (Combatting Illegal Phoenixing) Bill 2019 (Cth) (Bill).

Illegal phoenixing activity encompasses a broad range of activities by which directors (and their advisers) seek to avoid paying a company’s creditors. Typically, it is by transferring the assets to a different entity and shortly thereafter appointing an external administrator, leaving no assets for the affected creditors (often the ATO).

The current law does not expressly regulate illegal phoenixing activity, and does not contain any definition of illegal phoenixing. Rather, illegal phoenixing activity is primarily limited by the operation of the general duties of directors, and the various voidable transaction provisions which operate in the context of a liquidation.

Creditor-defeating dispositions

The Bill will provide for a powerful mechanism to deal with illegal phoenixing by the introduction of creditor-defeating dispositions¹ as a new category of voidable transaction.

Under proposed s588FDB(1), a creditor-defeating disposition means a disposition which has the effect of:

• Preventing the property from becoming available for the benefit of the company’s creditors in the winding-up of the company; or
• Hindering, or significantly delaying, the process of making the property available for the benefit of the company’s creditors in the winding-up of the company.

The amendments introduce new offences for:

• Company officers who fail to prevent the company from making creditor-defeating dispositions; and
• Other persons who facilitate a company making a creditor-defeating disposition.

There are various concepts or features which are relevant to the operation and impact of the new provisions. They include:

• The primary focus of the provision is on the effect of the transaction, not on any relevant intention;
• It extends to any transaction entered into in the twelve months immediately prior to an external administration. Significantly, liquidators need not prove that the company was insolvent at the time;
• There are various exceptions, most significantly for market value or where safe harbour applies;
• ASIC has significant power including to make administrative orders to recover property (for example if a liquidator is not fulfilling his or her obligations to recover property); and
• Liability extends to a person who engages in “procuring, inciting, inducing or encouraging” the disposition.

Market value

The most significant exceptions are transfers for market value and transfers in connection with “a course of action that satisfies” the safe harbour provisions.

Market value means the price that would be paid in a hypothetical transaction between a knowledgeable and willing, but not anxious, seller, to a knowledgeable and willing, but not anxious, buyer, who transacts at arm’s length.² This definition is familiar and consistent with accepted common law principles.³ 

The market value is to be assessed both at the time of entering into the agreement for disposition, and when the property is transferred. The test must be satisfied on at least one of these occasions.

Good faith defence

The good faith defence has only limited application. It cannot be relied upon by the “initial recipient” of the disposition. That is because the provision’s focus is on the effect of the transaction, not the relevant intentions.

The defence can, however, be relied upon by a subsequent purchaser.

ASIC enforcement of creditor-defeating disposition provisions

ASIC has wide-ranging powers to enforce the creditor-defeating disposition provisions. This includes to issue an administrative order to recover property the subject of voidable dispositions. A recipient of an administrative order may apply, within 60 days, to the court, for an order setting aside the administrative order.

Failure to comply with an administrative order is an offence subject to a penalty of up to 30 penalty units or imprisonment for six months, or both.

Penalties

Penalties for a contravention of the new provisions are up to 4,500 penalty units, or up to 10 years imprisonment, or both for individuals and up to 4,500 penalty units, or 10% of annual turnover, for corporations.

Corporations can also be vicariously liable for the conduct of employees in circumstances where:

• The Board, or a “high managerial agent” knowingly or recklessly carried out the conduct or authorised or permitted it; or
• A corporate culture existed within the Body Corporate that directed, encouraged, tolerated or led to non-compliance.

Accordingly, a corporation will not be liable for the conduct of a rogue employee.

Facilitators

Liability extends to a person who engages in “procuring, inciting, inducing or encouraging” the disposition.

Status of the Bill

The Bill passed through the House of Representatives on 13 February 2019.

The House of Representatives referred the Bill to the Senate Economics Legislation Committee (“Committee”) on 14 February 2019. The Committee produced a report on 26 March 2019 which is generally in support of the Bill, although the Bill’s progress has been effectively delayed until the new Parliament sits.

This article was written by David O’Farrell, Partner and Abigail Hill, Law Graduate.

Publication Editor: Grant Whatley

¹The expanded definition of creditor-defeating disposition is contained in proposed s588 FDB of the Act.
²S588 FG(9), exposure draft.
³Spencer v Commonwealth of Australia [1907] HCA 82.