Restrictions on Vote Stacking by Related Creditors – Reforms to the Insolvency Practice Rules

31 January 2019

As part of the Government’s commitment to implementing reforms to counter illegal phoenixing, amendments have recently been made to the Insolvency Practice Rules to restrict the ability of related creditors to vote assigned debts for their full value rather than the consideration paid only. The amendments were contained in the Insolvency Practice Rules (Corporations) Amendment (Restricting Related Creditor Voting Rights) Rules 2018 (Amending Rules) made on 5 December 2018.

The problem of illegal phoenixing has received substantial attention in recent times. The direct cost of illegal phoenix activity has been estimated in the range of $2.85 to $5.13 billion1 . In its simplest form, phoenixing refers to the process where the directors of a company deliberately avoid paying liabilities (such as tax and employee entitlements) by shutting down an indebted company and transferring its assets to another company (attempting to put those assets beyond the reach of creditors).

As is noted in the Explanatory Statement to the Amending Rules, phoenix operators may seek to appoint an external administrator who will collude with them to shift assets or refrain from conducting the required investigation into the company’s affairs. The Explanatory Statement also notes that one of the methods used by phoenix operators to increase their control of the outcomes of creditors meetings (and thereby facilitating phoenix activity) is to increase the value of related creditors’ voting rights and power. This is often done by a related creditor taking an assignment of a substantial debt but only paying nominal consideration for it and voting for the full value of the debt.

The purpose of the Amending Rules is to counter the ‘stacking’ of related creditor votes and therefore limiting the ability for phoenix operators to control the appointment and replacement of an external administrator of a company.

Under the Amending Rules, there are two principal amendments to the Insolvency Practice Rules:

  1. The insertion of 75-95(1A) providing a requirement for an external administrator to ask any creditor voting an assigned debt for evidence of the debt and the consideration for the assignment; and
  2. The insertion of 75-110(7) providing a regime by which the value of any related creditor vote of an assigned debt is to be calculated as the value of the consideration given for the assignment.

Accordingly, where the consideration given by a related creditor for the assigned debt is less than the value of the debt, the value of the vote will be limited to the consideration given and not the full value of the debt.

The amendments applied from 7 December 2018. The amendments impose positive obligations on external administrators receiving proofs of assigned debts in respect of both the calling for appropriate evidence of assigned debts and calculating the value of assigned debts for voting purposes.

If you have any questions in respect of these reforms or anti-phoenixing more generally, please contact one of our team.

This article was written by Neil Perl, Senior Associate in our Melbourne office

Publication Editor: Grant Whatley 

The Economic Impacts of Potential Illegal Phoenix Activity, PWC and Fair Work Ombudsman, p9, July 2018

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