Creditor defeating dispositions and phoenixing – further provisions rise from the ashes!

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The Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2019 (Cth) (Amending Act) which came into operation on 18 February 2020 has introduced provisions prohibiting “creditor-defeating dispositions” (CDD) of company property under certain circumstances. A CDD will have a meaning given to it by s 588FDB of the Corporations Act 2001 (Cth). The amendments operate to penalise individuals making or facilitating CDD’s and further allows both liquidators and the Australian Securities Investment Commission (ASIC) to recover property of the company disposed in this fraudulent way for the benefit of its creditors, including employees and relevant revenue authorities who lose out on tax revenue and superannuation guarantee charges.  In this article, we summarise a number of the key changes proposed in the Amending Act which relate to CDD’s.

What is illegal phoenixing?

Illegal phoenix activity is infamously difficult to define, although it usually occurs when individuals controlling a failed company (the failed co) strip and transfer the failed company’s assets to a new company (the new co). In this way, the new co ‘rises from the ashes’ with the benefits attained by the failed co, but without its responsibilities to creditors. The failed co may then be wound up or de-registered. This activity refuses creditors of the failed co, including employees, access to the transferred assets in order to satisfy debts owed to them. In the case of employees this may involve loss of accrued sick leave and other related employee entitlements. As such, ASIC describe this activity as illegal, whereas the Australian Tax Office (ATO) depicts it as fraudulent. Illegal phoenix activity has been troubling in Australia and the Fair Work Ombudsman has estimated that the total cost to the Australian economy resulting from such activities is somewhere between $1.8 billion and $3.2 billion annually. Illegal phoenix activity can be distinguished from legal phoenixing. Legal phoenix activity involves individuals in control of the failed co conducting themselves to genuinely rescue the failed co. This would occur by way of the new co paying fair consideration for the transfer of the assets from the failed co.

The New Regime

The central question according to the new insertions will be whether the disposition of property constitutes a CDD or not. The new regime will operate to:

  • Introduce new civil and criminal penalties in connection with conduct which results in the making of a CDD;

  • Allow liquidator’s to clawback dispositions of a company where they meet the requisite elements of a CDD;

  • Give ASIC the power to make orders to recover dispositions meeting the requisite elements of a CDD; and

  • Allow liquidators to seek compensation from those responsible for having made a CDD.

Transactions amounting to a CDD

Under the Amending Act (new section 588FDB of the Corporations Act), a CDD will be a disposition of property owned by the company where:

  • the consideration payable to the company for the disposition was less than the lesser of the following:

    • the market value of the property

    • the best price that was reasonably obtainable for the property (having regard to the surrounding circumstances at the time); and

  • the disposition has the effect of:

    • preventing the property from becoming available for the benefit of that company’s creditors; or

    • hindering or significantly delaying the process of making the property available for their benefit.

For the purposes of s 588FDB(2), if a company does something that results in another person becoming the owner of property that did not previously exist, the company has in fact made a disposition of the property. Further, if a company makes a disposition of property to another and that other person gives some or all of the consideration for the disposition to a third party other than the company, the company has in fact made a disposition of the property to the extent of the consideration provided.[1]

Important exceptions

Regardless of whether the disposition is a CDD, courts will not be able to make orders prejudicing the rights or interests of individuals if it is proven that persons later acquiring the property did so in ‘good faith’. In other words, the purchaser entered into the transaction to purchase property of the company for value (generally monetary) and without knowledge of any adverse claims against the property, equitable interests (for example, on the part of the employees) or that the disposition would constitute a CDD pursuant to the Amending Act.  For more information about good faith in insolvency read our article here.[2]

ASIC Orders and Recourse for Liquidators

Liquidators may be able to void CDD’s that have occurred if they were entered, or some part of it was done, within approximately 12 months before the company becomes insolvent or is the subject of external administration.[3] The power to void this type of transaction sits in conjunction with the existing voidable transactions that liquidators can “claw back”, as set out in existing part 5.7B of the Corporations Act 2001 (Cth).

ASIC has now gained the additional power of, at its discretion, making orders directing a person or company to transfer back to the company the asset previously disposed of or an amount that fairly represents the benefit that the person or company has received.[4] ASIC may undertake to make the order on its own initiative or at the request of liquidators of the company.[5] However, this request is time sensitive and may only be made 3 years after the relation-back day[6] and 12 months after the initial appointment of a liquidator.[7] Acting in contravention of the ASIC order would amount to an offence pursuant to Schedule 3 of the Corporations Act 2001 (Cth).[8]

Importantly, courts may set aside an order made by ASIC if they find that s 588FGAA did not apply.[9]

Offences Created

The Amending Act makes it an offence for both individuals and company officers to engage in conduct which results in the making, procuring, inciting, inducing or encouraging of a company to make a CDD where:

·         the company is insolvent or becomes insolvent as a result of the disposition being made; or

·         the company goes into external administration or ceases to carry on business within 12 months of the disposition being made as a direct result of its making.[10]

Liability pursuant to these offences applies to individuals and company officers[11] just as equally as to directors of the company. This means that employees other than directors who make decisions which affect the whole or a substantial part of the company must take note. Common examples include Chief Executive Officer (CEO), Vice President, Secretary, Chief Financial Officer (CFO) or Chief Operating Officer (COO).

Both ss 588GAB and 588GAC have corresponding exceptions available in subsection (3) of the amendments which operate to respect and exclude legitimate dispositions, provided they are:

  • made pursuant to court-approved arrangement; or

  • under a deed of company arrangement; or

  • by the company’s liquidator; or

  • by a provisional liquidator of the company; or

  • where safe harbour exceptions or market value transfers apply.

Key Takeaways

Further amendments set out in the Amending Act have potentially serious consequences on directors with respect to, among other things, the timing and authenticity of their resignations from the failing company and with respect to the company’s GST liability.

The new enactments operate to pursue illegal phoenix activity with an even greater veracity than before. It is therefore imperative that company directors, company officers and employees who play a substantial role in the financial management and organisation of the company be acquainted with the new amendments.

An overarching theme of the new regime is that in determining what a CDD is, it is focused to a degree on the resulting effect of the disposition rather than any requisite intention on the part of the individual or company officer.

Additionally, because the provisions extend to dispositions made in the 12 months prior to external administration of the company, liquidators will not be required to prove that the company was insolvent at the time of making the disposition. We would suggest to all directors that if they are in doubt as to whether an intended transaction they wish to effectuate could potentially constitute a CDD in contravention of the new provision introduced by the Amending Act, that those directors first speak to us so that they can subsequently make an informed decision in relation to whether to proceed with the contemplated transaction.

[1] s 588FDB (3) Corporations Act 2001 (Cth).

[2] https://www.emslegal.com.au/publications/2019/7/02/good-faith-in-insolvency-revisted

[3] ss 588FE (6B) and 588FDB of the Corporations Act 2001 (Cth).

[4] s 588FGAA Corporations Act 2001 (Cth).

[5] s 588FGAA (2) Corporations Act 2001 (Cth).

[6] see s 91 of the Corporations Act which sets out the meaning of “relation-back day” in connection with the winding up of a company.

[7] s 588FGAA (2) Corporations Act 2001 (Cth).

[8] see s 1311(1) Corporations Act 2001 (Cth).

[9] s 588FGAE (3) Corporations Act 2001 (Cth).

[10] see ss 588GAB and 588GAC Corporations Act 2001 (Cth).

[11] see defined term in s 9 of the Corporations Act 2001 (Cth).