Lost In Translation - First Judgment In Australia On Anti-Phoenixing Provisions, Creditor Defeating Transaction Set Aside

In the recent Victorian Supreme Court decision of Re Intellicomms Pty Ltd (in liq),¹ Associate Justice Gardiner delivered the first judgment in Australia dealing with the recently introduced anti-phoenixing provisions in sections 588FDB and 588FE(6B) of the Corporations Act 2001 (Cth) (the Act).

The case involved the sale of a commercial translating services business by Intellicomms Pty Ltd (In Liquidation) (Intellicomms) to an entity controlled by persons closely associated with Intellicomms immediately prior to Intellicomms being placed into voluntary liquidation.

Gardiner AsJ carefully considered the terms of sections 588FDB and 588FE(6B) before finding that the transaction was a voidable creditor defeating transaction.

Background

This case involved a claim by the liquidators of Intellicomms (Liquidators) to set aside a sale agreement dated 8 September 2021 between Intellicomms and a related entity, Technologie Fluentti Pty Ltd (TF) as a creditor defeating transaction within the meaning of s 588FE(6B) of the Act.²

Intellicomms operated a business providing commercial translating services to clients in Australia and New Zealand under the trading name “ezispeak”.  The sole director of Intellicomms was Ms Rebecca Haynes.  Intellicoms had 11 employees, which included four members of Ms Haynes’ family.  

The software used by Intellicomms was provided under licence by Callscan Australia Pty Ltd trading as QPC (QPC), which was also a minority shareholder in Intellicomms. 

QPC had been providing software under licence and related services to Intellicomms since May 2012, and by late 2020 Intellicomms had accrued a debt of around $750,000 to QPC.  QPC and Intellicomms then entered into negotiations regarding the potential capitalisation of QPC’s debt as well as a further potential capital raise by Intellicomms.

In February 2021, Intellicomms obtained a valuation from Rushmore Group which valued the company at approximately $11.3m as at 30 June 2020.  This valuation was provided to QPC as part of the negotiations.

However, the negotiations did not proceed smoothly.  QPC formed the view that Intellicomms had core problems with forecasting revenue and controlling overheads and expenses, which could only be solved by a change in management.

The negotiations subsequently broke down in July 2021.  Also in July 2021, Intellicomms obtained a new valuation report from FTI Consulting and provided updated cashflow projections to FTI for the purposes of the report.  That report valued Intellicomms at between $117,000 and $683,000.

Then, on 17 August 2021, QPC issued a statutory demand to Intellicomms for the outstanding debt which by that time had grown to $923,000.

This appears to have been the trigger for a number of events:

• on 30 August 2021, Intellicomms obtained yet another valuation report, this time from Nexus Business Consultants, which valued the goodwill in the business at $101,000 based on information provided by Intellicomms;
• on 25 August 2021, TF was incorporated with the sole director and shareholder of TF being Ms Michelle Gigliotti, a sister of Ms Haynes;
• on 8 September 2021, being the day before the final date for compliance with QPC’s statutory demand, Intellicomms obtained an updated report from Nexus Business Consultants, which valued the goodwill in the business at $57,000 based on updated information provided by Intellicomms;
• subsequently in the afternoon on 8 September 2021, Intellicomms entered into a sale agreement with TF for TF to purchase Intellicomms' business for $102,000, which purchase price could be adjusted to $58,000 if Intellicomms’ key contracts could not be novated to TF; and
• finally, in the afternoon on 8 September 2021, mere minutes after Intellicomms entered into the sale agreement with TF, Ms Hayes convened a meeting of Intellicomms at short notice and Intellicomms was placed into creditors’ voluntary liquidation. 

The Liquidators received a copy of the TF sale agreement two days after their appointment.  They subsequently formed the view that Intellicomms would likely only receive a net purchase price of $20,000 under the agreement due to the terms of the agreement, and that it was unlikely the sale agreement could be completed in any event.  The Liquidators also identified a number of other parties who were interested in acquiring the Intellicomms business.

The Liquidators then applied to have the TF sale agreement set aside as a creditor defeating transaction under sections 588FDB and 588FE(6B) of the Act.

The relevant law

Sections 588FDB and 588FE(6B) of the Act were recently introduced into the Act to prohibit phoenix activity and took effect from 18 February 2020. 

Phoenix activity is the stripping and transfer of assets from a company to another entity.  Such transactions are usually carried out by a company’s directors with the intention of defeating the interests of the company’s creditors in that company’s assets.  The new phoenixing offences prohibit creditor-defeating dispositions of company property and penalise those who engage in or facilitate such dispositions, and allow liquidators and ASIC to recover such property.  

Section 588FDB of the Act provides that a creditor defeating disposition is a disposition of company property for less that its market value (or the best price reasonably obtainable) that has the effect of preventing, hindering or significantly delaying the property becoming available to meet the demands of the company’s creditors in the winding up. 

The test for the purposes of section 588FDB is to be applied at the time of the relevant agreement for the disposition. 

‘Market value’ means the price that would be paid in a hypothetical transaction with a knowledgeable and willing, but not anxious, buyer who transact at arm’s length.  The alternative test of ‘best price reasonably obtainable’ recognises there will be legitimate situations where a company (in legitimate financial difficulty) may need to urgently realise assets (through a reasonable process) at less than market value.

A transaction is voidable under section 588FE(6B) of the Act if it is a creditor-defeating disposition made by a company at a time when the company is insolvent, or if as a result of the disposition, the company immediately becomes insolvent or enters external administration within the following 12 months.  

If a transaction is voidable under section 588FE(6B), the Court has jurisdiction under section 588FF to make one or more of the following orders:

• an order directing a person to pay the company an equal amount to some or all the money that the company has paid under the transaction;
• an order directing a person to transfer to the company property that the company has transferred under the transaction;
• an order requiring a person to pay to the company that amount, in the courts opinion, fairly represents some or all of the benefits that the person has received because of the transaction.  

The ultimate question for consideration in this matter was whether the liquidators had established that the amount payable under the sale agreement was less than the lesser of the market value and the best price reasonably obtainable for those assets within the meaning of s 588FDB, and if so, whether the relief sought should be granted.

Decision

There was no dispute that the sale agreement prevented the property of the company becoming available to creditors in the winding up and that it was entered into when Intellicomms was in insolvent.  Accordingly, the hearing largely dealt with the valuation evidence relied on by the parties.  

Gardiner AsJ rejected TF’s contention that in order for the sale agreement to be a creditor-defeating disposition, the liquidators must adduce sufficient evidence upon which the Court can determine an actual monetary value as to each of the market value of the assets and the best price reasonably obtainable for the assets, and that in each case those actual values must be higher than the consideration payable to Intellicomms by TF for the assets.  His Honour held that the liquidators are only required to establish that, on the balance of probabilities, the consideration payable under the sale agreement was less than both limbs contained in s 588FDB.

Gardiner AsJ found that:

• the sale agreement had all the features of a phoenix transaction (the effect was to strip Intellicomms of what assets it had to satisfy the claims of creditors and transfer them to a related entity);
• Ms Haynes had caused four valuations of Intellicomms to be obtained on the basis of “increasingly pessimistic” inputs she provided as to future trading revenue resulting in each successive valuation giving decreasing values for the company.  Moreover, Ms Haynes had varied the forecasted revenue inputs “at her whim” in an attempt to arrive as what she considered to be an acceptable valuation;
• there was no evidence that Ms Haynes sought offers to purchase from third parties, such as QPC which gave evidence at trial that it would have paid between $500,000 - $1,000,000 and funded the costs of sale;
• Ms Haynes caused the company to go into liquidation at its shareholders’ meeting that she convened without informing those who would be interested (such as QPC being a shareholder and a major creditor);

• the sale agreement had been “negotiated in secret” and entered into only minutes before the members’ meeting, a fact concealed from QPC which would have been prepared to pay considerably more than the consideration under the sale agreement;

• there was no legitimate urgency for Intellicomms to sell the assets without testing the market;
• Ms Haynes had planned the sequence of events carefully and there was no suggestion she had considered placing Intellicomms into voluntary administration to allow an orderly sale of the assets for the benefit of creditors (in lieu of proposing to members that it be placed in liquidation); and

• the transaction documented in the sale agreement had the effect of placing the company’s assets beyond the reach of its creditors. 

For these reasons, the Judge held that the sale agreement was a creditor-defeating disposition under section 588FDB and was therefore voidable under section 588FE(6)(B).

Lavan comment

This is a very important decision as it confirms the tests to be applied for identifying a creditor-defeating disposition under s 588FDB of the Act. 

In particular, the case confirms that under s 588FDB, liquidators do not need to prove the actual monetary market value of the assets or the best price reasonably obtainable for the assets.  Instead, liquidators are only required to establish that, on the balance of probabilities, the consideration paid (or payable) was less than the market value or the best price reasonably obtainable having regard to the circumstances existing at the time.

While this ultimately appears to have been a relatively obvious case of a creditor defeating disposition, it is likely that the anti-phoenixing provisions will be able to capture transactions where there is far less obvious evidence of the manipulation of an asset price and an intention to place assets beyond the reach of creditors.

If you have any questions about the operation of the anti-phoenixing provisions, the experienced Lavan team is here to help.