Illegal phoenixing becomes a voidable transaction

On 18 February 2020, the first tranche of the Commonwealth’s illegal phoenixing legislation came into effect in an effort to address avoidance of certain creditor payments.¹

For liquidators, this makes available a new voidable transaction claim, and the possibility of recovering funds for the benefit of creditors, if a company is found to have engaged in a creditor-defeating disposition.

As is well known, ‘illegal phoenixing’ arises when the assets of a company are transferred to a related company in an attempt to avoid payment of the vendor seller's debts.  Commonly, the seller is wound-up and its former business operations resumed through the buyer company.  Frequently, the seller is left with insufficient resources to sustain any proceedings against its former office holders for breach of duty.

Immediate changes

A number of significant amendments are made by these anti-phoenixing reforms to Part 5.7B of the Corporations Act² aimed both at:

• deterring transactions which have the consequence of impeding creditors’ access to company assets, so-called “creditor-defeating transactions”; and
• providing a mechanism through which liquidators may seek to unwind such transactions.

The amendments include the introduction of provisions which:

• impose criminal and civil penalties for company office holders who fail to prevent the company from making creditor-defeating dispositions;
• impose criminal and civil penalties for other persons (including, for example, insolvency practitioners) who facilitate a company making a creditor-defeating disposition;
• allow liquidators to apply to the court in relation to voidable creditor-defeating transactions;
• allow ASIC to make orders to recover, for the benefit of a company’s creditors, company property disposed of under a voidable creditor-defeating disposition; and
• prevent directors from improperly back-dating resignations and from ceasing to be a director in circumstances where they are the sole remaining director.

The amendments also extend the presumptions as to insolvency in section 588 E³ to creditor-defeating dispositions, meaning a company will be presumed insolvent for the 12 month period ending on the relation back date if proved to be insolvent within that time or if it kept inadequate financial records.

Under the new regime, a disposition of property by a company will be a creditor-defeating disposition if:

• the consideration received by the company, in exchange for the property, is less than the lesser of the market value of the property and the best price that was reasonably obtainable for the property; and
• the disposition had the effect of preventing the property from becoming available for the benefit of creditors, or of hindering the process of making the property available for the benefit of creditors.⁴

It is important to note that in circumstances where a company fails to maintain adequate financial records, a disposition of property by the company will be presumed to be a disposition for consideration that is less than the lesser of the market value of the property and the best price that was reasonably obtainable for the property.⁵

Upcoming changes

Schedules 3 and 4 of the new legislation⁶ are presently due to come into effect on 1 April 2020 and will make a number of amendments to the Goods and Services Act⁷ and the Tax Administration Act.⁸ The Schedule 3 and 4 amendments will have the effect of enabling the Commissioner of Taxation to: 

• collect estimated future GST liabilities;

• in limited circumstances, impose personal liability on directors for the GST liabilities of their company; and
• retain tax refunds in circumstances where a taxpayer has failed to lodge a tax return or to provide other information that may affect the amount of any tax refund. 

Lavan comment

Illegal phoenixing activity is said to be both costly and destructive and its effects can be far-reaching.  For these reasons, it is broadly accepted that legislative reform aimed at discouraging illegal phoenixing activity was well-overdue.  Some aspects of the new legislation have been the subject of criticism, particularly to the extent they may inadvertently frustrate legitimate business and commercial transactions.  There are genuine concerns about the ambit of transactions that may be captured as voidable creditor-defeating dispositions.
 
A mandated independent 5 year review of Schedules 1,3 and 4⁹ is provided for, to consider any potential unintended consequences of the new legislation. It is clear that, for the moment, the desire to curb illegal phoenixing activity has eclipsed any such concerns.
 
Whether these new measures will have the consequence of stifling bona fide corporate restructures remains to be seen.  However, in circumstances where criminal and civil penalties may now be imposed against persons involved in the facilitation creditor-defeating dispositions, this provides grounds both for caution to company officers proposing transactions which are not clearly at market value or the best price reasonably obtainable and cause for review by liquidators in any appointments.