What is Phoenix Activity?

Definition  
The term ‘Phoenix’ refers to the mythical creature which, upon its death, is reborn from the ashes of its predecessor.  By analogy, this describes a new business becoming ‘reborn’ out of the ‘ashes’ of a defunct business. This can involve a number of different practices, but essentially sees a director cycle productive business assets through a series of companies in a deliberate effort to avoid liabilities including tax, or trade creditors

It is worth noting however, that whilst there is a common understanding of this general analogy, there are no express definitions found in any Australian laws.

The Australian Securities and Investment Commission (‘ASIC’) describes phoenix activity as conduct that meets the following criteria:

Where an entity:

• Fails and is unable to pay its debts;
• Acts in a manner which intentionally denies unsecured creditors equal access to the entity’s  assets in order to meet unpaid debts; and
• Within 12 months another business commences which may use some or all of the assets of the former business and is controlled by parties related to either the management or directors of the previous entity.

Regulation
The Corporations Amendment (Phoenixing and Other Measures) Act 2012 was recently enacted.  The Amendment provides ASIC with increased power to wind up companies suspected to be engaged in phoenix activity.

ASIC issued a press release in September 2013 announcing it was stepping up surveillance of illegal phoenix activity.  The release states (amongst other things):

‘Illegal phoenix activity has far reaching and unfair consequences’.

‘As part of the surveillance program, ASIC will focus on the building and construction, labour hire, transport, and security and cleaning industries.’

‘We are looking at failed companies, mostly within the small business sector, from July 2011 onwards where there have been allegations of illegal phoenixing ,’ said ASIC commissioner Greg Tanzer.’

To read the full ASIC press release, please click here.

Risk
The real risk associated with phoenixing for directors lies in the transfer of assets from a “dead” company to the company that is “reborn”.  The issue here surrounds the consideration that follows the transfer more so than the transfer itself.  The targeted phoenixing that may result in serious penalties being imposed on an individual has usually involved the undervaluation of the former company’s assets.

This risk is particularly high when a company is undergoing a restructure or pre-packing.  Pre-packing is essentially when the core business assets are sold for fair market value to a new company, often a related entity.

It is imperative for any business considering a pre-packaged insolvency arrangement to take particular care and obtain advice from a lawyer.

Penalties and Liability
Should a director become involved in unlawful phoenixing activity, the individual is likely to breach a number of director’s duties under the Corporations Act 2001 (the ‘Act’) and general law.

The remedies that can be claimed against the director are varied and include:

• Damages
• Compensation
• An account for profits
• A constructive trust whereby the director holds the benefit of the phoenixing activity on behalf of creditors of the old company.

Directors can also be personally liable for the breaches of the civil penalty provisions under the Act wherein the Court can Order a penalty up to $200,000 per infringement.

Additionally, if the breach is reckless or dishonest, criminal liability can be imposed upon which further fines can be ordered, even imprisonment.

Furthermore, a director can be disqualified from managing a company for a period of up to ten (10) years.