Bulaw5915 Corporate Law Illegal Phoenix Assessment Answers

The Taskforce forms part of the Fraud and Anti-Corruption Centre, which is led by the AFP. Offences targeted by the Taskforce relate to serious fraud, money laundering and defrauding the Commonwealth. Current priorities include: criminality related to international tax evasion, fraudulent phoenix activity, trusts and superannuation.

Part A

Research the topic of phoenix activity and respond to the following questions:

1. What is meant by the term ‘phoenix activity’?
2. Can phoenix activity be beneficial to society? If so, how?
3. What purpose is behind phoenix activity? Can there be more than one purpose?
4. Who benefits from phoenix activity and who loses? Give reasons.
5. Is there a section of the Corporations Act 2001 (Cth) that specifically prohibits phoenix activity? If so, which section?
6. Are there sections of the Corporations Act 2001 which may be breached by phoenix activity? If so, identify at least two sections.
7. Identify (and correctly cite) at least one case in which phoenix activity was considered. What were the main issues and what was the decision?

8. Do you think prohibiting phoenix activity by creating a phoenix offence, or a phoenix prohibition is likely to be successful? Why, or why not?
9. How could an offence or prohibition be structured?

Part A

Answer 1: concept related to phoenix activity is usually reflected with the idea of a second company, in which it is newly incorporated. This new company is generated from the ashes of its failed predecessor in which both controllers and business of the second company are same.

In other words, phoenix activity means incorporating a new company for the purpose of takeover the insolvent business of a predecessor company. The legal concept of phoenix activity is the genuine failure and liquidation of the company. There are two forms of phoenix activity that are legal and illegal:

• Legal phoenix activity- it covers situations when another business is started by the previous controller because previous entity of controller is failed to rescue its business.
• Illegal phoenix activity-it is similar to the legal phoenix activity, but the main intention of the controller is to exploit the corporate form for the purpose of detriment the interest of unsecured creditors, employees, and tax authorities. In other words, directors of the company intentionally avoid the payment of creditors. This can be understood through example, directors are conducting the operations of the company responsibly, but instead of that company is not able to pay its debts (ASIC, 2013).

Answer 2: if controller conducts legal phoenix activity then only it is beneficial for the society, but in case illegal phoenix activity is conducted by the controller then situation is completely different. Phoenix activity is considered as illegal when controller incorporated new company for the purpose of continues the business of old company which has intentionally liquidated for the purpose of avoid the payments of the debts.

It must be noted that illegal phoenix activity impacts all the stakeholders of the company such as business community, employees, contractors, government and environment in following manner.

• Payment related to wages, superannuation, and employee entitlements are not made by the company.
• Business is getting unfair competitive advantage over other companies.
• Company fails to make payment to the suppliers.
• Revenue of the government is not paid, and business also imposes increased monitoring and enforcement costs on the government.
• Regulatory obligations are avoided by the business.

It must be noted that phoenix activity not only affect above stated stakeholders, but it also affects the whole society by depriving the funds which can be distributed to the hospitals, schools, roads, etc. various measures are taken by government for the purpose of reducing this activity such as by punishing the offenders as per the law (ASIC, 2016).

Answer 3: the main purpose of phoenix activity is to provide the way for winding up the company, rather than deregister the company by ASIC. This activity also allowed the employees to assist the government for the purpose of getting their entitlements from the failed companies. However, it must be noted that this purpose only reduces some side effects of the phoenix activity, and not eliminate the concept itself.

The other purpose of phoenix activity is to reduce the cost of the liquidation, and it also increase the speed of liquidation process by removing the procedure of filing application.

However, there are some other purposes also which are stated below:

• It provides opportunity to the directors by incorporated new company from the ashes of the old company.
• It provides opportunity to the liquidator to investigate the matter at earlier stage, and if required take necessary action (Mccoy, 2012).

Answer 4: Generally, directors and other owners of the business get the benefit from phoenix activity because they incorporate the new company and get rid from all their liabilities in the old company. This new company starts their new business and free from old liabilities. Assets of the old company are transferred in the new company, and Controllers of the previous business choose this move to start their business in a new way by leaving the creditors, employees, and government unpaid.

This activity is not beneficial for creditors, employees, government, and society in many ways, and some of these ways are stated below:

• Payment related to wages, superannuation, and employee entitlements which are accrued are not made by the company.
• Business is getting unfair competitive advantage over other companies.
• It affects the whole society by depriving the funds which can be distributed to the hospitals, schools, roads, etc (Henderson, 2014).

Answer 5: phoenix activity is not inherently illegal, and there is no express prohibition imposed by Corporation Act 2001 on Phoenix activity. Action conducted under phoenix context is considered as illegal when intention of the directors includes detriment of the interest of creditors and other stakeholders of the business. Wrongdoing on part of the directors is considered and whether directors breach any other law. Phoenix activity is considered as long standing issue, and various solutions are proposed for the purpose of solving this issue. Therefore, it is clear that there is no specific section in the corporation Act 2001 which specifically prohibits the phoenix activity.

Answer 6: yes, some sections of the corporation Act 2001 are breached by the phoenix activity, and these sections are stated below:

Section 180 of the Corporation Act 2001 impose duty on the directors and other officers of the organization to perform their duties and exercise their powers with due care and diligence that any reasonable person would exercise if they were the director or officer of the organization or hold the office of the director or officer of the company and had same responsibilities in the company.

This section further states that director or other officer of the company satisfy the above stated requirements while making any judgment of the business, if they:

• Make the judgment in good faith and for proper purpose.
• Directors must not have any material personal interest in the matter related to the business judgment.
• Inform other directors about the subject matter of the judgment up to the extent they believe appropriate.
• Directors must believe that judgment made by them is in the best interest of the company.

It must be noted that belief of the director that judgment made by them is in the best interest of the company is considered as rational if any reasonable person in that situation holds the similar belief (Corporation Act, 2001).

In case of phoenix activity, directors breach their duty under section 180 because they fail to perform their duties and exercise their powers with due care and diligence that any reasonable person would exercise. Directors also fail to make business judgment in good faith and in the best interest of the company.

Section 181 of the Corporation Act 2001 states, directors or other officers of the corporation must perform their duties and exercise their powers in good faith and in the best interest of the company. These section further states, director must perform their duties and exercise their powers for the proper purpose.

This subsection is civil penalty provision under section 1317E, and if any person contravenes subsection 1 of this section then such person contravenes complete section.

Directors of the company breach section 181 if they engage in illegal phoenix activity because they fail to make business judgment for proper purpose (Corporation Act, 2001).

Answer 7: ASIC v Somerville [2009] NSWSC 934- in this case, NSW Supreme Court held that solicitor was also guilty for abetting the directors of the company to breach their duties by engaging in the Phoenix activity. This case was considered as warning for all those directors who were advising for business restructuring, to take care that they were not step their legal and financial duties while restructuring their business.  

A fact of the case- Mr. Somerville was a solicitor, and he provides advice to the various directors of the company who are facing financial difficulties in their organization. Almost 8 defendants get such advice from the solicitor and some of them come back even two or three times. In every case Mr. Somerville provide advice to the director so that:

• Failing company “oldco” cease to conduct its business.
• New company “newco” was incorporated by the directors.
• Assets of oldco was sold to newco on following terms and conditions:
• Assets were transferred from oldco to newco
• Newco issues almost 100 "V" class shares to oldco in the form of consideration for the assets transferred by oldco. These shares give right to the oldco to get all the dividends declared by the newco up to an amount equivalent to the purchase price
• Employees of oldco were terminated and newco offered employment to these employees.
• Property, plant and equipment leases were taken by newco.
• All the liabilities and pre-transfer debtors were remained with oldco.

In this case, Court deals with the issue of phoenix activity, and it was the only case in which lawyer was also punished in this way. Civil penalty provisions were issued by ASIC against Mr. Somerville and eight directors of the companies. Court further stated that directors of the company were also liable for breach the statutory duties stated under section 180 and 181 of the corporation Act 2001.

Part B

Answer 8: Phoenix prohibition can send educative message to the controllers of the company and their advisors, and it also has potential to increase the commitment of directors and officers towards compliance. Three broad factors are there which deals with phoenix prohibition, and these factors are normative, social and calculative. These factors motivated the regulated persons to comply with the law. It must be noted that, individual who is normative motivated is complied with their internalized values or morals. Perception of such individual in relation of immorality is generally influenced by the level of disdain with which it is viewed by the society. Phoenix prohibition can be considered as one way with which such perception related to immoral behavior can be prevented, and it also help in increased the perceived value for not engaging in such behavior. Therefore, it is clear that phoenix prohibition has potential to send such message.

Individual who is motivated by social factors has desire to be approved and respected by their colleagues and followers. It also includes prevention of any negative publicity and reputational damage that may be result from any undesirable behavior such as breach of phoenix prohibition.

Persons motivated by calculated factors are concerned with the compliance cost which can be imposed on them for their wrongdoing and that enforcement action will be commenced. However, it must be noted that it is difficult to detect these factors and prosecute, because wrongdoers has ability to hide behind the corporate veil.

There are number of cases in which businessman are indulged in the phoenix activity through their adviser. Therefore, both Australian Securities and Investments Commission (ASIC) and the Australian Taxation Office (ATO) mainly focus on the pre-insolvency adviser or experts of business restructuring. In 2017, almost 80 officers of ATO conduct raids on the two premises of Melbourne because of the pressure put on the pre-insolvency industry. This issue was seriously considered by the ATO for the purpose of conducting special investigation through phoenix taskforce.

Therefore, various steps are taken by government for the purpose of creating the legal phoenix activity prohibition, and various reports are published for developing the illegal phoenix activity prohibition because it harms number of people in the society. Current laws are not sufficient for prohibiting this activity as it requires more strict laws which deal with this activity in stricter manner.

Failure of current laws clearly shows that existing measures are not sufficient because phoenix activity cause harm on continuous manner to number of peoples, and it also state that there is urgent need of specific illegal phoenix activity prohibition. There are number of reasons because of which this specific prohibition is not introduced yet. Alternative approach is suggested for the purpose of sending message through specific phoenix prohibition, which means ‘anti-phoenixing’ message to the market. Message must be sent that profit earned from phoenix activity will be lost and Court imposed heavy penalties on the person engaged in such activity. Therefore, parliament also informs the ASIC about the priorities of the government and the seriousness of this behavior (Henderson & Hedges, 2017).

Answer 9: phoenix prohibition can be structured in following way:

• The most important recommendations for structuring the phoenix prohibition are the compulsion use of director identity number by the director while conducting any corporate actions. Currently, it is possible for directors to move from one company to another company under the veil of virtual invisibility. It is not possible for regulator to track the directors who are continuously engaged in the phoenix entities.

Therefore, it is necessary to highlight the identity number of director so that it becomes easy for ASIC and other regulators to track the activities of the director. When ASIC has the knowledge regarding the activities of the director, then ASIC can also inform other authorities that particular company is under the surveillance. This option can increase the effective of investigations and tracking of companies conducted by ASIC and other authorities also.

• ASIC can also make provisions for conducting changes under the reports issued by liquidators, because no scope is given by the liquidators through which phoenix activity can be suspected by the regulators and hey did not ask for the contribution from a pre-insolvency adviser also. ASIC conduct investigations against various advisors and majority of them are honest and professional, but these advisors are defended by the attitude of regulator. Therefore, it is necessary to resolve the issues between regulators and ASIC. However, both liquidators and ASIC must change their attitude towards each other so that they can collaborate with each other, and resolve this issue with each other.
• Government must increase the maximum criminal fine for the statutory duties breached by the directors of the company and must be increased up to 4,500 penalty units so that it get similar consistency which the other offenses of serious nature under corporation Act 2001. Therefore, it becomes necessary to increase the maximum civil penalty  and criminal fines for breaching the statutory duties of director.
• Another approach for structuring phoenix prohibition is to state the general administrative, civil and criminal financial penalties, and the amount of penalties must be the multiple of gain arrived by the person from phoenix misconduct. The main aim behind this approach is to make sure that person think twice before indulging in any such conduct which is of unlawful nature, and if person engaged in any such conduct then further consideration must be given by such person. Court can also order pecuniary penalty against such order for the gain earned by individual while engaging in phoenix misconduct (CPA, n.d.).

References:

Anderson, H. & Hedges, J. (2017). Illegal Phoenix Activity: Is A ‘Phoenix Prohibition’ The Solution?. Retrieved on 31^st August 2017 from: https://law.unimelb.edu.au/__data/assets/pdf_file/0004/2271613/Anderson-et-al,-Illegal-Phoenix-Activity-Is-a-Phoenix-Prohibition-the-Solution-2017-Company-and-Securities-Law-Journal-forthcoming.pdf.

Anderson, H. (2014). Defining and Profiling Phoenix Activity. Retrieved on 31^st August 2017 from: https://business.monash.edu/__data/assets/pdf_file/0006/258936/defining-and-profiling-phoenix-activity.pdf.

ASIC v Somerville [2009] NSWSC 934.

ASIC, (2013). Small business-illegal phoenix activity. Retrieved on 31^st August 2017 from: https://asic.gov.au/for-business/your-business/small-business/compliance-for-small-business/small-business-illegal-phoenix-activity/.

ASIC, (2016). Illegal phoenix activity. Retrieved on 31^st August 2017 from: https://asic.gov.au/about-asic/contact-us/how-to-complain/illegal-phoenix-activity/.

Corporation Act 2001- Section 180

Corporation Act 2001- Section 181

CPA. New moves to stop illegal phoenix company activity. Retrieved on 31^st August 2017 from: https://www.intheblack.com/articles/2017/06/06/illegal-phoenix-company-activity.

Mccoy, O. (2012). Phoenix Fever. Retrieved on 31^st August 2017 from: https://www.claytonutz.com/knowledge/2012/september/phoenix-fever.