Illegal phoenix activity

By Scott Butler

In the last of our series of articles on the avenues for small to medium businesses to deal with their overdue tax debts, we look at illegal phoenix activity. Unfortunately, too many small businesses, on the advice of unlicensed and unqualified pre-insolvency advisers, turn to illegal phoenixing to attempt to avoid paying their tax debts. This exposes the directors to prosecution for breach of their duties and should be avoided at all costs.

A phoenix was a mythical bird that set fire to itself every 500 years and was born again, rising from its ashes.

The ATO describes illegal phoenix activity as being where a company deliberately liquidates its assets and transfers the assets to a new company to avoid paying its debts, including taxes, creditors and employee entitlements.^[1] Illegal phoenix activity covers both ‘fraudulent’ phoenix activity and ‘unlawful’ phoenix activity.

Fraudulent phoenix activity involves the deliberate and systematic liquidation of corporate trading entities with the intention of avoiding tax or other liabilities, and the continuation of the operation of that business through other trading entities, debt-free. The key feature of ‘fraudulent phoenix activity’ is the intention when setting up a company structure and incurring debts to exploit the corporate form to the detriment of unsecured creditors.^[2] With fraudulent phoenix activity there is the incurring of debts with knowledge that they will ‘phoenix’ the company to avoid paying them.

Unlawful phoenix activity, on the other hand, does not require an intention not to pay a debt when incurred. It only requires that the phoenixing of the company be conduct that contravenes the law.^[3] That contravention is generally a breach of a director’s duty:

1. to act in good faith in the best interest of the company and for a proper purpose; and
2. not to improperly use their position to gain an advantage for themselves or someone else or cause detriment to the company.

Although illegal phoenixing can occur in any industry or location, it is most common among building and construction, labour hire, payroll services, security services, cleaning, computer consulting, cafés and restaurants, and childcare services.^[4]

In 2018, it was estimated that the economy-wide annual cost of illegal phoenixing was between $1.8 billion and $3.2 billion. Further, the most significant direct costs in relation to illegal phoenixing were as follows:

• $1,162 – $3,171 million for businesses from unpaid trade creditors;
• $31 – $298 million for employees from unpaid entitlements; and
• around $1,660 million for the Government from unpaid taxes and compliance costs.^[5]

The Australian Securities and Investments Commission (ASIC), the Australian Taxation Office (ATO) and the Commonwealth Government are all taking action in an effort to combat illegal phoenixing.

The Phoenix Taskforce

The Phoenix Taskforce was established on 17 November 2014 through an amendment to the Taxation Administration Regulations and consists of 37 federal, state and territory government agencies, such as the ATO, ASIC and the Fair Work Ombudsman.^[6] The Phoenix Taskforce employs different strategies depending on whether the individuals identified are deemed to be high, medium or low risk, for example:

• high risk – the taskforce will use strong scrutiny upon those in this group and, if any are found to engage in illegal phoenixing, the taskforce will take action against them;
• medium risk – the taskforce will engage in a range of activities with this group that strongly encourages them to comply with the law; and
• low risk – the taskforce acknowledges that many in this group are undertaking legitimate business-rescue activities and works with them to provide education and advice on how to comply with the law and protect themselves.^[7]

The Phoenix Taskforce engages in early intervention, targets specific industries and works with key supply chain entities to prevent opportunities for illegal phoenixing. Further, it has made examples out of the worst phoenix operators and has a Top Phoenix Target program that aims to take away the profits of these individuals and disqualify and prosecute them.^[8]

Since 2015, the Phoenix Taskforce has achieved the following:

• the ATO and ASIC have prosecuted 25 illegal phoenix operators;
• ASIC has taken action against 12 registered liquidators and 79 company directors;
• there has been a reduction in businesses that display risk factors for illegal phoenixing and newly established companies linked to confirmed illegal phoenixing;
• interagency referrals within the Phoenix Taskforce have had positive correlations to identify businesses that are potentially at risk of engaging in illegal phoenixing; and
• the Serious Financial Crime Taskforce is actioning seven criminal phoenix matters.

In 2017-2018, ASIC banned 45 company directors, a number of whom were suspected to be involved in illegal phoenixing and prosecuted 382 individuals for 734 offences for failing to properly keep books and records, a risk indicator associated with illegal phoenix activity.^[9]

Anti-phoenixing provisions

The corporations and tax laws contain various provisions that target illegal phoenix activity. Under these laws:

• duties are imposed on directors and other officers to act in the best interests of the company generally and specific duties are imposed to protect the interests of the company’s creditors. Breaches of these duties are subject to criminal offences and civil remedies, including for officers acting dishonestly or for an improper purpose^[10];
• company liquidators are enabled to seek court orders to void transactions including insolvent uncommercial transactions and creditor-defeating transactions^[11];
• there are criminal offences and civil penalty provisions for:
  • company officers that fail to prevent the company from making creditor-defeating dispositions; and
  • other persons that facilitate a company making a creditor-defeating disposition,

however, the offences for creditor-defeating dispositions do not apply where the transaction was entered into as part of a course of conduct that is reasonably likely to lead to a better outcome than the immediate voluntary administration or winding up of the company being undertaken while the directors have the benefit of the safe harbour against insolvent trading;

• where a company is in liquidation, if ASIC believes there has been a creditor-defeating disposition, it can make orders to recover assets for the company’s creditors;
• liquidators and sometimes creditors can recover compensation from a company’s officers and other persons responsible for a company making a creditor-defeating disposition;
• resigning directors are prevented from improperly backdating resignations or ceasing to be a director when to do so would leave the company with no directors. In particular:
• a proprietary company must have one Australian-resident director over the age of 18^[12];
• a resigning director must be reported to ASIC within 28 days after that person stops being director. This resigning director may notify ASIC themselves;
• if resignation is reported after this 28-day period, the resignation takes effect from the day it is reported to ASIC. This prevents inappropriate backdating of director resignations and prevents any shift of accountability to other directors; and
• a director cannot resign or be removed by a resolution of members if doing so would leave the company without a director, unless the company is being wound up.

ASIC’s regulatory strategies to combat illegal phoenixing

ASIC advises it is working with other government agencies to combat illegal phoenixing by detecting, deterring and disrupting directors and advisers that engage in it. To do so, ASIC has established several regulatory strategies, including:

• education and outreach – educating industry representatives on how to detect companies that are potentially at risk of engaging in illegal phoenixing and ensuring these representatives are aware of their legal obligations;
• surveillance and compliance – identifying directors that have a history of failed companies and determining through data analytics if such directors may engage in future illegal phoenixing;
• the Liquidator Assistance Program – assisting appointed liquidators to obtain books and records where a director has failed to hand them over, as well as assisting in prosecuting the directors;
• the Assetless Administration Fund – providing a monetary grant to liquidators that are compiling a report into the failure of a company where there are not enough assets to fund the report;
• disqualifying directors – disqualifying directors that have been involved in two or more liquidated companies in the past seven years from managing any further companies; and
• enforcement action – taking action against people that facilitate, aid or abet illegal phoenixing, such as directors that breach their duties.^[13] An example of successful enforcement action is the action against pre-insolvency advisers, Stephen O’Neill and John Narramore, which lead them to be found guilty of money laundering.^[14]

[1] Australian Taxation Office, Illegal phoenix activity; Australian National Audit Office, Addressing illegal phoenix activity.
[2] Australian Securities and Investments Commission v Bettles [2020] FCA 1568
[3] Australian Securities and Investments Commission v Bettles [2020] FCA 1568
[4] Australian Taxation Office, The economic impact of potential illegal phoenix activity.
[5] Australian Taxation Office, The economic impact of potential illegal phoenix activity.
[6] Australian National Audit Office, Addressing illegal phoenix activity; Australian Taxation Office, Phoenix Taskforce.
[7] Australian National Audit Office, Addressing illegal phoenix activity.
[8] Australian Taxation Office, Phoenix Taskforce.
[9] Australian National Audit Office, Auditor-General Report No.32 2018-19 (Australian Government, 2019) p. 49.
[10] Corporations Act 2001 (Cth), s 184.
[11] Corporations Act 2001 (Cth), ss 588FB, 588FC and 588FE.
[12] Corporations Act 2001 (Cth), ss 201A and 201B.
[13] Australian Securities & Investments Commission, ASIC action on illegal phoenix activity.
[14] Australian Securities & Investments Commission, 19-30MR Pre-insolvency adviser sentenced to four and half years imprisonment for money laundering (13 November 2019).