Illegal Phoenix Activity And Misconduct - Discussion

Purpose of Phoenix Activity

Discuss about the Illegal Phoenix Activity and Misconduct.

Phoenix activity can be defined as the evasion of liabilities, like tax and employee entitlements, by systematic, wilful and cyclic liquidation of such entities which involves related corporate trading (Parliament of Australia, 2017). In the words of Australian Securities and Investment Commission, short for ASIC, phoenix activities involve a specific kind of conduct. In such cases where the organization is unable to pay its debts and acts in such a manner where the equal access to the organizations assets are deliberately denied to the unsecured creditors, which could allow them to meet them unpaid debts, and where within a single year a new business is established in which the assets, whether partly or wholly, of the old business are used and is controlled by the same people who controlled the previous organization (Taylor David, 2014).

Phoenix is a mythological bird, which dies and is reborn from its ashes. This analogy proves to be of held for defining phoenix activities, where a new business is formed from the ashes of the old business. Phoenix activities contain different practices, which are majorly concerned with the management of the old company, using the assets of the old company, to form a new company, for avoiding its different liabilities towards different stakeholders (Margret & Peck, 2014).

No, the phoenix activities can never be beneficial for the society. The reason behind this lies in the very purpose for which such activities are undertaken. The purpose of the indulging in such activity for a small group of people is to evade their liabilities, which they owe to different stakeholders. These stakeholders are a part of the society and include the creditors, the employees and even the government, which ultimately works for the benefit of the society. A small group of individuals indulge in activities which can be deemed as fraudulent and benefit themself by not having to pay their dues. The workers are not paid their entitlements, the creditors are not paid their debts and the nation has to bear millions of dollars in cost due to such activities (ASIC, 2017). This proves that phoenix activities are not beneficial for the society.

The purpose of phoenix activity is not just one but many. The easiness of indulging in phoenix activities, along with the same being an easy way to not fulfil the liabilities and remaining invisible from compliances are some of the factors for which the phoenix activities are indulged in. The management of the previous company evades the liabilities of such company, by forming a new company and saving costs by using the assets of the previous company (Oakes & Clark, 2017). The other purpose of taking part in phoenix activities is accumulating the debts, without having the intent of ever making repayments to such debts, and when the debt is claimed, liquidating the company to avoid the repayment of the debt obligations (Australian Government, 2009).

Adverse Impact on Society and Stakeholders

As has been stated earlier also, by taking part in the phoenix activities, a certain set of people obtain benefit by avoiding their liabilities in the matter of repaying what they took from others, apart from what they had to pay others for their services or as taxation. This set of people includes the management, as well as, the directors of the previous organization. Not only they fail to repay their dues, they also make use of the property of the previous company, which saves them the cost of buying new assets for the new company.

There are different stakeholder groups which have to face the brunt of the phoenix activities. The unlawful phoenix activities are problematic for the economy of the nation in the view of Senate Economics References Committee and a culture of disregarding the law was followed through these activities (The Conversation, 2016).  The 2015 Productivity Commission Report provided that in Australia, about 2,000-6,000 phoenix companies were present, due to which, the company had to bear costs of A$1.8 billion to A$3.2 billion on yearly basis (Productivity Commission, 2015). Due to the high amount of unpaid tax liabilities, the tax revenues of the nation are also hampered (Anderson, Ramsay & Welsh, 2016).

So, the nation is the first stakeholder which is affected, and the next stakeholder group is the employees. The unlawful phoenix activities have far reaching consequences and are unfair. This is evidenced from the loss which the employees have to bear. When a company indulges in phoenix activities, the employees of the previous organization are not paid their salary, and apart from this, their rightfully earned entitlements are also not paid to them. Creditor is also one of the stakeholder groups affected by phoenix activities. The creditors are small businesses, who face hardships when their dues are not paid. Along with this, the contractors of the previous company are also not paid the promised sum based on the contract. So, there are different stakeholder groups which are adversely affected due to phoenix activities (Anderson et al, 2017a).

There has been wide coverage of the phoenix activities in the papers, reports and enquiries of the parliament and yet, it is not defined anywhere in the Corporations Act, 2001. Through the latest amendments to this act, by the Phoenixing Act, the ASIC has been handed the discretionary power for winding a company in case some specific conditions have been fulfilled. And these conditions have been stated in section 489 EA (WIPO, 2015). ASIC has also issued Regulatory Guide 242 through which the situations have been properly explained in which the powers given under Part 5.4C of the amended act can be used. When an order for winding up is made under this section, the sale and distribution of the property of the company is handed over to the liquidator (Boss Lawyers, 2017).

Regulations and Legal Penalties

The specific penalties for indulging in unlawful phoenix activities are not covered under the corporate law regime, but the directors who take part in such activities can be made liable pursuant to Part 2D.1, which relates to the director duties. The phoenix activities can also result in transactions which are voidable or could result in the provisions contained in Corporations Act’s Part 5.8A being contravened, which are related to the employee entitlements (Martin, 2007).

Section 181 relates to the duty of the director and officers of the company to discharge their obligations and use their powers in a way which can be considered as proper, in best interest of company and shows good faith (ICNL, 2017). The duties related to making proper use of the position held by such individual and of the company information, are respectively covered under section 182 and 183 of the Corporations Act (Federal Register of Legislation, 2017). In case the directors take part in phoenix activities, the best interest of the previous organization is ignored and the information of the old organization is misused for the purpose of putting the new company in an advantageous position (Martin, 2007).

By indulging in phoenix activities, the directors of the old company, who are benefitted and take part in the new company, can be disqualified from being a director in any company on the basis of section 206C of this act and the period of disqualification is decided by the court (Latimer, 2012). Further, as these activities involve insolvent trading, the directors can be made liable based on section 588G of this act (Australasian Legal Information Institute, 2017). The reason for applying section 588G lies in the previous company being made insolvent by incurring liabilities and by making use of their assets for the new company. So, the stakeholder groups can hold the responsible directors and officers liable for the breach of these sections (Martin, 2007).

There are not many cases where the phoenix activities were properly nabbed. However, one of the cases where this was established is the case of ASIC v Somerville & Ors [2009] NSWSC 934. The defendant in this case was the attorney who had started legal practice which the company director advised and were facing financial difficulties. The defendant was made accountable as the restructuring advice was given by the company, when they knew that the new company was being created and the operations of the old company had not been discontinued (Mullette, 2009). As a result of this, the court passed a disqualification order for 6 years against the defendant, instead of the higher period sought by ASIC (Anderson et al, 2017a).

Case Study

The Productivity Inquiry conducted by ASIC in July 2015 saw a number of provisions being endorsed by the ASIC, in the form of being supplementary submission in closing, transferring and setting up of businesses. The reason for this stemmed from the ineffectiveness of the section 596AB provisions, which was supposed to put an end to the people indulging in unlawful phoenix activities. A key issue which is often highlighted is that actions to be brought against the director in cases of illegal activities can prove costly. All this led to the introduction of phoenix prohibitions (Anderson et al, 2017b).

These phoenix prohibitions fail to confine the phoenix arrangements which are sophisticated in nature, particularly when a transfer of assets is not involved. Also, the position of the ASIC, in the matter of phoenix prohibition creates is not very consistent. The Productivity Commission Report provided that the duties of the directors are not properly utilized in the context of phoenix activity and this is also the case for the provisions related to insolvent trading. Agreed that the civil penalties are imposed for indulging in insolvent activities pursuant to section 596AB, the criminal provisions can be solely activated by ASIC (Paolini, 2014). This makes the criminal conviction a difficult task in comparison to the implementation and enforcement of civil provisions. The reason for this lies in the need to show the element of mens rea for making a criminal case, in addition to providing proof where the claim can be provided without any uncertainties (Anderson et al, 2017b).

Getting back to the main question at hand, which is whether or not the phoenix prohibitions are really the key? This is undoubtedly a very appealing notion. The reason for this lies in these prohibitions sending an educated message for the advisors, as well as, the controllers of the company, along with having a high possibility for increasing the commitment towards compliances. To further consider this, three factors prove to be of help, and these are the normative factors, the social factors and the calculative factors. The people belonging to the first category are motivated internally for complying with the regulations, due to the moral reasoning held by them. This would mean that with the introduction of phoenix prohibition, people belonging to this group would not do anything which is undesirable or can be deemed as immoral. The social factors motivate these people and the need of being approved by the peers and being respected by them would make them avoid any damage to their reputation and would not attract any negative publicity, which would happen if the phoenix prohibitions are breached. The group of people who are motivated by the calculative factors would always consider the compliance costs and of the detection of a wrong done by them (Anderson et al, 2017b).

Though, when these prohibitions are carefully analysed, they do not show much conviction and the arguments which are given for favouring the phoenix prohibitions, fail to be convincing. The biggest difficulty in this regard is drafting the legislative provisions which could specifically deal with these issues, comparatively with respect to the director duties which are present right now, which could cover the complex manifestations for the phoenix activities in an effective manner. Where such a provision is proposed which is related to risks associated with externally discernible facts, it could prove to be very complex and also full of loopholes. Hence, there is a need to strictly impose penalties for the wrong done by the individuals, in place of imposing penalties on the particular situation where such incident occurred (Anderson et al, 2017b).

The main point being that there is no need for increasing the complexities in the law through which the illegal phoenix activities are presently governed. What is actually needed is the strengthening of the compensation, as well as, profit stripping remedies and imposing the punitive penalties for the breach of duties of directors. By adopting this proposal, two functions would be served. The first one is where the ASIC would incentivize and the second where the private litigants would make use of the contravening provisions in a more frequent manner as there would be high chances from making gains on the enforcement actions. Further, this would also help in deterring the unlawful phoenix activity operators as they would face a higher penalty by being a part of such activities (Anderson et al, 2017b).

The best solution here is the adoption of an alternative to these prohibitions. In this regard, there is a need to take steps towards improving the present provisions, instead of going for more burdens. For the contravention of duties of directors there is a need to seek sanctions. By introducing high penalties, and coupling the losses of such activities, the financial gains made from such activities can be used for the purpose of compensating the ones who were at loss as a result of such activities. Lastly, the costs for the non compliance by the directors also need to be improved. However, for this, there is a need for effective enforcement mechanisms to be deployed in the matter of duties of the directors. The frequency of the enforcement actions also need to be enhanced and this is a task for ASIC. And in place of creating a new law, the current law should be amended so that the miscreants and enforcers know about the changed norms (Anderson et al, 2017b).

It has been aptly stated in the preceding section, that the present law needs to be amended. The phoenix prohibitions have to be structured in a manner so as to include high penalties. This could be done by including the Crimes Act 1900 (NSW) provisions in the phoenix prohibition and the need to applying them in a stringent manner. Some of the provisions which prove to be of help include section 192F, 192G ad 192H (NSW Legislation, 2017).

The reach of the compensation orders, which the courts award pursuant to section 1317H need to be increased. Pursuant to these changes, the aggrieved party could be compensated by being awarded damages from the profits made and the liable party being imposed with civil penalties, as well as, being required to surrender the profits made. This liability should extend to the beneficiary of the wrongdoing parties, along with this, the criminal provisions needs to be strengthened. The director duties have to be so raised that people think twice before indulging in such acts (Anderson et al, 2017b).

References

Anderson, H., Ramsay, I., & Welsh, M. (2016). Illegal phoenix activity: Quantifying its incidence and cost. Retrieved from: https://law.unimelb.edu.au/__data/assets/pdf_file/0003/2070363/Anderson,-H,-Ramsay,-I,-and-Welsh,-M,-Illegal-Phoenix-Activity-Quantifying-Its-Incidence-and-Cost-2016-24-Insolv-LJ-95.pdf 

Anderson, H., Ramsay, I., Welsh, M., & Hedges, J. (2017a). Phoenix Activity. Retrieved from: https://law.unimelb.edu.au/__data/assets/pdf_file/0020/2274131/Phoenix-Activity-Recommendations-on-Detection-Disruption-and-Enforcement.pdf 

Anderson, H., Ramsay, I., Welsh, M., & Hedges, J. (2017b). Illegal Phoenix Activity: Is A ‘Phoenix Prohibition’ The Solution?. Retrieved 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  

ASIC. (2017). Small business-illegal phoenix activity. Retrieved from: https://asic.gov.au/for-business/your-business/small-business/compliance-for-small-business/small-business-illegal-phoenix-activity/

Australasian Legal Information Institute. (2017). Corporations Act 2001. Retrieved from: https://www.austlii.edu.au/au/legis/cth/consol_act/ca2001172/

Australian Government. (2009). Action against fraudulent phoenix activity. Retrieved from: https://archive.treasury.gov.au/documents/1647/PDF/Phoenix_Proposal_Paper.pdf 

Boss Lawyers. (2017). What is Phoenix Activity? Retrieved from: https://www.bosslawyers.com.au/phoenix-activity/ 

Cassidy, J. (2006). Concise Corporations Law (5^th ed.). NSW: The Federation Press.

Federal Register of Legislation. (2017). Corporations Act 2001. Retrieved from: https://www.legislation.gov.au/Details/C2013C00605

ICNL. (2017). Corporations Act 2001. Retrieved from: https://www.icnl.org/research/library/files/Australia/Corps2001Vol4WD02.pdf

Latimer, P. (2012). Australian Business Law 2012 (31^st ed.). Sydney, NSW: CCH Australia Limited.

Margret, J.E., & Peck, G. (2014). Fraud in Financial Statements. Oxon: Routledge.

Martin, A. (2007). Directors' Duties and Phoenix Companies. Retrieved from: https://www.allens.com.au/pubs/pdf/insol/pap4apr07.pdf 

Mullette, S. (2009). Phoenix Rising - Advisors to directors of phoenix company burned. Retrieved from: https://www.bartier.com.au/insights/phoenix-rising-advisors-to-directors-of-phoenix-company-burned/ 

NSW Legislation. (2017). Crimes Act 1900 No 40. Retrieved from: https://www.legislation.nsw.gov.au/#/view/act/1900/40

Oakes, D., & Clark, S. (2017). Phoenixing companies too easy and lucrative in Australia, new report finds. Retrieved from: https://www.abc.net.au/news/2017-02-24/phoenixing-companies-too-easy-in-australia/8301638 

Paolini, A. (2014). Research Handbook on Directors Duties. Northampton, MA, USA: Edward Elgar.

Parliament of Australia. (2017). Chapter 5: Illegal phoenix activity and other misconduct. Retrieved from: https://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/Insolvency_construction/Report/c05

Productivity Commission. (2015). Business Set-up, Transfer and Closure. Retrieved from: https://www.pc.gov.au/inquiries/completed/business/report/business.pdf 

Taylor David. (2014). What is Phoenix Activity? Retrieved from: https://www.taylor-david.com/news/what-is-phoenix-activity 

The Conversation. (2016). Illegal phoenix activity is costing us billions – here’s how it could be stemmed.  Retrieved from: https://theconversation.com/illegal-phoenix-activity-is-costing-us-billions-heres-how-it-could-be-stemmed-65335 

WIPO. (2015). Corporations Act 2001. Retrieved from: https://www.wipo.int/wipolex/en/text.jsp?file_id=370817