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Legal vs illegal phoenix activity

Discuss about the Illegal Phoenix Company Activity.

Phoenix activity is considered as the concept which is generated from the idea of the second company, often new company is incorporated. Incorporation of the new company is done from the ashes of the old company. It must be noted in this new company both controllers and business are same as of the old company.

Phoenix activity is defined as the incorporation of a new company for takeover the business conducted by the old company which becomes insolvent. The main aim of phoenix activity is to restructure the company which faces genuine failure and liquidation. Phoenix activity is divided among two categories that are legal and illegal.

Legal phoenix activity is conducted when controller of the business incorporate new company for conducting the business because it is not possible for the controller to rescue the business of the previous entity. On the other hand, illegal phoenix activity is conducted when owner of the business incorporate new company because it is not possible for controller to rescue the business of the previous entity, but intention of the controller is not good and decision taken by the controller detriment the interest of the creditors, employees, and government. For example, directors of the company start new business for the purpose of avoiding the payments due to the creditors, employees, and government authorities[1].

Legal phoenix activity is considered as beneficial activity for the society, but if phoenix activity is conducted in illegal way then it is not considered beneficial for the society.

Phoenix activity is illegal in nature when new company is incorporated by the controller of the company, but with the intention of defrauding the stakeholders of the company. In other words, company is liquidated for avoiding the payment due to creditors and government. This activity effect not only the creditors, but also the employees, contractors, government and environment. Following are some ways through which above stated stakeholders are affected:

  • Company fails to make payment in lieu of wages, entitlements, and superannuation funds.
  • Unfair competitive advantage is gained by the company over their competitors and other businesses.
  • Payment related to the suppliers is not made by the company.
  • Company fails to pay the revenue and any other amount due to the government, and extra monitoring and enforcement costs is also imposed on the government by the company.
  • Business continuously fails to meet the regulatory obligations.

Not only stakeholders of the company are affected by illegal phoenix activity but complete society is affected by this activity. Funds available for society such as funds contributed in roads, hospitals, schools, etc. are deprived by the business entity engaged in such activity. Government adopts various measures for preventing any such activity such as heavy penalties are imposed on the offenders[2].

Phoenix activity are conducted for various reasons, and the most important reason for conducting this activity is to provide procedure for wind up the company in simple manner, rather than adopting lengthy process of deregistering the company through ASIC.  It must be noted that this purpose allowed the employees of the company to get assistance under GEERS for claiming their entitlement from the company. This purpose only helps in preventing some disadvantages of this activity, and not eliminates the complete concept. Some other purposes of this activity are stated below:

  • It helps in reducing the cost of liquidation, and makes the procedure simpler.
  • Phoenix activity speed up the procedure by the removing the requirement of lodging application.
  • Opportunity for restructuring the business is given to the directors of the company.
  • Opportunity for conduct investigation at earlier stage for avoiding future consequences is given to the liquidator[3].

Impacts of illegal phoenix activity


Phoenix activity mainly provides benefit to the directors and other controllers of the business by incorporating the new company without discharging the liabilities of old company. New incorporated company adopts the business of the old company owned by controller, but did not adopt the liabilities. Assets belong to old co. are transferred to the new company without transferring the liabilities and controllers does not pay penny to the creditors, employees, and society.

Therefore, this activity is beneficial for controllers of the business, but it is not beneficial for the unsecured creditors, employees, government, and society because of the following reasons:

  • Non-payment of wages to the employees of the company.
  • Fails to pay amount due to creditors.
  • Business detriment the fund contributed to the society, etc[4].

It must be noted that no section is stated under the Corporation Act 2001 which specifically prohibits the phoenix activity, because phoenix activity is not inherently illegal. It is considered as illegal when intention of the controller of the business is not right and controller fails to act in the best interest of the company. For considering this activity illegal, wrong committed by the directors of the company is considered and duties breached by such directors. Government Issue Act on this activity, but that act does not state any action which specifically prohibits the activity.

Two sections of the corporation Act 2001, which are breached by the directors of the company while conducting phoenix activity is stated below:

Section 180- as per this section director and other officers of the company are obliged under this section to conduct their functions and exercise their power with reasonable care and diligence, that would be performed by any person who is appointed as the director or officer of the company or acquire the officer of the director and officer and incurred same responsibilities incurred by director and officer.

Clause 2 of this section sates that any director or officer at the time of making business judgment meet the above stated criteria only when:

  • Such director or officer makes business judgment in good faith and not for any improper purpose.
  • Director or officer does not possess any material personal interest in the business judgment.
  • Other directors of the company are fully informed about the subject matter of the business judgment.
  • Judgment made by the directors of the company must be in the best interest of the company.

Belief hold by the director or officer of the company that judgment made by them is in the best interest of the company is considered as rational only when any reasonable person holds the same belief in similar situation.

Therefore, in case of phoenix activity directors of the company knows that their decision is not in the best interest of the other stakeholders because directors fail to conduct their functions and exercise their power with reasonable care and diligence, that would be performed by any person who is appointed as the director or officer of the company or acquire the officer of the director and officer and incurred same responsibilities[5].

Purposes of phoenix activity


Section 181- as per this section it is the duty of the director and other officers of the company to conduct their operations in good faith, and such operations must be in the best interest of the company. Clause 2 of this section states that director and other officers of the company are also under obligation to conduct their operations for proper purpose.

It must be noted that this section is fall under civil penalty provision that is under section 1317E, and in case individual breach clause 1 of this section then Court considered it the contravene of whole section. Breach related to section 181 of the Act is considered if directors of the company engaged in phoenix activity because directors make business judgment for improper purpose[6].

ASIC v Somerville [2009] NSWSC 934- this case was decided by the Supreme Court of NSW and as per the Court solicitor was also held liable for influencing the directors to breach their statutory duties by indulging in phoenix activity. This case was the warning for all the directors of the company who are breaching their duties under the veil of restructuring, and for those solicitors also who were advising such activities to their clients.

Facts: in this case, Mr. Somerville gives advice to their clients, who are facing financial consequences in their business. From these clients, almost 8 directors of the company act on the advice given by solicitor. Advice given by solicitor includes following things:

  • Old company which was failed to restructure their business must be ceased, and new company was incorporated by the directors of the company.
  • Assets of the old company must be transferred to the new company by sale deed, and terms of deed states that:
  • Assets of the old company must be transferred to the new company.
  • V class shares were issued by new company to the old company in lieu of consideration of the assets transferred by old company to the new company.
  • Shares issues by new company provide right to the old company to receive all the dividends declared by the new company in respect of above mentioned shares.
  • Employees of the old company were terminated from their employment, and employment was offered to these employees by the new company.
  • New company taken various Property, plant and equipment leases.
  • Liabilities and pre-transfer debts of the old company are remained with the old company, and not transferred to the new company.

In this case, phoenix activity was conducted by the directors of the company and advised by the solicitor of the company. This case was the only case in which solicitor of the company was also held liable for advised wrong things to the directors of the company. Court held that both Mr. Somerville and other defendants of the company were liable under civil penalty provision. Court also held that directors of the company contravene section 180, 181, and 182 of the Act[7].

Educative message can be send to the controllers and advisers of the company through phoenix prohibition. This message has power to encourage the directors and other officers of the company to conduct their operation in the best interest of the company and compliance with the provisions of the Corporation Act 2001.

Phoenix prohibition includes three elements and these three elements provide motivation to the individual to comply with the law, and these elements are stated below:

  • Normative motivation- this motivation includes internal values and morals of the person, which means individual is forced by their internal values not to conduct any undesirable action. In other words, internal values and morals of the person prevent the person from conducting any action which is not right and disdain by the society. Phoenix prohibition can be considered as the option which helps in encouraging such thoughts in the individuals.
  • Social motivation- this motivation includes the desire of reputation and respect. In other words, those individuals who are motivated by the desire of earning reputation and respect. Such individuals also prevent themselves in including any such behavior which result in negative publicity or damage their reputation such as contravenes phoenix prohibition.
  • Calculative motivation- these motivation includes fear of penalty and compliance cost. In other words, individuals under this are motivated from calculated factors such as penalty and compliance cost. Penalty can be imposed on directors and other officers of the company for their wrongdoing and then action will be commenced against them. Generally, those directors who commit wrong hide behind the corporate veil, and it is difficult those scams.


In various companies, businessman ceases their old business and incorporates new company for the purpose of cheating their creditors. Australian Securities and Investments Commission (ASIC) and the Australian Taxation Office (ATO) put their attention on the business experts and advisers. ATO investigate two premises of Melbourne related to pre-insolvency industry with the help of 80 officers, because ATO seriously concerned this issue and investigate the matters with the help of phoenix taskforce.

Australian government takes number of measures to resolve the issue of phoenix activity, and also take steps to introduce the legal phoenix activity prohibition. Numbers of reports are published by the government for the purpose of dealing with the illegal phoenix activity prohibition. It is necessary because illegal phoenix cause harm to various peoples, and current laws in this regard are not considered sufficient because no section in the Act specifically prohibits phoenix.

Therefore, it is clear from the above facts that current laws are failed to provide sufficient measures which can prohibit phoenix activity specifically. This activity cause harm to the number of people and society because of which there is urgent need of specific illegal phoenix activity prohibition. Various reasons are present which prevents the development of specific prohibition. Therefore, it is the duty of government to take measures for the purpose of sending this message. In other words, message related to ‘anti-phoenixing’ can be send to the market. Such message clearly state that in case any individual is found by earning profit from phoenix activity will be heavily penalized from the Court[8].

Therefore, parliament also informs the ASIC about the priorities of the government and the seriousness of this behavior[9].

References

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

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

CPA. New moves to stop illegal phoenix company activity. < https://www.intheblack.com/articles/2017/06/06/illegal-phoenix-company-activity>, Accessed on 31st August 2017.

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

Henderson, A. (2014). Phoenix activity recommendations on detection, disruption and enforcement, < https://law.unimelb.edu.au/__data/assets/pdf_file/0020/2274131/Phoenix-Activity-Recommendations-on-Detection-Disruption-and-Enforcement.pdf>, Accessed on 4th September 2017.

ASIC v Somerville [2009] NSWSC 934.

CPA. New moves to stop illegal phoenix company activity. < https://www.intheblack.com/articles/2017/06/06/illegal-phoenix-company-activity>, Accessed on 31st August 2017.

Anderson, H. & Hedges, J. (2017). Illegal Phoenix Activity: Is A ‘Phoenix Prohibition’ The Solution?. < 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>, Accessed on 31st August 2017.

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