The Concept Of Phoenix Activities In Companies: Benefits And Legality

Definition of Phoenix Activities

Question:

Discuss about the Phoenix Activity and Law.

In case of companies the activities that include registration of a new company for the purpose of taking over the insolvent or failed business, that can be considered as rebirth of a precursor company such activities are considered to be phoenix activity. It is mentionable here that for a phoenix activity to be legal in nature, should be performed by genuine company that failed and took the decision of liquidation (Asic, 2017). In those cases it is legitimate use of the corporate form. Under the concept of limited liability, the shareholders and directors are excused under the law from personal liability associated with the debts of the failed company.

Thus, in other words, it can be stated that the wide range of activities with the help of which, when a company fails, the present business activities is taken over by another entity can be referred as phoenix activities of companies (Asic, 2013). Phoenix business activities range from complex illegal behavior real business rescues.   

It is a fact that, if phoenix activities are undertaken by a company with malicious motives like getting relieve from debts, such phoenix activities are indeed harmful and have negative impact. However, phoenix activities have certain benefits associated with it that turn out to be beneficial for the society it is it performed legally (Martin, 2007). Firstly, on the part of the company that decides to undertake phoenix activities due to complex situation experienced on its part like burden of huge debts which makes it difficult for the company to be functional can be prevented from getting closed completely and allow it to be functional with the help of its old set of employees with the help of undertaking phoenix activities. Thus the economic growth of the nation from the productivity of the particular company, also, does not get hindered. In addition to the above discussed aspect, with the help of phoenix activities the present employees of the company can be retained (Anderson et al., 2014). This would act as a contributing for the society in terms of maintaining the employment level and prevent adverse impact on the employment status of the society.      

On the part of the companies undertaking phoenix activities, there can be more than one motive. From a generic perspective, companies undertake phoenix activities in situations when it is in a troublesome condition, which generally includes huge debts on these companies. The difference of motives of these companies undertaking phoenix activities usually arises from the motives and ethics associated with it (Anderson, 2015). Ethically, the difference of motives of the companies undertaking phoenix activities can arise from the fact that, certain companies undertake these activities due to the fact that it will not be able to survive otherwise with the huge debts on these companies which they are liable to pay to banks.  On the other hand, there are certain companies which have unethical motives behind taking up such activities that result in different purposes behind the phoenix activities (Anderson et al., 2015). In other words, there are certain companies that perform phoenix activities for the purpose of avoiding making payments to the suppliers. This results in having two different sets of purposes behind phoenix activities on the part of the companies.

Benefits and Drawbacks of Phoenix Activities

In case of phoenix activities there are two parties mainly associated with it. One party is the responsible authority/ owner of the present company and another party is the person undertaking the company declared to be failed and liquidation.  In case when an individual declares the company to be failed and undertake phoenix activities, there are certain advantages the person can enjoy. As already stated, legally, phoenix activities are undertaken on the part of a company only when it experiences complex situation like that of huge debts it is responsible to pay to the bank (The Joy of Business, 2017). In such cases the directors, shareholder, owner of the company is benefited under the concept of limited liability. Under the concept of limited liability, the mentioned responsible authorities of the company are generally excused by the law from personal liability due to the failed debts of the company.  Thus, this turns out to be beneficial for the owner, directors and shareholders of the company. Other than that, they can also keep the company running is another advantage associated with phoenix activities for the directors, shareholders and owner of the company (Anderson et al., 2017). However, the mentioned responsible authority of the company also experiences certain losses, which not only includes losing the ownership or hold on the company but it also results limited scope of getting personal credit which is also applicable for small items. In certain cases, the owner or responsible authority of the company also experiences difficulty in opening bank accounts or making online payments even after long period of occurrence of the incident. Similarly, on the part of the individual undertaking the bankrupt company, the major advantage is getting a set of experienced employees in the particular field along its expansion (The Joy of Business, 2017). However, on the part of the company undertaking the bankrupt company becomes liable to pay the debts of the previous company is the major disadvantage of the company undertaking the bankrupt company. Thus, it can be stated that, in case of phoenix activities both the parties have certain profits and losses associated with it.     

Various legislations have been formed for the purpose of prohibiting illegal phoenix activities. One of the mentionable legislation is Corporation Act 2001 (Cth). There is more than one section of the legislation attempting the prohibition of illegal phoenix activities (austlii, 2017). One of the mentionable sections of the legislation is 596AB according to which individuals are prohibited from entering into transactions or agreements having the intention of denying entitlements. This clearly reflects that phoenix activities of companies with the motive of getting rid of personal debts and liabilities are prohibited under the legislation.  

Legality of Phoenix Activities

Performing illegal phoenix activities may result in breaching various sections of Corporations Act 2001 which have been formulated with the purpose of preventing it occurrence. One of the mentionable sections of the legislation in this context is Section 181. Illegal phoenix activities usual lack good faith. Under Section 181 of Corporations Act 2001, it has been stated that under the common laws, the directors are obliged to discharge their duties and exercise their power in such a manner which demonstrates good faith intended for the best interests of the company along with having proper purpose (austlii, 2017). In case of illegal phoenix activities undertaken by companies the intention is to get rid of debts and ensure personal benefits, which would result in breach of Section 181 of Corporations Act 2001.     

Another section of the legislation which may be breached due to illegal phoenix activity is Section 182 (1) according which a director is prohibited from improperly using the position for the purpose of gaining an individual advantage or advantage for another individual or cause damage to the benefits of the company. In case of illegal phoenix activities the responsible individual usually misuses his/her position for the purpose of personal gain that would result in breach of Section 182 (1) of Corporations Act 2001 (austlii, 2017). Due to the breach of the above discussed sections of the act the authority of the company may be awarded with pecuniary penalties of up to $ 200, 000.    

Cook v Deeks and Hinds: PC 23 Feb 1916 is a mentionable case which includes dispute with phoenix activity undertaken by the involved parties. The case included Hinds and Deeks who were directors of a construction company. A negotiation was held between them which were considered to be lucrative and involved a construction contract with Canada Pacific Railway. In this process it was decided by them that they wanted to enter into the contact on a personal basis which also included incorporation of a new company- Dominion Construction Company for the purpose of performing the work (swarb, 2017). Dominion Construction Company taken over the contract who performed the work and make the profit. Toronto Construction Company, a shareholder took a derivative action against Dominion Construction Company as well as against the directors.

The court held Hinds and Deeks to be guilty of breach of their duty in regards to their position which occurred in the process of securing the contract. It was further held that the actions they performed were also required to ensure the benefit of the shareholder- Toronto Construction Company. However, it was observed that they conducted the company affair in such a manner which deliberately exclude the interest of the shareholder and further use their influence and position to exclude the company whose interest were required to be protect by them under their duty (swarb, 2017). On this basis, it was legally concluded that the individuals having control of the company would operate in manner so as to secure the interest of the company as well as act for the benefit of the company rather than their personal interest that can be seen to be absent in case of Cook v Deeks and Hinds: PC 23 Feb 1916 due to performance of illegal phoenix activity.    

Legislation Surrounding Phoenix Activities

There has been various efforts in prohibiting illegal phoenix activities with the help of creating phoenix offence. However, the success of these actions is required to be analyzed. There are various legislations like Corporations Act 2001- Section 596 AB, Section 180-184 , Section 121 of Bankruptcy Act 1966 (Cth) with the help of which efforts have been made towards creating offence. However, as major issue with these phoenix prohibitions is it will be able to capture posh phoenix arrangements that exist within corporate groups which prevents involvement of assets transfer (Anderson et al., 2017). The fact cannot be ignored that with the help of such activities clear demonstration regarding the severity of with which government along with its agencies consider phoenix conduct and consider it in their mechanism can be identified.  Other than that, prohibiting phoenix activity by phoenix offence also becomes inactive in case of illegal phoenix activity with the help of pre-insolvency advice.   It is further mentionable that, in spite of applicability of duties on the part of the directors to illegal phoenix activity and the presence of civil sanctions which are formulated for enhanced level of enforcement the approximate costs of phoenix activity to the economy indicates that these activities are still prevalent indicating the failure of enforcement activities. The lack of available data also makes it difficult to identify the occurrence of these activities. The lack of affectivity of the phoenix offence actions can also be established with the help of the fact that the maximum penalty due to failure in providing liquidations with records and book is $ 9,000 which is beneficial for an individual with large sum of debts to get rid of it. According to (squarespace, 2009) it can be noticed that 75% of insolvent trading cases are won by liquidator further establishing the lack of affectivity of phoenix prohibition activities. Other than that, in only 64% of cases compensation order was less than $ 200,000 in only 11$ of the cases compensation order was more than $ 500,000 also establishing its limited effectively. In addition to this, approximately, 8,5000 insolvency appointment every year in which only 2 judges every year provides an average compensation order of less than $200k reflects the fact that phoenix prohibition activities in insolvent trading is not effective and in case of pre-pack of directors it provides limited barriers (squarespace, 2009).       

In order to make prohibition activities more structure like phoenix prohibition activities, in a generic sense, enhanced level of detect of the activities which are prohibited like phoenix activity is required. The key of achieving success in these cases are sharing and gathering information.

Court Cases Involving Phoenix Activities

In order to make phoenix activities more structured, all directors are required to have direct identification number with the help of which they can link with previous and present directorships (Anderson et al., 2017). This will help in having the present company scenario along with its management which would further help in scrutiny.

With the help of sharing this information to regulators associated with tackling illegal phoenix activity the occurrence can be further managed effectively. In addition to this, liquidators reports to ASIC regarding prior misconduct along with misconduct during liquidation would help in gathering and sharing meaningful information (Anderson et al., 2017). It is also important to provide the public with required information for the purpose of protecting themselves in the process of dealings with a particular company. Such initiatives would help the businesspeople to identify and protect themselves from shonky operators and help them run legitimate businesses in a fair manner.

It is mentionable that disruption can be achieved easily than prevention. For the purpose of achieving this, a probationary category i.e. restricted directorships is required to be imposed on directors followed by five corporate failures on their part during a period of 10 years. These directors are then required to be restricted in the companies in which they would be eligible to manage (Anderson et al., 2017). Their names are also needed to be made available on a register. These identified directors are required to be made subjected to increased number of reporting requirements and regulatory scrutiny. Prosecution of pre-insolvency advisers helping in illegal phoenix activity is also required due to the roles played by them in the wrongdoing. With the help of meaningful penalties and the ability it prevent new company from enjoying the benefits by the court are also important in structuring prohibition. 

References

Anderson, H. (2015). Phoenix activity-a context not a crime. Australian Insolvency Journal, 27(2), 35.

Anderson, H. L., Hedges, J., Ramsay, I., & Welsh, M. A. (2017). Illegal Phoenix Activity: Is a'Phoenix Prohibition'the Solution?.

Anderson, H. L., O'Connell, A., Ramsay, I., Welsh, M. A., & Withers, H. (2014). Defining and Profiling Phoenix Activity.

Anderson, H. L., O'Connell, A., Ramsay, I., Welsh, M. A., & Withers, H. (2015). Profiling Phoenix Activity: A New Taxonomy.

Anderson, H., Ramsay, I., Hedges, J. and Welsh, M. (2017). Here's what must be done to detect, disrupt and deter phoenix activity in Australia. [online] The Conversation. Available at: https://theconversation.com/heres-what-must-be-done-to-detect-disrupt-and-deter-phoenix-activity-in-australia-73367 [Accessed 14 Sep. 2017].

Anderson, H., Ramsay, I., Hedges, J. and Welsh, M. (2017). How director ID numbers and "restricted directorships" could help stamp out phoenix activity in Australia. [online] SmartCompany. Available at: https://www.smartcompany.com.au/business-advice/legal/director-id-numbers-restricted-directorships-help-stamp-phoenix-activity-australia/ [Accessed 14 Sep. 2017].

Asic. (2013). Small business-illegal phoenix activity. [online] Available at: https://asic.gov.au/for-business/your-business/small-business/compliance-for-small-business/small-business-illegal-phoenix-activity/ [Accessed 14 Sep. 2017].

Asic. (2017). Illegal phoenix activity. [online] Available at: https://asic.gov.au/about-asic/contact-us/how-to-complain/illegal-phoenix-activity/ [Accessed 14 Sep. 2017].

austlii. (2017). CORPORATIONS ACT 2001. [online] Available at: https://www.austlii.edu.au/cgi-bin/viewdb/au/legis/cth/consol_act/ca2001172/ [Accessed 14 Sep. 2017].

Martin, A. (2007). Director Duties and Phoenix Companies. Allen Arthur Robinson, Sydney.

squarespace. (2009). Pre-Pack: A Legitimate means to Phoenix an Insolvent Company. [online] Available at: https://static1.squarespace.com/static/55ecf59ee4b01655ac9ab08c/t/55efa4ffe4b0a4ee627c43c3/1441768703387/Pre-Pack+170510.pdf [Accessed 14 Sep. 2017].

swarb. (2017). Cook v Deeks and Hinds: PC 23 Feb 1916. [online] Available at: https://swarb.co.uk/cook-v-deeks-and-hinds-pc-23-feb-1916/ [Accessed 14 Sep. 2017].

The Joy of Business. (2017). The Ethics Of The Phoenix. [online] Available at: https://www.thejoyofbusiness.co.uk/how/the-ethics-of-the-phoenix/ [Accessed 14 Sep. 2017].