Phoenix companies targeted in suite of draft law reforms introduced

Last year right before Christmas, the Gillard government released a set of two draft bills directed at cracking down on phoenix companies – the Corporations Amendment (Phoenixing and other measures) Bill 2012 (the Phoenixing Bill), and the Corporations Amendment (Similar Names) Bill 2012 (the Similar Names Bill). Yesterday was the deadline for submissions on the second of these Bills.

For the uninitiated, a “phoenix company” is a vehicle used by some directors of a failing company, to continue to trade on using a new entity, stepping away from and leaving the unpaid debts of the business in the shell of the old company. In other words, one day a company ceases trading and is left behind with just a pile of debts, and the next day the phoenix company, like the bird from Greek mythology, rises from the ashes, opens its doors and trades on with the same assets and customers. Often, the phoenix company bears a closely similar name to the old company, making it easier to assume the old company’s goodwill. However in some cases, the old company’s reputation is poor, so the phoenix company will trade under an entirely different banner, to avoid the taint of the old name. In either case it is a misuse of the company law concept of limited liability.

In Parliament yesterday, in debate on the second reading of the Phoenixing Bill, Joe Hockey said that Dun and Bradstreet research reveals that of companies that “became insolvent” in 2009-2010, 29% had one or more directors who had previously been involved with a failed, wound-up entity. This compares with 10% during the 2004-05 financial year. It would appear, then, that phoenix activity is on the rise. The ATO has been reported as stating that there are about 6000 phoenix companies in Australia and from 7500 to 9000 directors who will have personal liabilities under this legislation.

It was a curious move, for the government to release the two bills just 5 days before Christmas, and give interested parties tight time-frames to respond, largely running through the Summer break period – 24 January in the case of the Phoenixing Bill and 29 February for the Similar Names Bill. (Note that although the submissions received by Treasury have not been published, the Phoenixing Bill has already been introduced and read in the House of Representatives on 15 February 2012, the second reading debate has taken place yesterday and today.) This haste is especially surprising after last year’s false start as to other draft legislation designed to combat phoenix companies and rogue directors, in particular with regards to company’s taxation liabilities. On 24 November 2011 I posted the news that the government had withdrawn a bill then before Parliament, which was to increase the ATO’s powers to pursue directors personally for certain company tax liabilities – without first issuing a DPN, and broaden the range of taxes for which a director could be made personally liable – you can read my post here.

Earlier today, the Parliamentary Secretary to the Treasurer, the Hon David Bradbury MP, issued a press release to the effect that Tony Abbott and the Coalition have announced that they will “say no” to the Phoenixing Bill, which Mr Bradbury described as legislation that would ensure workers are able to access their entitlements where directors have abandoned a company. Unsurprisingly, Mr Bradbury used expressions such as “workers [should not be] dudded out of their entitlements…” and the punchline was “Tony Abbott and the Coalition should stop saying ‘no’ and back this legislation so that workers are not left out in the cold.” However the speeches I read in Hansard do not suggest a blocking of the proposed measures, rather an urge for a more careful and less hasty consideration of aspects of them.

In any event, that’s the political spin. Here is the substance of the proposed new laws.

Phoenixing Bill

This Bill proposes amendments to the Corporations Act 2001 (Cth) (the Act) which would give ASIC certain powers to address phoenixing activity. In particular, the Bill gives ASIC the administrative power to order the winding up of abandoned companies. The power would be triggered when, amongst other grounds, it appears to ASIC that a company is no longer carrying on its business.

The primary aim of this measure is the protection of workers’ entitlements, and indeed is part of the range of reforms included in the government’s Protecting Workers Entitlements Package, a 2010 federal election commitment confirmed by announcement in the 2011-12 Budget.

Already, workers employed by a failed company can seek to recover certain unpaid entitlements through the Government’s General Employee Entitlements and Redundancy Scheme (GEERS). However they can only do so if the company is placed into liquidation, which is of no assistance if the directors have simply walked away from the company without winding it up.

ASIC’s proposed new power to order the winding up of a company will enable employees more swiftly to access GEERS. It will have the additional benefit of enabling a liquidator to investigate the affairs of an abandoned company, including suspected phoenix activity or other misconduct.

A secondary set of measures in this bill are cost-saving measures aimed at facilitating the publication of corporate insolvency notices on a single publicly available website, rather than in the print media or the ASIC gazette.

Similar Names Bill

The Similar Names Bill proposes amendments to the Act which will impose personal joint and individual liability on a director for debts of a company that has a similar name to a pre-liquidation name of a failed company (or its business) of which that person was also director for at least 12 months prior to winding up. You might want to read that sentence again. The debts for which a director could become personally liable are debts incurred by the new (phoenix) company within five years of the commencement of the winding up of the failed company. Five years. You might want to read that again too.

The bill is not proposed to have retrospective effect. It will only apply to debts incurred after the legislation comes into force, and where the winding up of the old company commenced after the legislation comes into force. Directors would not be liable for the debts of the new company when the failed company has paid all of its debts in full. There is the incentive for directors not to try to walk away from a failed company leaving unpaid liabilities in its shell. However on one view, it is a surprising approach to take, which has already lead to some confusion (see below).

Innocent directors could avoid liability by obtaining an exemption from liability from the liquidator, or a similar Court-ordered exemption, if they can establish they have acted honestly and, in all the circumstances, ought fairly to be excused from liability. Some of these concepts will be already familiar to corporations lawyers.

The liquidator, or the Court, in considering whether to grant an exemption must take a number of matters into account, including whether there were reasonable grounds to suspect insolvency at the time debts were incurred by the failed company (more familiar concepts). Another matter the liquidator or the court must consider is, in broad terms, how brazen has been the extent of “phoenix activity” in the particular case. Specifically –

  • the extent to which the new company has assumed the assets, employees, premises and contact details of the failed company, and
  • whether any act or omission by the directors was likely to create the misleading impression that the new company was the same company as the failed company.

Of course one can see the clear potential for directors of multiple companies with related names in the same corporate group to get caught by these proposed new laws. The Bill does seek to address this. It provides an exemption for directors of a similarly-named company that was carrying on business in the 12 months before the commencement of the winding up of the failed company. A question will be whether this exemption goes far enough to avoid the imposition of liability on directors with no involvement in phoenix companies or activity , beyond the intended scope and focus of these reforms.

Commentary

I have to confess when I started reading the exposure draft of the Similar Names Bill and its explanatory document, I was expecting to see that the directors of the phoenix company were being made personally liable for the liabilities of the failed company that they had sought to shed, by leaving them behind in the shell of the failed company. However, clause 596AJ of the Bill imposes personal liability upon directors for the debts of the new company, referred to as the “debtor company”, not the debts of the failed company. Unfortunately, the drafters of the explanatory document accompanying the exposure draft of the bill were confused themselves. They explain clause 596AJ accurately as imposing liability for debts of the debtor company. However in the passages explaining Court-ordered exemptions from liability (under clause 596K(1)), they refer to exemptions for liability of “some or all of the debts of the failed company to which the person is otherwise liable under clause 596AJ”. I re-checked the exposure draft again, and this explanation is inaccurate. It is to be hoped that there will be no such confusion in the final version of the Bill and its explanatory memorandum, when those documents are finalised post-submissions.

Effectively, if a phoenix company is formed, directors will want to be confident as to its trading health and adequacy of its working capital, as they may be personally liable for the debts of the new company for the next five years. This is bound to raise concern in the business community, because there may be circumstances were some directors become personally liable for something they were not involved in and were not aware was going on, through no fault or carelessness of their own. Query whether the scope for obtaining exemptions appropriately protects them, when that process could easily turn out to be expensive and drawn out. Even if a director successfully obtains an exemption from the liquidator of the failed company, without having to go to Court, clause 596AL(7) provides that the liquidator is entitled to be paid “reasonable remuneration” for making an exemption determination. Paid, that is, by the director.

Another problem may be that some phoenix companies (with same assets, same employees, same premises, same contact details, same customers) use different names from that of the company whose business they assumed, because the old name is tainted and the new entity has not wish to be affected by it. It would appear that such phoenix companies will not be caught by the proposed new laws.

Another issue is that the Similar Names Bill only addresses situations where the new company uses a similar company name to the old company or business. If the new company uses a similar business name, this would not appear to be caught by the Bill as presently drawn.

Also, the Bill does not seek to define the where the line is drawn in terms of the degree of similarity required before a name is deemed to be so similar as to “suggest an association with the failed company”. It is unknown if this omission was deliberate or not, but it could be said to be asking for trouble to provide no better guidance to the business community, and to the Courts which will be required to apply these laws.

Conclusion

I suggest it may be better if Treasury takes a more measured approach to the finalisation of the Similar Names Bill, including better consultation with the public and interested bodies than it allowed with regards to the Phoenixing Bill, and a more careful consideration of the ramifications and potential gaps or shortcomings of the Bill as presently framed. We can await developments with interest.

On a final note, on 27 January 2012, Treasury also announced the release of an exposure draft of another bill: the Personal Liability for Corporate Fault Reform Bill 2012, for which the closing date for submissions is 30 March 2012.  This is described as the first tranche of proposed amendments to Commonwealth directors’ liability legislation, and covers Treasury (non-taxation) legislation. The stated aim of these reforms is to harmonise the principled approach to the imposition of personal criminal liability for corporate fault already provided for across Australian jurisdictions. Treasury’s announcement may be read here.

4 thoughts on “Phoenix companies targeted in suite of draft law reforms introduced

  1. Pingback: Proposed Law on Phoenix Activity Falls Flat « markmckillopbarrister

  2. Pingback: Newsflash #2: Phoenixing Bill passed in the Senate | Carrie Rome-Sievers, Barrister

  3. Pingback: Snapshot updates on Willmott Forests, phoenixing and new offers of compromise rules | Carrie Rome-Sievers, Barrister

  4. Pingback: Merry Christmas & a note for my own amusement | Carrie Rome-Sievers, Barrister

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