Australia: Directors & Officers: Phoenixing Reforms

Insurance update

At the end of 2011, the Federal Government introduced two draft Bills directed at clamping down on companies that engage in "phoenix" activity.

A phoenix company is a vehicle used by directors of a failing company. Like the bird in Greek mythology, the failing "phoenix" company rises from the ashes of a former version of itself and trades with the assets and customers of the old failing company whilst leaving the debts and other liabilities in its shell. In this way, the directors are able to block unsecured creditors of the failed company from accessing the phoenix company's assets. Often the phoenix company bears a name very similar to the failed company, making it easy to take advantage of the failed company's goodwill. Where the failed company has a poor reputation however, the phoenix company will often trade under an entirely different name.

The draft legislation proposes to introduce a range of measures to make phoenix activity less attractive, whilst granting ASIC additional administrative powers.

Phoenixing Bill

The draft Corporations Amendment (Phoenixing and Other Measures) Bill 2012 focuses on amendments to the Corporations Act 2001 (Cth) (Act) that provide ASIC with power to address phoenixing activity. The key provision gives ASIC administrative power to order the winding up of a company when, amongst other grounds, it appears to ASIC that the company is no longer carrying on business.

Currently, the Government's General Employee Entitlements and Redundancy Scheme (GEERS) provides employees of a failed company with an opportunity to seek to recover certain unpaid entitlements. However, employees can only do so if the company is placed into liquidation, and this is of no assistance to employees of a company whose directors have simply walked away from the company but not wound it up, as is the case with a phoenix company. The Bill seeks to overcome this by allowing employees access to GEERS once ASIC takes steps to wind up a company. It would also enable a liquidator to investigate the affairs of an abandoned company, including where there is suspected phoenix activity or misconduct.

Similar Names Bill

The Corporations Amendment (Similar Names) Bill 2012 proposes amendments to the Act which would impose personal joint and individual liability on a director of a new phoenix company for debts incurred by the phoenix company where:

  1. that company has the same or a similar name to the name of the failed company; and
  2. the director of the phoenix company was also a director of the failed company for at least 12 months prior to its winding up.

As such, the debts for which a director could be liable are the debts incurred by the phoenix company, not the failed company. Further, the Bill prescribes that a director could be personally liable for debts incurred by the phoenix company within five years of the commencement of the winding up of the failed company.

The Bill does provide for some exemptions. A director is not liable where:

  • the failed company has paid its debts in full; and/or
  • the director can establish that he/she acted honestly.

In considering whether a director acted honestly, the court will consider:

  • whether, at the time the failed company incurred the debt, there were reasonable grounds to expect it was insolvent;
  • the extent to which assets, employees, premises and contact details of the failed company have been transferred to the phoenix company; and
  • whether anything done or omitted to be done by the failed company is likely to have created the misleading impression that the failed company and phoenix company are the same entity.

If a phoenix company is formed, its directors will want to be confident of the trading health and working capital of the new company as they may be personally liable for the debts of the new company for five years. Whilst an exemption may protect them, obtaining an exemption could be an expensive and time consuming process.

Reaction to the Bills

The Similar Names Bill has been subject to particular criticism. One issue raised is that not all phoenix companies are created with the same or similar name to the failed company, particularly if the failed company had no goodwill with its customers. The Similar Names Bill does not address this and as currently drafted, would not impose any liability on those directors who engage in phoenixing activity by using a business name which is not the same or similar to the failed company. Further, the Similar Names Bill does not draw a clear line in terms of determining how similar the names of the failed and phoenix companies need to be to link the phoenix company with the failed company.

Although the Similar Names Bill provides creditors of the phoenix company with access to the directors' personal assets, it provides no recourse to the creditors and employees of the failed company, which are likely to be the hardest hit.

The proposals also appear to create the potential for the directors of multiple companies with related names in the same corporate group to get caught by the new laws, even where they have been trading honestly. Consequently, the Australian Institute of Company Directors has expressed the view that it should be made clear in the Similar Names Bill that imposition of personal liability on directors should only apply when fraudulent phoenix activity has occurred, not when a business has failed.

The time period in which interested parties can comment on the Bills has now passed and the final versions of the Bills are awaited.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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