Directors and companies may soon face a stricter penalty regime for employing 'sharp corporate practices' in an attempt to prevent, avoid or reduce obligations to pay creditors and employee entitlements upon a company's insolvency.
The Australian Government's consultation paper released in early May 2017 calls for submissions to crack down on phoenix activity and corporate restructures after a reported blowout in the Fair Entitlements Guarantee (FEG) scheme saw the government (and ultimately taxpayers) shoulder $1 billion in entitlement payments for employees of insolvent companies over the past four years.
Under the existing FEG scheme, the government provides financial assistance for certain unpaid employee entitlements to eligible employees who have lost their jobs due to the insolvency of their employer. The scheme has been criticised as presenting a 'moral hazard', as it enables certain employers to use smart corporate practices to prevent, avoid or minimise paying entitlements with the knowledge that the government, and ultimately the taxpayer, will pay some or all of any outstanding employee entitlements.
Despite the introduction of provisions under Part 5.8A of the Corporations Act, which criminalises such deliberate restructuring, there have been no successful prosecutions in 17 years since the provisions took effect.
Whilst the use of sharp corporate practises are not always strictly illegal, the Government claims such tactics place an unfair burden on taxpayers where they result in reliance on the FEG scheme.
Examples of these tactics include:
- utilising a company or corporate group structure whereby employees are employed by an entity which does not provide for their entitlements and where insufficient realisable assets are available to offset liabilities owed to employees if they are made redundant, or the assets of the entity which employs the workers are transferred to related entities prior to the employees being made redundant
- utilising illegal phoenix company activities and arrangements, including transmissions of businesses and transfers of a company's assets for nominal or no value to another company with a similar name, with the same directors or officers, before placing the company in liquidation for the purpose of avoiding debts to company creditors including liabilities owed to employees
- adopting deliberate practices to unfairly manage an insolvency to the detriment of creditors (for example, by a director appointing a 'friendly' liquidator to wind-up a company, with the liquidator then not investigating suspect transactions in the liquidation process); and
- conduct of some company receivers and company liquidators appointed by security agreement holders who do not comply with their obligations under the law to pay employee entitlements out of the proceeds of circulating assets of the business (such as trade debtors), but instead pay those amounts to their appointers.
The Government's proposed changes aimed at deterring these 'inappropriate' behaviors which ultimately exert financial pressure on the FEG scheme and taxpayers include:
- lowering the threshold of proof in the provisions in the Corporations Act to include recklessness as a fault element rather than just subjective intention
- increasing the maximum penalties under the Act
- introducing a civil penalty (separate to the criminal offence) based on an objective test
- expanding the parties who may bring a civil action to include the Department of Employment, the Fair Work Ombudsman and the Australian Tax Office; and
- reforms to target groups which abuse the corporate veil to rely on the FEG scheme, such as introducing a shared obligation for a group structure to meet unpaid employee entitlements of their related entity.
The paper suggests that there will be a strong focus by Government and its agencies (ASIC) on this behavior and potentially more prosecutions.
If implemented, the reforms will increase directors' personal liability exposure for the debts of the company, adding to their obligations under the director penalty regime which was expanded in 2012 to include personal liability for outstanding superannuation obligations of the company.
In the days leading up to this article being published, the Labor Party announced a policy to crackdown on phoenix activity, under which Australian company directors will be forced to undergo an identity check and be assigned a special identification number. The policy is aimed at exposing unscrupulous directors who abuse the current rules (which do not require extensive proof of identify) and register numerous companies using different versions of their name.
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