One of the attractions of incorporating a company for many people commencing a business is that it can limit the personal liability of its directors to creditors. That is, the company, which has its own legal identity, may owe money to others while the directors personally are somewhat shielded and protected.
This separation, whilst beneficial when adopted for legitimate purposes, can be used as a ‘loophole’ for unscrupulous operators to rack up debts and abandon them while moving their business to a company. This practice, known as phoenix activity, may or may not be legal, depending on the circumstances. Which is why it’s always beneficial to first gain legal advice from an experienced business lawyer when you are unsure.
What is illegal phoenix activity?
Illegal phoenix activity occurs where a company is liquidated, wound up or abandoned to avoid paying its debts. This is usually achieved by a new company being set up and the assets and business being transferred to the new company, which then assumes the business operations. The former company still holds all the existing debts, but the assets are no longer available to meet those debts. Meanwhile, the new company commences operations free of the existing debts, notwithstanding that the business operations may have remained the same.
This practice directly impacts sub-contractors, suppliers, and employees, who are unable to recover sums owed to them. It also often involves an unpaid tax liability, impacting society as a whole.
While it might sound like there would be little warning that a company might engage in phoenix activity, there are many signs associated with the practice. Some of the warning signs would only be identified if you investigated the company and business records, for instance changes to the company name, appointment of ‘straw’ directors (people not involved in running the business or company itself), or transfer of assets. However, there are other signs that you can look out for, depending on whether you are an employee or another business.
If you are an employee, one of the things you might look out for are changes to the ABN and business name on your payslip while all other details remain the same. Similarly, if the name on the payslip is not that of the party you believe you work for, this could indicate phoenix activity.
Other things to look out for include if you don’t receive a payslip at all, or your superannuation is not being paid regularly, as it falls due. It is a good idea to make sure your super is being paid into your nominated account quarterly to ensure that you don’t end up out of pocket. If you don’t and the company is wound up, it may not be possible to recover your entitlements.
If you are in business, before you engage with another company, particularly small companies, it is a good idea to do some due diligence. This would include checking the ABN register and the ASIC Connect Registers, asking for references, and doing credit checks. You might also want to take some steps to reduce the risk of not being paid, such as requiring payment up front or requiring a significant deposit prior to delivery or completion of services.
The difference between illegal phoenix activity and a legal phoenix company
There are also circumstances which would technically be classified as phoenix activity but are not illegal. This occurs where a company genuinely fails, through no fault of the director, and they wish to operate the same business through a new company to rescue the business.
For a restructure to be legitimate, any assets to be transferred to the new company must be sold for fair market value on commercial arm’s length terms to a new company. If this is the case, there is no detriment to the creditors, because they still have access to the proceeds of the sale of the assets, which were sold at market value.
A major difference between legal and illegal phoenix activity is the intention of the directors. Where the activity is legal, the director is not acting to avoid the company’s liabilities. In contrast, where a lot will depend on the intentions of the directors, it is not a legitimate restructure if you dispose of company assets below market value with the intention to make them inaccessible to creditors.
Illegal phoenixing essentially involves activities orchestrated by company officers or associates aimed at avoiding liability for company debt. Where the activity is legal, the directors are not typically viewed as attempting to avoid liability.
If you find that your company is in financial trouble and you want to restructure with a new corporate entity, it is a good idea to appoint a restructuring partner to make sure that your activities are seen as legitimate and lawful.
If you or someone you know wants more information or needs help or advice, please contact us on (08) 8344 6422 or email [email protected].