Illegal Phoenixing and Creditor-Defeating Disposition: The First Court Ruling

In February 2020, an amendment to the Corporations Act 2001 was introduced as part of the Commonwealth government’s insolvency law reform.

The Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2019 was designed to crack down on illegal phoenixing across Australia, bolster the powers of ASIC, and improve the ability of liquidators to adequately address and pursue illegal phoenix activity - a practice that the government estimated was costing the economy billions of dollars every year.

In May 2022, the first Court ruling was made on these anti-phoenixing provisions, and it has provided interesting reading for those advising clients that are in financial difficulty, or whose clients may have customers experiencing financial difficulty!

What is Illegal Phoenixing?

The practice of illegal phoenixing occurs when a company or business entity is stripped of its assets and they are transferred to a new entity for below market consideration (while the outstanding debts remain with the former entity).

Illegal phoenixing may be either opportunistic (in that the intention to avoid debts arises as the company starts to fail) or intentional, where businesses may be set up with the intention to ultimately fail, using repeat insolvency or complex corporate structures to avoid payment of debts.

The common characteristic of illegal phoenixing however, regardless of whether it is intentional or opportunistic, is that it renders a company unable to pay its debts, hindering the process of liquidation and denying creditors access to the entity's assets to meet the unpaid debts.

A Real-World Example of Illegal Phoenixing

Smith Hancock was recently appointed as the liquidator of Company A, a company which provided services within the construction industry and held several assets including debtors, plant and equipment and works in progress.

Approximately two months prior to our appointment, Company A ceased to make any further payments from its bank account and effectively appeared to have ceased trading.  Company B was then incorporated – taking on the employees of Company A, continuing its operations, and using the assets and premises of Company A. The director of Company B was a former employee of Company A. The initial shares of Company B were held equally between the director of Company B and the director of Company A.

The customers of Company A were notified of a change in Company A bank details, and were asked to remit outstanding payments to a new bank account understood to be in the name of Company B.  Company B is understood to have acquired in excess of $199,000 of Company A’s assets. No consideration was provided to Company A for this transfer of business and assets, other than an allegation that Company B was required to pay the outstanding wages of the employees and make some nominal payments to supplier accounts to ensure continued trade.

Company A, when placed into liquidation, was left with creditor claims exceeding $2 million.

While this matter is ongoing, it is our intention to conduct public examinations regarding the transfer of Company A’s business and assets with a view to commencing recovery proceedings.

Creditor-Defeating Dispositions and Illegal Phoenixing

Closely linked to the practice of illegal phoenixing, a creditor-defeating disposition occurs when a company transfers property to another entity for less than its reasonable market value with the intention of hindering the company’s ability to meet the claims of its creditors. 

The newly introduced Section 588FDB of the Corporations Act states that a disposition of property of a company is a creditor-defeating disposition if:

• the consideration payable to the company for the disposition was less than the lesser of either the market value of the property or the best price that was reasonably obtainable for the property, having regard to the circumstances existing at that time; and
• the disposition has the effect of preventing, hindering, or significantly delaying, the property from becoming available for the benefit of the company’s creditors in the winding-up of the company.

Under the new amendments to the Corporations Act, a creditor-defeating disposition will also be voidable upon liquidation of the company, subject to the criteria set out in that section (predominantly, that the transaction occurred within 12 months prior to the relation back-day, or up to the date of appointment, and the company was or became insolvent as a direct or indirect result of the transaction).

In addition, the Corporations Act sets out a range of new duties to prevent creditor-defeating dispositions by extending liability to persons who facilitate a company making a creditor-defeating disposition, including professional advisers such as solicitors and accountants. 

Under the Act:

• An officer of a company must not engage in conduct that results in the company making a creditor-defeating disposition of property of the company; and
• A person must not engage in conduct of procuring, inciting, inducing, or encouraging the making by a company of a disposition of property that results in the company making the disposition of the property.

Remedies and Penalties Under the Act

If a creditor-defeating disposition is proven to have occurred, a range of remedies will be available.

The Australian Securities & Investments Commission (“ASIC”) now has the ability to make an administrative order, extending the provisions available to liquidators to recover the assets disposed of via illegal phoenixing.

Such administrative orders state that:

• the property involved in a creditor-defeating disposition be returned; or
• the amount representing the benefit be paid to creditors or liquidators; or
• an amount that ‘fairly represents’ the proceeds be paid.

The amendments also introduce criminal and civil penalties for individuals and corporations that contravene the duties to prevent creditor-defeating dispositions. Penalties may include fines of up to 4,500 penalty units ($999,000) for individuals and 45,000 penalty units ($9,999,000) for corporations. Individuals can also be imprisoned for up to 10 years and corporations can be fined up to 10% of their annual turnover.

The First Court Ruling on Anti-Phoenixing Provisions

On 11 May 2022, the Supreme Court of Victoria delivered judgment in Re Intellicomms Pty Ltd (in liq) [2022] VSC 228, the first case to address the new provisions of the Corporations Act.

In this matter the Court held that a sale agreement transferring the business assets of Intellicomms Pty Ltd (“Intellicomms”) immediately prior to the appointment of the liquidator was a creditor-defeating disposition as defined in section 588FDB of the Corporations Act.

Intellicomms procured four separate valuations of its business and assets in 2021, leading up to its liquidation. Each report provided decreasing valuations of Intellicomms' business and assets. Each valuation was prepared from information provided by Intellicomms demonstrating a worse financial position for Intellicomms, but no explanation was proffered as to why multiple valuations were sought in such a short period of time. The Court found that the valuations did not include all assets that were transferred by Intellicomms.

The court determined that the consideration payable under the sale agreement was less than the market value of the assigned assets and the best price that was reasonably obtainable for them, with such disposition of the assets clearly having the effect of preventing that property from becoming available for the benefit of the creditors of Intellicomms in the winding up. The sale agreement was also entered into at a time when Intellicomms was insolvent. In particular, the Court described that the Sale Agreement amounted to a “brazen and audacious example” of a phoenix transaction.

The Court also noted that while it foresaw difficulties in declaring the sale of the business transaction void, due to the dynamic nature of the business of Intellicomms, such difficulties were the making of those who entered into the illegal phoenixing transaction and such declaration should ultimately be made.

The decision provided some insight into the test the Court will apply when considering whether a transaction is a creditor-defeating disposition.

Moving Forward

Future cases will further clarify how the Amendments will be applied and any penalties imposed.

However, it is apparent that a liquidator will only be required to establish that, on the balance of probabilities, the consideration payable for the disposition was less than the market value and best price reasonably obtainable at the time of the transaction having regard to the circumstances existing at the time.  A liquidator will NOT be required to establish sufficient evidence upon which the Court can determine the actual monetary value of the market value or the best price reasonably obtainable for the assets.

Moving forward, the amendments to the Act will hopefully provide greater clarity regarding illegal phoenixing transactions and scope for liquidators to recover assets during winding-up proceedings.

For more information on creditor-defeating dispositions and illegal phoenixing, contact the team at Smith Hancock.