Economic growth and development are key indicators of the success of any nation. To safeguard the interests of creditors and shareholders, Australian company laws introduced phoenixing laws to deal with situations where a company is deliberately liquidated or wound up to avoid financial obligations such as paying debts and taxes.

Illegal Phoenixing

The term “Illegal Phoenix Activity” refers to the act of establishing a new company to continue the business of an old company that has been liquidated or abandoned in order to evade payment of outstanding debts, including taxes, creditors and employee entitlements. This generally occurs when the company directors abandon the old company or transfer the business without payment of true or market value, leaving the debts with the old company. Once the assets have been transferred, the old company is placed in liquidation or abandoned, and if a liquidator or administrator is appointed, there are no assets to recover, which means creditors cannot be paid. However, not all company failures involve illegal phoenix activity, as genuine company failures may happen. Legal phoenix activity, also known as a Company Restructure, occurs when directors responsibly manage a failed company and operate the same business using another company without engaging in illegal phoenix activity.

In Australia, the Australian Securities and Investments Commission, ASIC, reported costs exceeding $ 5.13 billion in phoenix scams per annum. The government introduced specific laws, including the Corporations Act 2001 and the Income Tax Assessment Act 1936, to prevent such fraudulent activities and impose penalties.

To combat illegal phoenix activity, the Australian federal government announced a series of reforms in the 2018-19 federal budget. The Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020 (Cth) amended the Corporations Act 2001 (Cth) (Corps Act), introducing new criminal offences and civil penalties for officers who do not act in the interests of the creditors and fail to prevent the company from making creditor-defeating dispositions. The reforms also enable ASIC to make orders to recover assets lost through illegal phoenixing activity or require a person to pay an amount to the company that, at ASIC’s discretion, fairly represents the benefits that the person has received due to the disposition.

Recently, the Supreme Court of Victoria handed down the first decision enforcing the new regime in Re Intellicomms Pty Ltd (in liq) [2022] VSC 228. The court held that the sale of the business to a related party immediately before the company went into liquidation was a creditor-defeating disposition under section 588FDB of the Corps Act and described the sale agreement as a ‘brazen and audacious example’ of illegal phoenixing activity.

Impacts of illegal Phoenixing

Illegal phoenixing can cause significant harm to Australia’s economy:

First, it causes financial loss to creditors, contributing to the credit crunch. Creditors may have no alternative recourse other than legal proceedings to recover their funds. These costs the creditor time and money, reducing liquidity in the economy.

Second, it reduces tax revenue. Companies may raise funds without paying taxes, creating an uneven playing field in the market.

Third, it leads to job losses. The workers, mainly the dependent employees, lose jobs, which affects their income and standard of living.

Fourth, it undermines the trust of the public in the market relating to the authenticity of companies.

Legal Phoenixing

Legal phoenixing is the transfer of business assets and operations to another company without incurring liability for debts and obligations. Unlike illegal phoenixing, legal phoenixing is a legitimate business operation that can provide debt relief for companies facing financial uncertainty.

To be considered legal, phoenixing involves proper legal procedures, and the stakeholders of the new company will have legal obligations to streamline previous financial obligations.

Impacts of Legal Phoenixing

Legal phoenixing can also have significant impacts on Australia’s economy, which include:

First, it allows the reorganization of troubled businesses, protecting their creditors and jobs created by the initial organization. This leads to economic stability, reducing the number of bankruptcies, and encouraging new business developments.

Second, it rejuvenates corporate governance by removing outdated business processes and policies and replacing them with updated ones, thus increasing overall efficiency and productivity.

Third, it enhances competition, leading to diversification in the market, increasing consumers’ disposable income, and reducing prices.

Both illegal and legal phoenixing have different impacts on the economy of Australia. Illegal phoenixing harms the economy, while legal phoenixing optimizes economies of scope, empowering businesses to focus on their core competencies, and contributing to the attainment of strong economic growth. It is advised that stakeholders stay aware of the legal repercussions of illegal phoenixing to avoid legal lawsuits and a tarnished reputation in the market.

To ensure compliance with legal requirements and recommend structures for small businesses to succeed, our team of restructuring and strategic advisory lawyers can provide detailed advice and assistance.