By John Winter, Chief Executive Officer, Australian Restructuring Insolvency and Turnaround Association
Probably the most perplexing part of the current debate on phoenixing of businesses is why there's so much debate about it.
Let's cut to the chase: we know that illegal phoenixing is ripping off creditors, its ripping off taxpayers and giving offenders an unfair business advantage. We also know that there's a whole range of laws that can be used to stop phoenixing already in existence. We know that registered liquidators report over 8,000 potential instances of offences involving directors to ASIC every single year. We know that almost no-one is prosecuted for being involved in illegal phoenixing.
What's actually going wrong?
Well, the first and most obvious issue is that the evidence is not being converted into prosecutions. Absent those prosecutions a strong signal is being sent to the market that you can phoenix and get away with it. The extent of that problem occurs because this has been going on for so long that it has now become endemic behaviour in some industries, to the extent that some company directors actually build their corporate structure with an engineered insolvency in mind from the start, taking their profit from not paying their bills.
Is it illegal?
This is one of the most important questions. There's good phoenixing and there's bad phoenixing.
Good phoenixing is what you'd properly call restructuring and turnaround. It's taking a business in some element of distress and getting it back in shape. Sometimes that requires debt compromises. Those debt compromises, though, are done with full disclosure and agreement and without undue duress on both sides of the table. It's discussions that involve professionalism and integrity where you as a creditor can say to your debtor "ok, you've been honest about being unable to repay me, I can work out a deal with you that means I will get paid some of what you owe me now, but I will back you on that to remain a good and responsible customer in the future". Everyone wins from that. And all business involves risk and compromise.
Bad phoenixing is where you don't have say as a creditor. Where your reasonable claim on payment, and on assets that may back that potential payment, are spirited away by some deceptive move and are hidden from recovery by you.
We'd contend that s588FE(5) of the Corporations Act already gives the basis for prosecuting action against directors who do this type of bad phoenixing.
How do we stop it?
Well, it gets stopped by real action. We have to send the signal to the market that you can't get away with it and the cost for doing it outweighs the potential benefit.
They're pretty good at that in the UK. Companies House in the UK (their equivalent of ASIC) regularly promotes stories of their success in prosecuting dodgy directors. And so, the market responds with phoenixing being less endemic.
Aside from that, here's a few key ways to end illegal phoenixing:
1. Reduce the burden of proof
We readily accept that it's expensive and hard for ASIC to meet the evidentiary burden to enforce many of the aspects of the Corporations Act. So, let's make repeat offending, even repeat usage, a strict-liability or administration offence with large dollar fines and director/officeholder banning. A similar regime already exists in bankruptcy under s 139ZQ of the Bankruptcy Act.
2. Director Identity Numbers
There appears agreement on both sides of politics to make this law, but let's ensure it does become a requirement. If we need a tax file number for personal income, surely we can require directors to have a registration that prohibits them using fake or slightly altered names.
3. Stop Directors Backdating Resignations or Abandoning Companies
These are two of the better suggestions in the current anti-phoenixing proposals. That directors can wilfully abandon a company and leave it director-less is farcical. That you can back date a resignation with legal effect, even more so. We even support a regime in which both companies and individual directors have a mutual obligation to separately report resignations and registrations. The company structure brings with it privileges, it should also come with responsibilities.
4. Fund liquidators to pursue directors
One of the main issues that gets exploited by illegal phoenixers is that a company is left so stripped of assets that a liquidator remains completely unfunded to pursue proper investigations. Liquidators are the first line of defence against phoenixers. The Assetless Administration Fund (AAF) exists to support liquidators to do this, but, at the moment, the liquidator must make a lengthy application (when they are already unfunded) which has a low probability of being successful. The AAF needs to be larger and more easily accessible and to a significant degree.
5. Require follow up on liquidator reports of director offences
In every liquidation, a registered liquidator must report to ASIC if they suspect director offences have occurred. Currently, this disappears into a black hole. Creditors should hear back from ASIC about this before an insolvency appointment is concluded, and they should be told why ASIC isn't investigating further or pursuing the directors.
ASIC's Annual Report 2015/16 reported that liquidators lodged 9,951 reports with 8,258 alleging misconduct. Of those, following supplementary reports, only 129 reports (1.5% of the reports alleging misconduct) were referred for compliance, investigation or surveillance. There were only 36 directors banned in this period.
6. Restrict related party voting
Phoenixing is all about transactions with related parties. Stop them voting on proposed removal and replacement of an external administrator (to the extent that a liquidator is aware of – or able to verify – a creditor's 'related' status). That shuts them out of the process. Of course, that does place an additional burden on other creditors to become and remain active in the insolvency process – but we think that's an important responsibility, regardless.
This proposal is found in the current anti-phoenixing paper and we'd strongly agree with it.
7. Shut down the dodgy "pre-insolvency advisers"
These dodgy advisers – almost all unqualified and currently unregulated
– are the vultures who are teaching people how to phoenix their businesses and, largely, get away with it.
They need to be shut down. How? Well each of them are currently giving advice that is either legal advice, tax advice or financial product advice.
Guess what? Giving legal advice without being a qualified, registered practicing lawyer is an offence. Giving tax advice without being a registered tax practitioner is an offence. Given financial product advice without an AFSL is an offence. Sometimes the solution is all too obvious.
Registered liquidators, and especially ARITA Professional Members, are a key part of the solution to addressing illegal phoenix activity. As a profession, we are tired of seeing this erosion of the confidence in the insolvency process, especially when the solutions are obviously at hand.