Alert – Bills to battle phoenix activity released for public comment

23 January 2012

Exposure drafts of two Bills aimed at reducing phoenix activity were released for public comment on 20 December 2011.

The Corporations Amendment (Similar Names) Bill 2012 (Similar Names Bill) will expose directors to personal liability for their company's debts, if:

  • the company's name is the same as or similar to a company or business name of another company that has been wound up; and

  • the director was also a director of that other company; and

  • the debts are incurred within five years after the start of the winding up of the other company.

The Corporations Amendment (Phoenixing and Other Measures) Bill 2012 (Phoenixing Bill) will give ASIC administrative power to order that a company be wound up, generally in circumstances where ASIC considers that the company has been 'abandoned'. This will trigger employees' entitlements under the Government's General Employee Entitlements and Redundancy Scheme (GEERS).

Both Bills reflect election commitments in the Protecting Workers' Entitlements package announced in July 2010. But will their proposed measures be effective?

What is phoenix activity?

Phoenix activity occurs when the directors of a company deliberately misuse the corporate form, with the intention of denying unsecured creditors access to the assets of the company in order to meet their unpaid debts. For example, shortly after Company A fails, a new Company (Company B) commences trading, using some or all of the assets of Company A. Company B is commonly controlled by the directors or controllers of Company A, or their related parties.   These arrangements may also be facilitated by placing Company A into external administration before, or shortly after the transaction is completed.

Similar Names Bill

If passed, this Bill will impose joint and several personal liability on directors of a debtor company which is known by a name that is the same, or similar to, a pre-liquidation name of a failed company of which they were directors, for the debtor company's debts incurred in the five years after the start of the winding up of the failed company.  The liability is subject to limited but important exemptions.

Liability

Section 596AJ imposes liability on a person for debts incurred by a debtor company if:

  • the person was a director of the debtor company when the debt was incurred;

  • the person was a director of a failed company at any time during the 12 month period prior to the start of the winding up1 of the failed company;

  • when the debt was incurred, the debtor company was known by a name that is the same as a pre-liquidation name of the failed company, or so similar to a pre-liquidation name of the failed company as to suggest an association with it; and

  • the debt was incurred after the Bill's commencement and within the 5 years beginning at the start of the winding up of the failed company.

Key concepts: 'failed company' and 'pre-liquidation name'

A failed company is defined as a company that has been wound up, if an unsecured debt or claim was proved in the winding up, and the winding up started after the Bill's commencement. The definition is both broad and narrow. It is broad because it does not acknowledge or allow for the range of circumstances in which a company is wound up, for example in legitimate corporate restructuring that has nothing to do with phoenix activity, as set out below.  It is narrow in that the company does not 'fail' (as defined) until the winding up has been completed – by that time, there is no company left!

A pre-liquidation name is any name by which the company was known in the year leading up to the start of the failed company's winding-up. For that purpose, a company is 'known' by its own name and by the names of each of its businesses (sections 596AP–596AQ).

Bearing in mind these definitions:

  • In the scenario referred to above, the Bill imposes personal liability on the directors of Company B to pay the new debts incurred by that company after the transaction is completed.  This would be in addition to any existing liability they may have for those debts under the insolvent trading laws.  The Bill does not give the creditors of Company A any additional rights to recover their debts.  While the creditors may be the same, with essential creditors being able to get their debts paid as a condition of ongoing support of Company B, other non essential creditors can be left behind.

  • On the other hand the Bill proposes exposing directors to personal liability in some corporate restructuring circumstances that have nothing to do with phoenix activity. For example, where directors of a company having a combination of bad and good businesses decide to take the good businesses out, for fair value, and place them in a new company in which they will continue to operate under their present business names, distributing the purchase price to the creditors of the old company in its winding up though not discharging all of the old company's debts, the directors expose themselves to liability for future debts of the new company for a period of up to 5 years.

However, there are some exemptions from liability.

Exemptions from liability

If the failed company has paid all its debts, the directors of the debtor company will not be personally liable for its debts under section 596AJ (section 596AN).

A director may apply to the Court or the liquidator of the failed company seeking exemption from section 596AJ liability.  The Court may, on application by a director, make an order exempting a director from section 596AJ liability for some or all of the debts of the debtor company. The exemption may be subject to conditions, and can be prospective (subsections 596AK(1)-(2)).

The Court may only make an order if it is satisfied that the person has acted honestly, and that having regard to all the circumstances of the case the person ought fairly to be exempt from liability under section 596AJ (section 596AK(3)). We note the similarities between this wording and the Court's more general power of exemption under section 1318.

In exercising its power to make the order, the Court must have regard to (section 596AK(4)):

  • whether, immediately before the debt was incurred, there were no reasonable grounds for the director to expect that the company would be able to pay the debt;

  • the extent to which and the circumstances in which any assets, employees, premises or contact details of the failed company have become those of the debtor company;

  • whether any act or omission of the director or of the failed company is likely to create the impression that the failed company and the debtor company are the same entity;

  • whether the director has previously been liable under section 596AJ.

The liquidator of a failed company has similar powers of exemption from liability for the debts of the debtor company, subject to the caveat that he or she must not exercise their powers contrary to the Court (section 596AL). A director seeking relief from the liquidator must provide a copy of any section 596AK applications or orders relating to them. There may be some difficulty in the practical application of section 596AL. Given the five year liability period, the liquidation may be over by the time the director has occasion to seek exemption, leaving no other option but to seek exemption from the court. 

A director will be exempt from personal liability for the debts of the debtor company if it was carrying on business throughout the year ending at the start of the winding up of the failed company: section 596M.

We note that the anti-phoenixing provisions in UK and NZ insolvency legislation provide an exemption where the new company has purchased the whole, or substantially the whole, of the company in liquidation under an arrangement with a liquidator, administrator, or receiver, subject to appropriate notice being given to creditors.2    We suggest that the Similar Names Bill would benefit from the addition of this exemption, to facilitate genuine business recovery efforts by directors (particularly within corporate groups).

The inclusion of such an exemption would support the objectives of the Bill, providing a further incentive to pursue legitimate corporate reorganisations  by first placing the company into external administration.  If a transaction of this kind is undertaken while a company is in external administration, creditors are in a better position to challenge or prevent the transaction taking place, including blocking or challenging a deed of company arrangement which may be promoted to prevent the liquidation of the former company, than if the company is placed into external administration after the event.  While there have been instances of the voluntary administration regime being abused to facilitate phoenix company activity, creditors will be generally better off with it, than without.

The Phoenixing Bill

The Phoenixing Bill will amend the Corporations Act to:

  • give ASIC the administrative power to order that a company be wound up;

  • impose a notification requirement on insolvency practitioners in relation to paid parental leave payments; and

  • include a regulation-making power so that methods of publication of events in an external administration may be prescribed.

Winding up by ASIC

The Phoenixing Bill will give ASIC the power to order the winding up of a company, where it is otherwise deregistered, deregisterable or abandoned. The explanatory material foreshadows that ASIC will be able to use this power to place abandoned companies into liquidation so that a liquidator may investigate and report on alleged misconduct, or to investigate and take action in respect of any uncommercial transactions entered into by the company prior to deregistration.

ASIC may order that a company be wound up if:

  • it is more than six months late in responding to a return of particulars sent to it by ASIC, has not lodged any other documents with ASIC in the past 18 months and ASIC therefore considers that the company is no longer carrying on a business (section 489F(1));

  • it has not paid its annual review fee within 12 months of the due date (section 489F(2));

  • the company's registration was reinstated by ASIC under subsection 601AH(1)(section 489F(3)); or

  • ASIC is of the view that the company is no longer carrying on business, has provided notice of its intention to the directors and received no objection (section 489F(4)).

ASIC need not give any notice of its intention to exercise its powers under sections 489F(1)–(3). If ASIC orders under section 489F that a company be wound up, the company is deemed to have passed a resolution that it be wound up voluntarily under section 491. If the Phoenixing Bill is passed, these new winding up powers will apply both prospectively and in relation to past reinstatements, failures to provide returns of particulars, and failures to pay review fees. It is a prerequisite of any payment to employees under GEERS that the company has been formally placed into liquidation. The objective of this reform is arguably protection of workers' entitlements, rather than prevention of phoenix activity.

Publication requirements

The Corporations Act currently requires publication of a range of notices in the print media or the ASIC Gazette in the course of an external administration. The Phoenixing Bill will amend the Corporations Act to allow for publication through other means, prescribed by regulations (not yet released).

Other amendments

If passed, the Phoenixing Bill will amend section 497(1) to clarify that the requirement for a meeting of creditors to be 'convened' within 11 days after the voluntary winding up resolution is passed refers to the meeting being held, rather than merely arranged.

The Department of Families, Housing, Community Services and Indigenous Affairs (FAHCSIA) is responsible for the administration of the nationwide Paid Parental Leave Scheme. It funds the provision of parental leave payments by employers, and as such will generally be notified of a liquidator's appointment. However, FAHCSIA will not always be a creditor – for example, if an employee has received all paid parental leave payments owing to them at the time of the insolvency. The Phoenixing Bill amends the Corporations Act to require FAHCSIA to be notified if an insolvency practitioner is appointed to a company that is a paid parental leave employer.  Again, the objective of this reform is arguably protection of workers' entitlements, rather than prevention of phoenix activity.

Other efforts to combat phoenix activity

The Government introduced the Tax Laws Amendment (2011 Measures No 8) Bill into Parliament on 13 October 2011. This omnibus Bill included a Schedule 3, which if passed would have extended the current director penalty regime to include superannuation guarantee payments as well as PAYG obligations, and added teeth to the Commissioner of Taxation's enforcement powers under that regime. The Bill's provisions were flagged in the May Budget as one element in the Government's efforts against phoenix activity.

Schedule 3 was removed from the Bill on 22 November 2011 (the remainder of the Bill has since passed into law), following a recommendation for its removal by the House of Representatives Standing Committee on Economics. The Committee broadly supported the Bill's initiatives as a logical extension of the director penalty regime, but cautioned that the Bill as it stood lacked sufficient safeguards to ensure that innocent company directors were not caught by provisions intended to snare the relatively small number of directors engaged in deliberate and repeated dishonesty. The Committee recommended that the Government investigate whether the Bill should specifically target phoenix operators and whether the proposed defences to liability should be expanded. The Committee recommended that Schedule 3 should be removed so that the balance of the Bill could pass. 

The Government has indicated that it intends to bring the amendments back into Parliament, following consultation, as early as possible in 2012. At the time of writing, no further consultation has been announced and the Department of Prime Minister and Cabinet has not released its programme of legislation proposed for introduction in the Autumn sittings. Parliament resumes on 7 February 2012.

Conclusion

The Phoenixing Bill contains some reasonable measures for facilitating the protection of workers' entitlements. These measures are unlikely to affect the position of the majority of directors. However, the Similar Names Bill imposes additional personal liability on company directors in circumstances which are too broadly defined. The Bill unduly limits the ways in which directors, having acted honestly, may seek exemption.

Consultation on the Phoenixing Bill closes on 24 January 2012. The Similar Names Bill remains open for public comment until 29 February 2012. If you would like your views on the Similar Names Bill to be communicated to Treasury, please get in touch with any of the Minter Ellison contacts listed for this Alert.


1 We use the expression 'start of the winding up' to encompass cases where, under the Corporations Act, the 'relevant date' at which winding up is taken to have commenced is the date of an earlier administration or provisional liquidation.

 In the United Kingdom, in the absence of leave from the Court or an applicable statutory exception, a director or shadow director of a company that has gone into insolvent liquidation cannot be a director or a shadow director of a company known by a 'prohibited name' within 5 years of the date of liquidation of the former company.
A 'prohibited name' is a company or business name by which the liquidated company was known at any time in the 12 months before the date of the liquidation, or a name so similar as to suggest an association with the liquidated company. Breach of this prohibition renders the director personally liable for the company's debts (sections 216-217 of the Insolvency Act 1986 (UK)). The statutory exception for a company purchasing the whole, or substantially the whole, of the business from the liquidator, administrator or receiver is found in the Insolvency Rules 1986 (UK), rule 4.228.  In New Zealand, sections 386A and 386C of the Companies Act 1993 (NZ) impose personal liability on directors, in almost identical terms to the UK legislation. Section 386D provides an exemption from liability where the business is purchased under arrangements with a liquidator, administrator or receiver. 

Author(s) Robert Austin, Michael Hughes