Disrupting the phoenix – how to tackle a business scourge

Thousands of creditors are left in the ashes when crooked directors vaporise corporate entities and slink away from debts. But a major research team is tackling the issue.

Too many tradies, hired labour and suppliers know the problem. They work on a building site, or sell goods and services to a company. They do the work on time and to standard, only to discover the company that owes them thousands of dollars no longer exists. The company’s directors have quietly transferred all the business and assets into another entity, abandoned their liabilities and left trade creditors to chase the ghost of an empty company.

It’s known as “phoenix” activity. A company burns its creditors and a new one rises from the ashes, untroubled by old debts. It happens in the construction industry, the labour-hire sector, in hospitality, management consultancy and retailing, in property development and financial services.

It’s an endemic problem that, by some estimates, costs the Australian community as much as $3 billion a year. That figure represents wages and entitlements owed to employees; considerable sums owed to trade creditors and suppliers; and payments of myriad forms of tax owed to the Australian Tax Office. Financial damage inevitably leads to an erosion in trust in the business sector.

For decades, Australian authorities and law reform advocates have examined the insidious and expensive scourge of phoenix activity in the corporate world. Yet for all the recommendations, insights and inter-agency goodwill, there has been a frustrating lack of action. That may be about to change.

The Turnbull government has recently outlined plans to tighten registration requirements for directors, penalise professional advisers who enable illegal phoenix activity, and enhance the powers of the Tax Office. The aim is to deter and penalise illegal phoenix activity.

People are very surprised to learn how easy it is, how unenforced it is and how people’s lives are destroyed by it.

Many of its proposed reforms draw on the substantial body of work published by a team of senior researchers from Monash Business School and the University of Melbourne Law School which, over several years, has extensively examined phoenix activity. The team earlier this year formulated a lengthy list of recommendations aimed at disrupting and curbing illegal phoenix activity and strengthening penalties against directors who abuse the system.

An issue that resonates

Professor Michelle Welsh, who is head of Monash’s Department of Business Law and Taxation and one of the four main researchers on the Phoenix Project, says illegal phoenix activity is an issue that resonates profoundly with people from all walks of life.

“It’s a disgrace, and it has a huge impact on ordinary people,” Professor Welsh says. “People are very surprised to learn how easy it is, how unenforced it is and how people’s lives are destroyed by it. It costs the community greatly and it has a significant detrimental effect.”

Professor Welsh notes, however, that not all phoenix activity is illegal. Despite best efforts and good intentions, entrepreneurs do fail and unprofitable businesses slide into oblivion. The research team does not believe it is fair to penalise unintended failures or, indeed, to penalise phoenix activity per se. Instead, they want the wrongdoing punished.

Where there is evidence of misconduct and corporate transgressions on the part of directors or other officers, such as abandonment or negligence of their duties, or where there is a deliberate effort to evade creditors, payments to the Tax Office or other responsibilities, that is when the business of shucking off corporate shells shifts into the realm of illegality.

“We think that one of the real ways to tackle this whole issue of phoenix activity is to make it harder for directors to do it,” Professor Welsh says. “It is too easy, it is cheap and it is under-enforced.”

Phoenix activity has been identified in a range of areas, including to:

The research team examined all publicly available Australian data on phoenix activity, including reports, media releases and evidence from the Australian Securities and Investments Commission, the Tax Office, Fair Work Ombudsman, Treasury, the Productivity Commission and the Commonwealth Director of Public Prosecutions.

It also examined information presented to the 2003 Cole Royal Commission into the building and construction sector, plus evidence to parliamentary inquiries and reports by the former Australian Securities Commission and accountants PricewaterhouseCoopers. As well, the team requested additional, specific information from the regulators and reporting bodies, such as liquidators.

The Phoenix Project found that while there is widespread acknowledgement of illegal phoenix activity, there is a paucity of reliable data about the incidence and size of it. Evidence garnered from liquidators’ reports on external administrations and from the Tax Office suggests thousands of individuals, companies and trusts repeatedly engage in phoenix activity.

Billions written off

A major forum of regulatory and enforcement agencies in 2013 heard the Tax Office alone had a watch list of more than 2000 individuals and 30,000 “entities” that were suspected of engaging in phoenix activity, and much of this was phoenix activity designed to avoid Goods and Services Tax in the property development sector. Perhaps most astonishing, though, was the Tax Office’s admission that it had written off about $10.8 billion over 10 years due to phoenix-related activity.

One of the Turnbull government’s proposed changes is directors to undergo tougher identification checks and to be assigned a unique identification number, which could be used to “map” relationships between that individual and corporate entities or other persons.

There is an apparent mismatch between the amount of illegal phoenix activity that  we think is going on and the enforcement action.

This proposal has been advocated for some years by the Phoenix Project team, which believes it will at least deter and disrupt some phoenix activity. At a starting point, anyone wanting to become a director would need to present 100 points of identification (passport, driver’s licence, official records).

The unique director identification number (DIN) would help persons searching the Australian Securities and Investments Commission’s database to locate, in one search, all the companies linked to that director. This proposal, which was supported by the Productivity Commission in its 2015 report, would alert regulators to directors with a questionable business record or a history of dissolving companies into administration.

As well, the Phoenix Project team wants the ASIC database to be made a free resource so that consumers and suppliers could easily check corporate credentials.

Most importantly, though, the team wants regulators to significantly increase their enforcement of breaches of directors’ duties. They have called for tougher penalties on directors, not companies. The Phoenix Project recommendations include changes to the Corporations Act and the Fair Work Act, such as:

  • increasing maximum civil pecuniary penalties for breaches of directors’ duties under s1317G of the Corporations Act from $200,000 per contravention to $500,000
  • more than doubling the statutory maximum fine for criminal breaches of directors’ duties from 2000 penalty units to 4500 units
  • considering penalties that represent a multiple of the benefit gained from the illegal activity, similar to fines in the cartel regime
  • amending s1317H to give courts power to award compensation to creditors of the abandoned company in a phoenix structure and, in civil penalty proceedings, give courts discretion to order disgorgement of benefits
  • imposing restrictions on directors who have been involved in five or more insolvencies within a 10-year period
    paying more attention to the role played by insolvency practitioners, accountants, lawyers and other professionals who quietly advise directors how to conduct a phoenix insolvency.

“There is an apparent mismatch between the amount of illegal phoenix activity that  we think is going on and the enforcement action,” Professor Welsh says. “We don’t know why this is the case.”

Several of the Phoenix Project’s recommendations have also been accepted into Labor’s policy platform, including the call for tougher penalties and the plan for director identification numbers.

The Turnbull government’s proposed reforms include a stronger focus on professional advisers such as liquidators, accountants or lawyers that might be providing pre-insolvency advice for directors seeking to avoid their responsibilities. It has said it will consult further on the measures in the next few months while it awaits the outcome of an enforcement review by ASIC.

Professor Welsh says the Phoenix Project researchers hope their deter-and-disrupt recommendations might eventually gain legislative support. But they believe that without tougher penalties and more rigorous enforcement on the part of regulators, directors engaging in illegal phoenix activity will continue to rip off the Australian community.

“There are stories everywhere about this. People really ‘get’ it,” she says. “This is the one research project that I have been involved with over the years where, when your friends ask ‘What are you working on?’ and you explain it to them, they really do get it. It resonates, and it causes real damage to our economy and our communities.

“We are hopeful that, with the traction the DIN and ID check proposals have received so far, they might one day make it into law.”

Published on 3 Oct 2017