Fraudulent behaviour, in which a new company is created from the remains of a liquidated company, is known as phoenix activity. This type of business fraud costs the Australian economy somewhere between $2.85 and $5.13 billion every year, according to the Australian Taxation Office (ATO). (1) Directors of companies caught engaging in illegal phoenix activity are subject to fines and even prison terms. However, it is possible for organisations to rise from the ashes successfully and legally.
Some companies see their debts get out of hand and then, to avoid paying them, liquidate the business. When they transfer the assets of this liquidated business to a new company and continue to trade, they could be breaking the law. It’s important for organisations looking to trade their way out of debt to understand what they can and can’t do. Not all phoenix activity is necessarily illegal, and transferring assets legally can be a useful way to restructure a failing business.
When a business has been managed responsibly but still fails, it may be able to legally continue trading after liquidation as another corporate entity. The Australian Securities and Investments Commission (ASIC) actively investigates companies suspected of fraudulent phoenix activity, so liquidation should be a last resort.
There are four basic steps for company directors to avoid illegal phoenix activity:
- Directors have managed the company responsibly yet it still can’t pay its debts.
- The directors hand the insolvent company over to an external administrator.
- The registered liquidator realises the company’s assets to pay liquidation costs and creditors including employees.
- The directors start a new business.
The key here is that the company directors have taken all steps to pay its creditors as opposed to liquidating the company to avoid that responsibility. Fraudulent phoenix behaviour usually involves the directors transferring the company’s assets for little or no payment before the failing company is liquidated, so they can avoid paying creditors.
It’s important for organisations to make sure they don’t engage in illegal phoenix activity because the penalties for directors can be severe and can include disqualification from being company directors in the future. Companies facing financial difficulties have a number of options before declaring insolvency. Directors should seek professional advice as soon as they suspect the business may be in trouble because there are ways to turn it around and the sooner these efforts start, the more likely they are to succeed. Options range from restructuring, securing finance, and improving efficiencies to liquidation, receivership, or personal insolvency.
Navigating these issues can be stressful and confusing so it’s essential to enlist expert advisers to steer the company through this difficult time and reach a resolution that benefits all stakeholders.
Domenic Calabretta, Managing Director, Mackay Goodwin
