Illegal phoenixing is a deceptive manoeuvre used by some businesses to sidestep their obligations, leaving creditors, employees, and other stakeholders at a loss. It involves deliberately transferring assets from an indebted company to a new one, leaving the former to face insolvency. Such predatory practices not only damage the economy but also erode trust in the business community.
Is phoenixing illegal?
Itโs important to note that there is a difference between illegal and legal phoenixing. The term comes from the mythical fire bird that rises from the ashes. Phoenix activity is when a legitimate and newly created company is registered to take over an insolvent or unsuccessful company.
So, what is illegal phoenix activity? Phoenixing becomes illegal when the activity involves deliberately transferring assets from an indebted company to a new one, leaving the former to face insolvency.
What is the impact of illegal phoenix activity?
Illegal phoenix trading carves a trail of destruction through entire industries, costing the Australian economy up to $5.1 billion annually.
Operators use sophisticated tactics that take advantage of loopholes in lawsโsuch as shirking director responsibilities through false identification, or confusing creditors by invoicing and paying through different company names and bank accounts. They also prey on generous credit terms offered by the ATO to continue operating, meaning it is often years before theyโre reported.
The question is then, how can business owners identify and start to resolve issues associated with phoenix activity? Weโve outlined the seven red flags of illegal phoenixing and how to protect yourself if youโre caught up with an illegal phoenix operator.
7 red flags to identify illegal phoenix activity
1. New companies are created for each new project
Setting up stand-alone companies for each consecutive project is a practice that can isolate potential losses and accountability if things go bad. Operators will move their resources to the next company and new project, leaving nothing behindโexcept unpaid creditors.
2. The same business, owners and premises exist, but there are variations in the companyโs name
When one company phoenixes into another through unscrupulous methods, the new iteration uses the same company name with a subtle variation. For example, adding โ(Aust)โ or โNSWโ to the proprietary limited name. The business appears to be the same, giving outsiders the impression theyโre dealing with the same company. On paper, however, it is a completely new entity.
3. Puppeteering of directors
This refers to the fact that the companyโs directors are not actually the real directors. The use of โpuppetโ or โstrawโ directors is a classic play by phoenix operators to protect themselves from the blowback of putting their companies into liquidation. Operators will put their spouses, friends or vulnerable citizens looking for work as straw directors. The fake directorsโ business involvement is limited to being registered as directors, signing paperwork and following the real directorsโ instructions.
4. Trading and contracting through different companies
The purpose of trading and contracting through different companies is to create confusion and to leave behind a complicated paper trail. In a case of illegal phoenix activity, when a contract is entered into for a particular supply or service, the contractor subsequently introduces additional entities into the arrangement. For example, this could involve paying from a related companyโs bank account or invoicing from another company name. This tactic enables operators to dupe unwitting partners when things go bad.
5. Tax-quoting or other unexplained extraordinarily competitive pricing
The practice of tax-quoting involves the estimators building in the non-payment of tax or other accruable costs to the project costings to win the job and pass those savings on to the customer. The risk of project failure here is high and the possibility of a liquidator unwinding elements of the transaction is real.
6. Taxation obligations arenโt met
The Australian Taxation Office and various state tax agencies are some of Australiaโs most generous credit providers, collecting their revenue years after becoming due and payable. Illegal phoenix operators will take advantage of these long lines of credit, leaving the revenue agencies as the last unpaid creditors when liquidating their companies.
7. Restructuring with unlawful advice
When it appears a company is going through some form of restructuring that doesnโt completely make sense, it pays to know a little more about who is behind the restructuring advice. Many illegal phoenix advisers are former insolvency industry professionals who have either been deregistered as liquidators or otherwise can no longer operate within the legal bounds of the Corporations Act. With a loss of accreditation, they may just be on the lookout for ways to take advantage of certain companies to make money.
How to protect yourself from illegal phoenix activity
To protect against the negative impact of illegal phoenix trading, in addition to being aware of the 7 red flags of phoenixing, businesses can take a few simple steps when getting into business with a new, unfamiliar partner.
Make sure you get paid on time
Get paid on time and upfront, and donโt over-extend credit to any one business. Getting guarantees from individuals associated with the company and from head companies of groups for any credit advanced. This helps to ensure the controlling minds behind the company are more invested and provides additional surety in case business goes bad and the company canโt afford to pay.
Cross-collateralising
Cross-collateralisation is when an asset, already used as collateral for an initial loan, serves as collateral for another loan, offering an additional layer of security for the lender. Should the debtor fail to meet scheduled repayments for either loan, the lender can initiate the liquidation of the asset, applying the proceeds towards loan repayment.
It’s essential for creditors to strengthen their position further by perfecting security registrations across any relevant entities using the Personal Properties Securities Register (PPSR). The PPSR is pivotal as it guarantees a creditor’s priority right to be paid during liquidation, ensuring enforceability if a liquidator comes into play.
Cross-collateralisation is when you use one asset that has been provided as collateral for an initial loan as collateral for a second loan. This adds an extra layer of security. If the debtor is not able to make scheduled repayments on either loan, then the lender can force the liquidation of the asset and use those proceeds as repayment instead.
Get the right advice
External advisors and proper due diligence reviews can provide valuable information on who businesses are actually dealing with. Banks always conduct pre-lending reviews when advancing significant sums of money to businesses. So there is no reason why other businesses canโt do the same with their credit.
What to do if you are impacted by an illegal phoenix operator
If you suspect that youโre in business with a company that is phoenixing or has been phoenixed, there are a number of precautions to take and remedies still available:
- Donโt rely solely on government intervention to dismantle the phoenix and protect the creditors.
- Limit any further credit advances and begin collecting out.
- Amend credit terms to provide more surety for existing debts.
- Stop doing business with them and pursue any outstanding debts.
If a business has been impacted by an illegal phoenix operation then the company should immediately:
- Get a good liquidator involved to provide advice or replace the incumbent liquidator. It pays to shop around for a good liquidator.
- Whilst registered liquidators are heavily regulated by Australian Securities and Investments Commission (ASIC), there are a small portion that skirt the thin blue line of the law and can charge significant sums of money to creditors without delivering their promised outcomes.
- Get a respected advisor for insolvency-related matters on board. An example of a respected advisor is a member of the Australian Restructuring Insolvency and Turnaround Association (ARITA) or the Turnaround Management Association. ARITA members adhere to a comprehensive code of conduct and will not facilitate illegal phoenix operations but work diligently to put a stop to illegal phoenix operators.
An impacted company can then direct the liquidator to recover any assets and unwind any uncommercial transactions. Anti-phoenixing legislation provides liquidators, creditors, and ASIC significant new powers to tackle phoenix trading and unwind unlawful transactions the company has entered into.
A good liquidator will seek funding via regulators or creditors. Funding is regularly provided to liquidators to further their investigations through:
- Australian Securities and Investments Commission
- Australian Taxation Office
- Department of Employment
- Commercial litigation funders
- Creditors
To get the best outcome for creditors from a phoenixed business, the liquidator should explore all opportunities to fund further investigations and report all offences identified against the company and its directors to ASIC.
For advice regarding illegal phoenxing, please contact your local William Buck Restructuring and Insolvency practitioner.
