The Public Enforcement of Sanctions against Illegal Phoenix Activity: Scope, Rationale and Reform
| DOI | 10.1177/0067205X1604400202 |
| Date | 01 June 2016 |
| Published date | 01 June 2016 |
| Subject Matter | Article |
ILLEGAL PHOENIX ACTIVITY: SCOPE, RATIONALE AND
REFORM
Michelle Welsh* and Helen Anderson**
ABSTRACT
The loss suffered by unsecured creditors of all insolvent companies is the non-payment
in full of amounts rightfully owed to them. This loss is all the more unacceptable to
creditors when a company has been illegally phoenixed by the transfer from the
insolvent company of assets at undervalue. One way of increasing the pool of funds
available for distribution to creditors is to issue proceedings seeking compensation
against directors alleging that their ‘phoenixing’ amounted to a breach of directors’
duties or insolvent trading. Such an action may be instigated by the liquidator and by
ASIC. ASIC’s enforcement role can be contrasted with the recovery role of the liquidator
where the latter acts primarily in the furtherance of private interests, being those of the
insolvent company’s creditors; ASIC’s mandate, on the other hand, is to act in the public
interest. The purpose of this article is to examine the enforcement roles of liquidators
and ASIC where suspected illegal phoenix activity has occurred. Following
consideration of the difficulties faced by liquidators acting on behalf of creditors of
phoenixed companies, this article considers whether it is appropriate, from a policy
perspective, for the public regulator to promote private interests by exercising its
enforcement powers for the benefit of creditors. The argument in favour of a publicly
funded regulator seeking compensation for creditor losses is particularly compelling in
the context of illegal phoenix activity, given the inability of creditors to bring
enforcement proceedings themselves and the difficulties faced by liquidators when they
seek redress for creditors’ losses.
I INTRODUCTION
There are many practical impediments faced by plaintiffs when they seek redress for
civil wrongs. These impediments, which are often discussed in the context of the access
to justice debate, include issues of the cost and complexity of litigation, the structure of
* Associate Professor, Monash Business School, Monash University.
** Professor, Melbourne Law School, University of Melbourne. The authors thank the
Australian Research Council for its generous support for this research: DP140102277,
‘Phoenix Activity: Regulating Fraudulent Use of the Corporate Form’.
202
Federal Law Review
Volume 44
_____________________________________________________________________________________
the legal system, and the scope for private settlement of disputes. 1 This article is
concerned with the impediments faced by a specific category of victim of civil wrongs
— creditors of insolvent companies — and in particular creditors of insolvent companies
that have been illegally ‘phoenixed’. Illegal phoenix activity occurs when company
controllers close down one company with unpaid debts and transfer its assets for
undervalue to a newly created company, with the intention of exploiting the corporate
form to the detriment of the creditors of the defunct company. The loss suffered by
unsecured creditors of all insolvent companies is the non-payment in full of amounts
rightfully owed to them. This non-payment is all the more unacceptable to creditors
when a company has been illegally phoenixed. This is because the transfer from the
insolvent company of assets at undervalue deliberately diminishes the funds that would
otherwise have been available to the liquidator for sale and ultimate distribution to the
creditors.
Insolvency law has a number of unusual features which impact on the ability of
unpaid creditors to obtain redress for the loss they have suffered: the collective
distribution regime that deprives individuals of their rights to bring separate actions;
the fact that an insolvent company, by definition, lacks sufficient funds to pay all
claimants; general ignorance about rights under complex corporate law; and
underfunded liquidators, reluctant to initiate legal action, who are nonetheless acting on
behalf of vulnerable creditors. Creditors of phoenixed companies are further impacted
by the blurring of lines between legal and illegal behaviour that complicates the situation
for whoever brings the action; the absence of a specific ‘phoenix’ offence; the apparently
unassailable nature of the separate legal status of companies and the limited liability of
its shareholders; and economic dogma that celebrates business triumph after business
failure.
One way of increasing the pool of funds available for distribution to creditors of
companies that have been illegally phoenixed is through an action seeking
compensation for wrongdoing against directors. Directors of companies that have been
illegally phoenixed may have committed a breach of duty or may have engaged in
insolvent trading.2 As creditors of insolvent companies do not have enforcement rights,
they are dependent on others, primarily liquidators, to take action on their behalf against
these errant directors. The role of the liquidators is to advance the interests of creditors
by finalising the affairs of companies being wound up; to recover company assets; to
issue proceedings against directors seeking compensation where appropriate; and to
distribute assets amongst eligible creditors.3 Yet liquidators face many impediments
which limit their ability to effectively perform their role for the benefit of creditors. The
1 A 2014 Productivity Commission report contained recommendations to improve access to
justice generally which included measures concerning consumers’ lack of information about
avenues of redress, the value of early and informal solutions, problems with the formal
system of justice, and access to justice for disadvantaged people. Productivity Commission,
Parliament of Australia, Inquiry Report No 72: Access to Justice Arrangements (2014), 41–72
2 Corporations Act 2001 (Cth) ss 180–183, 588G. Phoenixing may also constitute a range of tax
crimes under the Taxation Administration Act 1953 (Cth) pt III div 2. Directors may also be
liable for certain unremitted company tax obligations under Taxation Administration Act 1953
(Cth) sch 1 div 269. These are discussed further below.
3 Corporations Act 2001 (Cth) s 477.
2016
The Public Enforcement of Sanctions against Illegal Phoenix Activity
203
_____________________________________________________________________________________
most significant is a lack of money which is particularly pronounced where phoenix
activity has taken place.
Where suspected illegal behaviour may have occurred in the lead up to the
insolvency, the public regulator, the Australian Securities and Investments Commission
(ASIC), has enforcement powers against the directors personally. In exercising these
powers, ASIC seeks specific deterrence to secure the future compliance of this director,
as well as general deterrence to warn the regulated population. ASIC’s enforcement role
can be contrasted with the recovery role of the liquidator. While the latter acts primarily
in the furtherance of private interests, being those of the insolvent company’s creditors,
ASIC’s mandate is to act in the public interest. ASIC’s governing legislation requires it
to exercise its enforcement function in the ‘interests of commercial certainty, reducing
business costs, and the efficiency and development of the economy’.4 Nonetheless, this
dichotomy is not so clear-cut. The article will show that liquidators play an important
quasi-regulatory role, assisting ASIC in detecting wrongdoing at the time of the external
administration of a failed company. Likewise, ASIC’s role in seeking to deter
misconduct5 can facilitate creditor recovery where it seeks a compensation order against
directors engaged in wrongdoing. In other words, seeking this private benefit for some
creditors can be recognised as achieving a public benefit as well. By viewing the
compensation order as the imposition of a penalty, general deterrence of wrongdoing
can be achieved, and all creditors and market participants benefit through better
compliance with the law.
The purpose of this article is to examine the enforcement roles of liquidators and
ASIC where suspected illegal phoenix activity has occurred. Following consideration of
the difficulties faced by liquidators acting on behalf of creditors of phoenixed
companies, this article considers whether it is appropriate, from a policy perspective, for
the public regulator to benefit private creditor interests. The fact that ASIC has been
granted the power to seek compensation orders raises interesting normative questions
about the appropriate approach of a public regulator in this context. Should a public
regulator use the limited resources at its disposal to seek compensation on behalf of
creditors who have suffered a loss as a result of illegal phoenixing? If so, should ASIC
do this rather than seeking a penalty payable to the government?6 Even if ASIC’s sole
objective is to deter phoenix activity — a purely public benefit purpose — obtaining a
private benefit for victims might be an appropriate use of resources if it is done in
furtherance of that purpose and does not detract from it. This could be achieved via a
civil penalty application alleging a contravention of the duties owed by directors. A
compensation remedy
To continue reading
Request your trial