The Order of the Illegal Phoenix: The rebirth of a struggling business

Like the immortal phoenix rising from the ashes, a new company, often just established, might arise from the winding-up of a failing company. When that new company’s officers and directors are essentially the same of the failing company, and the new company resumes business activities of the now defunct company, what is known as “phoenix activity” might be in play.

Phoenix activity can be entirely legal, but these practices become illegal when they deny the old company’s debtors what they might have otherwise received if the company’s assets had been properly dealt with.

Illegal phoenix conduct leaves creditors out in the cold and can amount to breaches of statutory duties under the Corporations Act 2001 (Cth) (Corporations Act) and attract significant penalties – including fines and imprisonment.

Care needs to be taken if you find yourself operating a struggling company or, on the other hand, if you find yourself dealing with a company that you suspect may shortly go up in flames.

What’s the difference between legal and illegal phoenix activity?

Phoenix activity can be an entirely lawful option for a struggling business, especially if the value of the old company’s assets is maintained.  Where a company’s directors have sought to responsibly manage their company, yet it fails, it would be open for them to start a new company operating the same business without engaging in illegal phoenix activity.

In a lawful scenario, there is no prejudice to the rights of creditors, including employees and entities such as the ATO.  Legal phoenixing results in the company’s assets, employee entitlements and other property and liabilities being transferred to the new company at market value, securing equal if not more favourable outcomes for creditors.  This may be the case where the old company’s assets are specialised, no market exists for their sale, or the costs of appointing a liquidator would diminish the pool of assets to be sold.

Illegal phoenix activity, on the other hand, involves the old company being abandoned and the new company acquiring the assets of its predecessor for below fair market value. Once the assets have been transferred, the old company is placed in liquidation or is abandoned by its directors.  If there are no assets to recover, the creditors of the old company cannot be paid.

In Australian Securities and Investments Commission (ASIC) v Bettles [2020] FCA 1568, Greenwood ACJ describes two types of ‘illegal phoenix activity’, being fraudulent phoenix activity and unlawful phoenix activity.

Fraudulent Phoenix Activity

Fraudulent phoenix activity involves a deliberate, systematic and sometimes cyclical liquidation of related corporate entities, accumulating debts without any intention of repaying those debts.  In doing so, there is a deliberate and fraudulent effort to maximise the creation of wealth at the expense of creditors.

Unlawful Phoenix Activity

On the other hand, unlawful phoenix activity occurs where there has been a contravention of the Corporations Act.

Contraventions of the Corporations Act which can make phoenix activity unlawful include:

1. breaches of a director’s duties to take care, act in good faith or misuse their position (or being involved in a director’s breach);
2. disposing of company assets at less than market value prior to the external administration of the company (otherwise known as a creditor defeating disposition); or
3. failure to keep financial records.

The penalties for engaging in unlawful phoenix activity include civil penalties, criminal offences, disqualification from managing a company and even direct liability of directors and officers to the company’s creditors.

Looking out for the signs

ASIC suggests that some of the warning signs of illegal phoenix activity include:

1. the company fails and cannot pay its debts;
2. the company changes its name to its Australian Company Number (ACN) and a new company is registered, often with a similar name to the old company;
3. the directors or former directors transfer the assets from the old company to the new company for less than market value;
4. the new company operates the same or similar business as the old company, sometimes from the same premises, using the same assets and employees;
5. the new company often uses the same bank account, advertising material, websites or contact details as the old company;
6. the people involved in managing the old company control the new company.

What to do if you suspect illegal phoenix activity?

You can report suspected illegal phoenix activity to the Phoenix Taskforce, a cross-governmental taskforce dedicated to the investigation and elimination of illegal phoenix activity.

In 2022-2023, the Phoenix Taskforce disqualified five directors from being involved in the management of a company because of their involvement in illegal phoenix activities and aided the ATO in:

1. completing nearly 3,000 audits and reviews; and
2. collecting more than $107 million in revenue.

Otherwise, if a creditor has evidence that a company is considering undertaking an illegal phoenix activity, it may be able to take a range of actions including applying to the court seeking orders to freeze the company’s assets, preventing their dissipation.

If you are a company in financial difficulty, or a creditor who has seen the warning signs of illegal phoenix activity, McCabes’ Insolvency Group offers expertise and experience in all aspects of corporate insolvency. 

This article is intended to provide commentary and general information only.  You should obtain legal advice specific to your own situation. Please contact us if you require advice on matters covered by this article.