By Greg Smart
In Greek mythology, the phoenix is a mystical bird that, at the end of its life cycle, ignites into flames. A new young phoenix rises from the ashes of the old. In business terms, a phoenix transaction is one whereby assets are transferred from an insolvent company into a fresh company for little or no consideration. It is often a hallmark of these transactions that the liabilities will remain in the insolvent entity, to smoulder in the proverbial ashes.
While it may sound appealing to “quarantine” debt in an old company while running the business profitably in a fresh entity, phoenix transactions will generally have devastating consequences for creditors and directors alike.
Common Characteristics of a Phoenix Transaction There are several common features that exist in most phoenix transactions, though not all of the features will be present in every such transaction.
Features to look for include:
- The former company changing its name, and the new company adopting the old name or a very similar name.
- No money or other consideration passing from the new company to the old company.
- The new company continuing to use the old companies premises, telephone number or fax number.
- The new company “accepting” liability for debts owed by important trade suppliers.
- The new company collecting debts owed to the old company.
- The new company continues to employ all of the same staff.
Consequences of a Phoenix Transaction
Without exception, the effect of a phoenix transaction is to reduce the pool of assets available to meet the debts of the company. This will mean that creditors are unable to have their debts paid in full, if at all.
For this reason, a liquidator of the former company will often pursue the new entity for the return of the assets. Further, whilst there is no law prohibiting a phoenix transactions per se, in almost every case, the conduct associated with a phoenix transaction will constitute a breach of the director’s duties under sections 180, 181, 182 and 183 of the Corporations Act 2001. Broadly speaking, those sections impose of a director a duty to act with good faith and in the best interest of the company. Where the company faces insolvency or near insolvency, those duties can extend to the creditors of the company.
A director who breaches his or her duties either recklessly or with intentional dishonesty commits an offence.
Further, the provisions imposing the duties on directors are “Civil Penalty Provisions”. Section 1317H allows the company to apply for a compensation order against a person who has contravened a civil penalty provision. That compensation order can include any profit that has been made by the person by reason of the breach and any loss because of diminution of value. Such an application could be commenced by the liquidator controlling the former company.
Put simply, a director involved in a phoenix transaction risks becoming personally liable to the former insolvent company.
Consideration
In order for a transfer of assets from one company to another to be valid, it must be in exchange for valuable consideration. Consideration need not be money but, according to the Butterworth’s Concise Australian Legal Dictionary, may consist of “some right, interest, profit, or benefit accruing to the one party, or some forbearance, detriment, loss or responsibility given, suffered or undertaken by the other.”
The long and the short of it is that something of value must pass to the old company to replace the valuable assets.
This will means that there is something to which creditors may have recourse to satisfy their debts.
Importantly, it must be a real consideration and not a paper entry or other illusion.
Advisors
The decision in ASIC v Sommerville & Ors [2009] NSWSC 934 found that advisors, such as solicitors and accountants, who actively assist directors to breach their duties, such as by establishing a phoenix company, may be guilty of aiding and abetting under the Corporations Act 2001.
Although this is yet to be tested, theoretically, such a conviction would render the advisor personally liable to a compensation order on the application of the company.
