By John Price, Commissioner, Australian Securities & Investments Commission

This article was submitted to the Australian Institute of Company Directors for publication in the Company Director magazine in June 2016

Creating new companies from the ashes of failed concerns is illegal if the aim is to avoid paying employees or debtors, or escape other financial obligations.

Here the Australian Securities and Investments Commission (ASIC) explains its approach to the significant problem of illegal phoenix activity.

Company failures can be nothing more than bad luck. But there are some directors who deliberately walk away from a failed company with the intention of avoiding liabilities and subsequently establishing a new company to conduct the same business – this is known as "phoenix activity". Directors and/or their business advisors can face tough sanctions, including imprisonment, if they are involved in such activities.

This illegal activity is costly to individuals, businesses and the Australian economy. A PwC report commissioned by Fair Work Ombudsman entitled Phoenix Activity; Sizing the Problem and Matching Solutions, estimated that the total annual detrimental cost of illegal phoenix activity on the Australian economy is approximately $3.19 billion. Of that amount, the report estimates annual costs:

• Up to $655 million for employees, in unpaid wages and other entitlements;
• Up to $1.93 billion for businesses, as a result of unpaid debts for goods and services that have been provided; and
• Up to $610 million for government, mainly as a result of unpaid tax – but also due to payments made to employees under the Fair Entitlement Guarantee.

From ASIC's perspective, the key characteristics of illegal phoenix activity involve circumstances where:

• A company fails and is unable to pay its debts;
• Directors of that company act in a manner which intentionally denies unsecured creditors (usually small businesses and employees) equal access to that company’s assets in order to meet unpaid debts; and
• Within some period of time soon after the failure of the initial company (usually within 12 months), a new company commences using some or all of the assets of the former business, and is controlled by parties related to either the management or directors of the previous entity.

The unfair competitive advantage that operators get by engaging in illegal phoenix activity has a significant impact across a variety of sectors, including small business.

ASIC’s latest Enforcement report “Report 476 ASIC enforcement outcomes: July to December 2015”, released in March 2016, outlines the type of enforcement actions that ASIC takes in relation to misconduct associated with this type of behaviour.

The report provides details on a range of things including the work that ASIC undertakes when small businesses become victims of misconduct, or where business owners operate outside of the law, thereby disadvantaging other businesses.

ASIC also runs targeted surveillance campaigns designed to detect and combat illegal phoenix activity. These focus on company directors who have a history of involvement in failed companies, are currently operating in certain higher risk industry sectors, e.g. construction, and who fit other criteria developed by ASIC for this program.

While there may not be a single statutory offence for "illegal phoenix activity", the key characteristics of this type of activity often involve breaches of director's duties. These include circumstances where the director/s have not acted in good faith in the best interests of the company and for a proper purpose, asset stripping, making false statements and/or failing to provide books and records to liquidators.

During the period July 2016 to December 2016, ASIC took 194 criminal actions against directors and banned 14 directors from managing corporations for the type of misconduct that is often associated with illegal phoenix activity.

ASIC also takes a pro-active approach to supporting small businesses and helping them to protect themselves from unscrupulous operators.

This includes providing free education to small businesses regarding their obligations under the Corporations Act 2001. Examples include a dedicated "Small Business Hub" on ASIC's website where members of the public can find information about various business structures and the rules and obligations associated with running a business as a company.

ASIC has also launched the "ASIC Guide for Small Business Directors" which provides directors of small businesses with key information relevant to their business type.

ASIC provides free, user friendly tools like ASIC’s Business Checks, which enable business owners to undertake important due diligence in relation to potential customers, or suppliers, with whom they may be entering into new relationships.

For more information about illegal phoenix activity, and what to look out for, visit Small business-illegal phoenix activity.

For information in relation to small business more generally visit ASIC's Small Business Hub.