Putting assets beyond the reach of creditors: An audacious example of illegal phoenixing and its legal implications
By Associate Professor Anil Hargovan, School of Management and Governance, University of New South Wales
- First reported case on new anti-phoenixing provisions in Corporations Act.
- Asset stripping is a key strategy used by phoenix operators to avoid repaying debts.
- Re Intellicomms Pty Ltd has important liability lessons for insolvency practitioners, company officers and pre-insolvency advisers
The recent decision by the Supreme Court of Victoria in Re Intellicomms Pty Ltd (in liq)[1] [2022] VSC 228 (Intellicomms) is of legal significance for all insolvency practitioners, company officers and pre-insolvency advisors for at least three key reasons.
First, there are no prior legal authorities dealing with the creditor-defeating disposition in s 588FDB of the Corporation Act 2001, an amendment introduced in February 2020 by the Treasury Laws Amendment (Combatting Illegal Phoenixing) Act 2020. The law reform is designed, as suggested by the title of the statutory amendment, to combat illegal phoenix activities.
In Intellicomms a business Sale Agreement, initiated by a company director which disposed of the company’s business assets to a related company and put it beyond the reach of creditors, was declared a voidable transaction by the court under ss 588FDB and 588FE (6B). The judge considered the sale agreement to have all the features of a phoenix transaction and was viewed to be a ‘brazen and audacious example’ of such illegal conduct.[2]
Second, the risk for company officers is that illegal phoenix activity, as noted by the corporate regulator,[3] can involve breaches of directors’ duties (including failing to prevent creditor-defeating dispositions under ss 588FDB and 588GAB), fraudulent concealment or removal of assets by company officers and can attract large fines and up to 15 years imprisonment for directors and secretaries.
Third, the reach of the 2020 law reform extends to the actions of pre-insolvency advisers, and other entities that, while not formally responsible for the management of a particular company, are responsible for designing and implementing illegal phoenix schemes. Section 588GAC focuses attention on those facilitating illegal phoenix schemes and is of potential relevance to the facts and ‘blatant’ conduct of the key participants in the Intellicomms case.
The creditor-defeating disposition provision in section 588FDB(1) provides, relevantly:
(1) A disposition of property of a company is a creditor-defeating disposition if:
(a) the consideration payable to the company for the disposition was less than the lesser of the following at the time the relevant agreement (as defined in section 9) for the disposition was made or, if there was no such agreement, at the time of the disposition:
(i) the market value of the property
(ii) the best price that was reasonably obtainable for the property, having regard to the circumstances existing at that time and
(b) the disposition has the effect of:
(i) preventing the property from becoming available for the benefit of the company’s creditors in the winding-up of the company or
(ii) hindering, or significantly delaying, the process of making the property available for the benefit of the company’s creditors in the winding-up of the company.
A transaction is voidable under s 588FE(6B) (b) if it is a creditor-defeating disposition made by a company at a time when the company is insolvent, or if as a result of the disposition, the company immediately becomes insolvent or enters external administration within the following twelve months.
Potential consequences arising from a voidable transaction are dealt with in s 588FF which is concerned with the recovery of money or property for the benefit of creditors of an insolvent company. The court may direct a person to pay the company an amount equal to some or all of the money that the company has paid under the transaction as well as make an order to transfer to the company property that the company has transferred under the transaction.
Before examining the ‘blatant’ offending voidable transaction in Intellicomms,[4] it pays to briefly consider the policy considerations underpinning s 588FDB of the Act.
Creditor-defeating disposition
The Explanatory Memorandum introducing the Treasury Laws Amendment (Combatting Illegal Phoenixing) Bill 2019 observed in respect to phoenix activity:[5]
While the scale of illegal phoenix activity ranges from the opportunistic to the systemic, a common characteristic is the stripping and transfer of assets from a company to another entity. Such transactions are carried out by a company’s directors or other controlling minds with the intention of defeating the interests of the first company’s creditors in that company’s assets. Such transactions are also facilitated by others, including unscrupulous pre-insolvency advisers, accountants, lawyers or other business advisers, who advise companies on how to engage in illegal phoenix activity.
The Explanatory Memorandum proceeded to observe that the Act:[6]
… introduces new phoenixing offences to prohibit creditor-defeating dispositions of company property, penalise those who engage in or facilitate such dispositions, and allow liquidators and ASIC to recover such property.
In respect of s 588FDB, the Explanatory Memorandum viewed a creditor — defeating disposition as:[7]
… a disposition of company property for less than its market value (or the best price reasonably obtainable) that has the effect of preventing, hindering or significantly delaying the property becoming available to meet the demands of the company’s creditors in the winding-up.
As to the intended operation of s 588FDB, the Explanatory Memorandum made the following observations:[8]
A particular asset of the company not being available for division among creditors on winding up is not in and of itself a creditor-defeating disposition. It is also necessary to establish the company received consideration that was less than the market value of the property disposed of and less than the best price reasonably obtainable for the disposition.
The test is applied at the time of the relevant agreement for the disposition is entered into or — if there is no agreement for the disposition — at the time of the disposition.
In this context, market value means the price that would be paid in a hypothetical transaction between a knowledgeable and willing, but not anxious, seller to a knowledgeable and willing, but not anxious, buyer, who transact at arm’s length.
The reason for the alternative test of the ‘best price reasonably obtainable’ was explained in the Explanatory Memorandum as follows:[9]
… [it] recognises there will be legitimate situations where a company may need to realise assets at less than market value. This is particularly the case for companies in legitimate financial difficulty that have urgent cash flow needs. The legitimate urgency with which these companies may seek to realise the value of assets means their actual disposal of assets may not realise the same market value price as the hypothetical not anxious seller.
In these cases, the circumstances of the disposition — including the financial circumstances of the company – and the reasonableness of the steps the company took or should have taken to realise the value of the asset will be relevant to determining whether the disposition is a creditor-defeating disposition. For example, a company that sells property through a reasonable process such as a public auction designed to obtain the best price available will not make a creditor-defeating disposition.
Facts
Intellicomms operated a business providing translation services in Australia and New Zealand. On 8 September 2021 Intellicomms entered into a Sale Agreement with Tecnologie Fluenti Pty Ltd (TF Pty Ltd) under which TF Pty Ltd bought Intellicomms business assets.
Shortly after signing the business Sale Agreement, on the same day, the sole director of Intellicomms convened a shareholders’ meeting at which it was resolved to place the company into creditors’ voluntary liquidation with debts in excess of $3.2 million. The liquidators were appointed liquidators in the winding up.
TF Pty Ltd was incorporated on 25 August 2021, two weeks prior to the appointment of the liquidators. The sole director and shareholder of TF Pty Ltd was Ms Gigliotti, a sister of the sole director of Intellicomms. Prior to the sale, Ms Gigliotti was employed by Intellicomms as its financial and payroll administrator.
Although the timing of the execution of the business Sale Agreement and the shareholders meeting which followed shortly afterwards was not explained, the court noted that on that very day the compliance period for a statutory demand which had been served 21 days earlier on Intellicomms by a large creditor (QPC who was also a minority shareholder in Intellicomms) for what was apparently an undisputed debt of $923,310 was due to expire.
But for the creditors’ voluntary liquidation, initiated by the director of Intellicomms, QPC would have had legal standing the following day to file an application for an order to wind up Intellicomms in insolvency. Once such an order was made, the winding up of Intellicomms would have ‘commenced’ and the business Sale Agreement would have been a void disposition under s 468(1) of the Act.
The purchase price of $102,000 payable under the business Sale Agreement was, however, subject to adjustment by operation of numerous conditions in the agreement. The net result, in the opinion of the liquidator, was that the amount payable to Intellicomms was reduced to $20,727.17.[10] Moreover, the liquidator stated that the cost of performing the various obligations required to complete the business Sale Agreement would likely exceed the purchase price payable under the agreement.
Evidence was led by the liquidator to show that QPC, a major creditor, was interested in purchasing the business assets of Intellicomms at an indicative purchase price of between $500,000 and $1,000,000.[11] QPC, however, was deprived of an opportunity to make a legal offer due to the hurried and secretive nature of the sale and purchase transaction between the related parties, Intellicomms and TF Pty Ltd.
Legal issues
TF Pty Ltd admitted that the business Sale Agreement prevented the company’s assets from becoming available for the benefit of Intellicomms creditors in the winding up and that it was entered into when Intellicomms was insolvent (for the purpose of s 588FE(6B)(b)).
The key question for judicial consideration was whether the liquidators had established that the amount payable under the business Sale Agreement was less than the lesser of the market value and the best price reasonably obtainable for those assets within the meaning of s 588FDB, and, if so, whether the relief sought by the liquidators (that the transaction be declared void) should be granted.
The defendant, TF Pty Ltd, contended that the transaction was not in breach of s 588FDB in spite of the surrounding circumstances of the business Sale Agreement which were, as readily conceded by counsel for the defendant, ‘undoubtedly unattractive in the extreme to those with any affinity with insolvency law.’[12]
The defendant contended that for the business Sale Agreement to be a creditor-defeating disposition, the plaintiffs must establish sufficient evidence upon which the Court can determine an actual monetary value as to each of the market value of the assets and the best price reasonably obtainable for the assets. Furthermore, in each case, those actual values must be higher than the consideration payable to Intellicomms by TF for the assets.
The plaintiffs submitted that there is no requirement in the wording of s 588FDB that the plaintiffs undertake these tasks. The plaintiffs also submitted that, in any event, there was sufficient evidence before the Court to enable it to perform that task.
Decision
The court rejected the defendant’s contention. It held that the liquidators are required to establish that, on the balance of probabilities, the consideration payable under the Sale Agreement was less than both of the limbs contained in s 588FDB.[13]
The court accepted the plaintiffs’ submission that, having regard to the circumstances surrounding the time of the sale, the best price reasonably obtainable for the business assets was not less than the market value.[14]
Those ‘circumstances’ included the fact of QPC’s apparent interest in purchasing the business assets of Intellicomms for an amount that was significantly higher than the sale price under the Sale Agreement. Other influential matters surrounding the disposition included the fact that:[15]
- The director of Intellicomms took no steps to ascertain whether the business assets could be sold to a third party other than TF Pty Ltd
- TF Pty Ltd was presently owned by the sister of the sole director of Intellicomms and was incorporated only two weeks prior to the Sale Agreement
- There was no legitimate urgency for Intellicomms to sell the assets without testing the market;
- There was no suggestion that Intellicomms considered voluntary administration under Part 5.3A of the Act in lieu of being placed in liquidation
- The director of Intellicomms concealed from QPC that she executed the Sale Agreement at the time that she was requesting their assistance as a shareholder to enter into a resolution for Intellicomms to be placed into liquidation.
The court accepted the plaintiffs’ submission that the factors above also suggested that the purchase price under the business Sale Agreement was less than the best price that was reasonably obtainable in the circumstances.
The court also rejected four independent valuations of the business assets produced by Intellicomms, in a short period of time, as being unreliable. The director of Intellicomms was found to have provided inputs for each succeeding valuation which reflected an increasingly grim outlook for the company, with the direct effect of decreasing the valuation. The court exposed the motive behind the valuation strategy adopted in Intellicomms:[16]
… [the director of Intellicomms] did so in order that she could arrive at a valuation which would minimise the consideration payable by TF (Pty Ltd), an entity which was established shortly before the execution of the Sale Agreement and the liquidation as a NewCo vehicle, arranging so that her sister as TF’s director and shareholder would give the appearance of [the director of Intellicomms] being once removed from TF. It seems that [Intellicomms director’s] motive for doing this was to prevent QPC, who was a shareholder and also Intellicomms largest creditor, from having the opportunity to purchase what assets Intellicomms had either from a liquidator or an appointed administrator.
Based on the findings above, it was held that the business Sale Agreement had all the hallmarks of a classic phoenix transaction for the following reasons:[17]
… it involves the transfer of the assets of an insolvent enterprise to an entity controlled by persons closely associated with it, leaving behind significant liabilities with no means to satisfy them. The transaction documented in the Sale Agreement, which had the effect of placing Intellicomms’ assets beyond the reach of its creditors …
The court described the business Sale Agreement as ‘audacious’ due to the following circumstances surrounding the transaction: [18]
… [the sole director of Intellicomms] caused the company to go into liquidation at a shareholders’ meeting that she convened without informing those who would be interested, including a shareholder and one of its major creditors, … QPC of the fact that she had entered into the Sale Agreement only minutes before the members’ meeting.
It seems clear from the evidence that [Intellicomms’ director] had planned the sequence of events carefully in close consultation with her business management consultants … There is no suggestion that [the director] considered placing Intellicomms into voluntary administration under Part 5.3A of the Act in lieu of proposing to its members that it be placed into liquidation; if administrators were appointed and the sale process placed in their hands, there would be no suggestion that the sale process was not at arm’s‑length.
The business Sale Agreement was held to be a creditor‑defeating disposition under s 588FD, a voidable transaction under s 588FE(6B) and, relevantly, the court was also satisfied that the application was brought within the time period prescribed by s 588FF(3)(a)(i). The court has indicated its intention to make ancillary orders for the return of the business assets to Intellicomms for the benefit of all unsecured creditors. The precise terms of the court order, however, are yet to be determined.
Legal implications
There are important legal implications arising from the decision Intellicomms for insolvency practitioners, company officers and for business management consultants or pre-insolvency advisors involved in advising on restructure options during corporate insolvency.
For the first time, a court was tasked with considering the elements that the liquidator has to prove to establish that a transaction was a creditor-defeating disposition.
Subject to an appeal, if initiated, Intellicomms affirms that a liquidator does not need to prove the actual monetary value of the assets or the best price reasonably obtainable for the assets. In adopting such an approach to the operation of s 588FDB, Intellicomms suggests a less strict evidentiary hurdle will suffice for liquidators alleging that a transaction is a creditor-defeating disposition.
The key takeaway message, in this regard, is that it is sufficient for a liquidator to establish that, on a balance of probabilities, the consideration paid was less than the market value or the best price reasonably obtainable at the time of the relevant agreement or the disposition. This is a positive development as it is likely to greatly assist in achieving the policy aims of s 588FDB which is to deter and disrupt illegal phoenix activity. The latter often arises through the manipulation of asset prices with an aim to place company assets beyond the reach of creditors.
Intellicomms also sends a clear and sharp message to all company officers and their advisors that the disposal of corporate assets during insolvency in breach of s 588FDB will invite close scrutiny by insolvency practitioners and the courts and likely that of the corporate regulator, ASIC, to deter future illegal phoenix conduct.
The decision in Intellicomms, together with the trenchant judicial observations on the brazen and audacious nature of the illegal phoenix conduct, suggests that the director of Intellicomms and their pre-insolvency adviser may not be off the hook. ASIC has a key role …., ASIC, has a key role to play in the enforcement of ss 588GAB and 588GAC which, respectively, imposes a duty on company officers to prevent creditor-defeating disposition and prohibits persons (such as advisors) from procuring creditor-defeating disposition. The object of Subdivision B of Division 3 of Part 5.7B (which contains ss 588GAB and 588GAC) is to deter the practice of disposing of a company’s assets to avoid the company’s obligations to its creditors.
The purpose of the prohibition in s 588GAC:[19]
… is to address the actions of unscrupulous facilitators and pre-insolvency advisers, and other entities that, while not formally responsible for the management of a particular company, are responsible for designing and implementing illegal phoenix schemes.
To this end, based on the facts and outcome in Intellicomms, it is highly conceivable for the director of Intellicomms to have fallen foul of s 588GAB and for the advisor to have fallen foul of s 588GAC by procuring, inciting, inducing or encouraging the creditor-defeating disposition. None of the statutory defences in s 588GAC(3) appear to be relevant to the facts in Intellicomms – these include, dispositions made under a DOCA, or scheme of arrangement, or by a liquidator, or during a course of action when the safe harbour is applicable.
If so, for criminal penalties to apply, s 588GAB(1) creates an offence in which recklessness is the fault element and therefore officer liability is attracted on the basis of engaging in conduct that results in the company making a creditor-defeating disposition. In contrast, to attract the civil penalty provisions for breach of s 588GAB(2), it must be shown that the officer knows, or a reasonable person in his or her position would know, that the disposition is a creditor-defeating disposition. It is arguable that the facts evidencing a flagrant disregard of the anti-phoenixing law and the decision in Intellicomms are capable of supporting both sets of penalties.
Penalties for a contravention of the new offence provisions are 4,500 penalty units or three times the benefit obtained (and detriment avoided), or imprisonment for 15 years, or both (for an individual).
Similarly, the ‘brazen and audacious’ phoenix activities in Intellicomms suggests that ASIC also has decent prospects of success in enforcing the civil or criminal penalty provisions in s 588GAC, against the advisor, should it exercise its law enforcement powers in this regard.
If so, it will send a clarion call to deter core behaviour of phoenix operators and will signal that the anti-phoenixing provisions in the Corporations Act have a large and meaningful role to play and that the game is not worth the candle. On the other hand, failure by ASIC to consider legal action runs the risk of undermining public policy on illegal phoenix conduct.
For these reasons, it will be desirable for the corporate regulator to closely examine the decision in Intellicomms and explore the potential liability of the key participants involved in the conduct of the illegal phoenix activity.
Anil Hargovan can be contacted on (02) 93853577 or by email a.hargovan@unsw.edu.au
Material published in Governance Directions is copyright and may not be reproduced without permission. The views expressed therein are those of the author and not of Governance Institute of Australia. All views and opinions are provided as general commentary only and should not be relied upon in place of specific accounting, legal or other professional advice.
[1] Intellicomms Pty Ltd (in liquidation) v Tecnologie Fluenti Pty Ltd [2022] VSC 228.
[2] Ibid at [288].
[3] https://asic.gov.au/for-business/small-business/closing-a-small-business/illegal-phoenix-activity/. See further for the distinction between illegal phoenix activity and legal phoenix activity.
[4] Intellicomms Pty Ltd (in liquidation) v Tecnologie Fluenti Pty Ltd [2022] VSC 228 at [244].
[5] Explanatory memorandum to Treasury Laws Amendment (Combatting Illegal Phoenixing) Bill 2019 (Cth) [1.3]
[6] Ibid at [1.9]
[7] Ibid at [2.12]
[8] Ibid at [2.16]-[2.18]
[9] Ibid at [2.19]
[10] Intellicomms Pty Ltd (in liquidation) v Tecnologie Fluenti Pty Ltd [2022] VSC 228 at [38].
[11] Ibid at [199].
[12] Ibid at [15].
[13] Ibid at [235].
[14] Ibid at [242].
[15] Ibid at [207].
[16] Ibid at [229].
[17] Ibid at [16].
[18] Ibid.
[19] Explanatory memorandum to Treasury Laws Amendment (Combatting Illegal Phoenixing) Bill 2019 (Cth) [2.81]