Legislation aimed at businesses that leave their debt behind doesn't go far enough, writes Steve Harris.
IN DECEMBER, the Australian government introduced the Similar Names Bill as a means of targeting phoenix activity. An analysis of history shows that the reforms do not go far enough.
Sacrosanct in company law is the principle of limited liability, which excludes directors from personal liability for debts incurred by their companies. This is an indispensable privilege, but like all privileges, it is open to abuse.
Phoenix activity where a director abandons a failed company, sets up a new one, transfers the business and continues trading is done for the calculated purpose of escaping liabilities to creditors and employees of the failed company.
In response to the 1980s recession, the British government mooted a raft of reforms to insolvency law. One reform proposed to make directors of a phoenix company personally liable for its debts.
A decade later, British company law experts dubbed the reform an "unmitigated failure" because of its inability to curb phoenix activity.
Wind the clock forward another 10 years and the Australian government is proposing to introduce the same reform that failed in Britain.
The government is to be commended for taking steps to address phoenix activity estimated by the ATO to cost the Australian economy between $1 billion and $2.4 billion a year however, the Similar Names Bill is unlikely to ameliorate its impact.
Maurice Blackburn's first concern is that the bill only targets this activity where the phoenix company trades under the same or similar name.
It is true that a similar name may be used by directors who wish to surreptitiously transfer the business of a company, thereby retaining its customers, market share and goodwill.
But directors will often transfer the business to a company with a purposefully dissimilar name, in order to avoid the taint associated with the failed company's unpaid debts. Despite the different name, the business will employ the same staff, at the same premises, serving the same customers the same products. The only change is that it leaves behind its debts.
A recent case highlights the ease of that escape. In 2002, a company called Hot Metal started transferring its business to a new company called Bico Designs. Hot Metal had failed to pay its employees' superannuation to the tune of $76,731 and had a tax debt of $296,068. Its director was disqualified from managing companies for five years, but that did nothing to help Hot Metal's employees, or Australian taxpayers.
It is this type of abuse that the government needs to tackle and the Similar Names Bill won't do it.
The second limitation is that the Similar Names Bill provides creditors of the new, similarly named company with access to the directors' personal assets to satisfy their debts, but provides nothing to creditors and employees of the failed company those who are most often aggrieved by the phoenix activity. The hardest-hit creditors and employees are left hanging out to dry.
Take for example the directors of a printing business who told a pregnant worker that she had "caused an inconvenience" and gave her the sack (just before Christmas). The directors and their company, Wongtas, were hauled to court over this in 2010. Soon after, the directors put Wongtas into liquidation and registered a new company, Wangtas, which began the same operations from the same location.
The Federal Court held that the liquidation of Wongtas had been carried out for the purpose of avoiding financial penalties under the Fair Work Act. Nevertheless, the proceeding could not be maintained against Wongtas because the company no longer existed. The pregnant employee wasn't paid her wages and didn't get her job back.
As a consequence of the countless examples of clients suffering similar losses at the hands of dodgy directors, Maurice Blackburn made a submission to the Australian government about the proposed Similar Names Bill.
We recommended that the Australian government amend the bill so that it is aimed at all phoenix activity, regardless of whether the two companies have a similar name. We also believe that directors should be made personally liable for the debts of the failed company, in order to protect those most often left lamenting.
The Australian government has taken an important first step by recognising that the current legislation does not provide sufficient protection from phoenix activity.
The next step is for the government to take action that will protect those damaged by phoenix activity.
Steve Harris is general counsel at Maurice Blackburn Commercial.
Frequently Asked Questions about this Article…
What is phoenix activity and why should everyday investors care?
Phoenix activity is when a director abandons a failed company, sets up a new one, transfers the business and keeps trading to escape debts owed to creditors and employees. Everyday investors should care because phoenixing abuses the principle of limited liability, harms creditors and workers, distorts competition and can mask the true financial health of businesses you might invest in.
What is the Similar Names Bill and what does it aim to do?
The Similar Names Bill, introduced by the Australian government in December, targets phoenix activity where a new company trades under the same or a very similar name to the failed company. Its goal is to stop directors from using near-identical company names to retain customers and goodwill while leaving debts behind.
Will the Similar Names Bill stop phoenix activity effectively?
The article argues the bill is unlikely to be fully effective. It only targets cases where the new business uses a similar name, but directors often avoid the rule by registering a dissimilar name while keeping the same staff, premises and customers. The bill also gives creditors of the new similarly named company access to directors' personal assets, but it does not provide redress for the employees and creditors of the failed company—the people most often harmed.
Who is most harmed by phoenix activity and are there real examples?
Employees and unsecured creditors are typically the hardest hit. The article gives examples: Hot Metal left unpaid employee superannuation of $76,731 and a tax debt of $296,068 before transferring its business to Bico Designs, and Wongtas’ liquidation was followed by the same business operating as Wangtas, leaving a pregnant worker unpaid despite a Federal Court finding the liquidation was used to avoid penalties.
Does current law make directors personally liable for debts left behind by phoenix companies?
No — the article explains the principle of limited liability generally shields directors from personal liability. The Similar Names Bill gives certain creditors of a new, similarly named company access to directors' personal assets, but it does not automatically make directors personally liable for the debts of the failed company. Maurice Blackburn recommends broader personal liability in its submission.
How much does phoenix activity cost the Australian economy each year?
According to the Australian Taxation Office estimate cited in the article, phoenix activity costs the Australian economy somewhere between $1 billion and $2.4 billion a year.
What reforms does Maurice Blackburn recommend to better tackle phoenix activity?
Maurice Blackburn recommended amending the bill so it targets all phoenix activity regardless of whether the two companies have a similar name, and making directors personally liable for the debts of the failed company to better protect employees and other creditors.
Has making directors personally liable for phoenix activity worked elsewhere?
The article notes that a similar reform was proposed in Britain after the 1980s recession and a decade later company law experts called that reform an 'unmitigated failure' because it did not curb phoenix activity. The article suggests Australia should learn from that history when shaping its approach.
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