Phoenix laws won't fix the real problem

While phoenix activity is estimated to cost the economy at least $3 billion a year in lost income, it is a mere sideshow to the sleeper in the economy: the growing army of technically insolvent companies that systematically churn through suppliers with the intention of never paying them back.

Debt collection agency Prushka, estimates there are tens of thousands of companies in Australia that are technically insolvent. They don't have to go to the trouble of "phoenixing" due to a flawed debt collection system that is wreaking havoc on the small business sector.

Prushka's Roger Mendelson says while phoenixing is epidemic in the building industry, there are many more builders who are trading while technically insolvent, which means they are unable to pay their debts when they fall due. They are having a bigger impact on SMEs than phoenix companies because there are more of them.

To put it into perspective, the ATO estimates there are about 6000 phoenix companies in Australia, while Mendelson estimates there are 60,000 companies trading while insolvent.

The system makes it too hard for small businesses to chase after debts. If a company fails to pay its debts the creditor has to obtain a judgment. If undefended this can take up to three months and cost $1000.

If still unpaid, the creditor then serves a statutory demand, which can cost up to $800.

If the demand isn't satisfied within 21 days, the company is deemed insolvent. The next step is to wind up a company, which costs about $5000. An estimated 5 per cent of creditors proceed to this stage because of the costs and relatively low chance of success. It helps explain why the latest ASIC statistics reveal just 3304 court-appointed liquidations in the past year.

Mendelson says there has been a 40 per cent increase in clients issuing demands in the past year. There are two reasons for this: debtor companies really are insolvent and are unable to pay their bills and are surviving by juggling and relying on the credit of their suppliers and secondly companies are aware that creditors are unlikely to spend money winding them up.

To illustrate, a house builder and financier in Springvale, Victoria, has numerous open files where suppliers are chasing it for payment.

On a product review website the company has attracted numerous complaints, including: "They are not builders! They are con artists. They take lock-up payments before frame stage and still don't pay their trades. Then they say they can't afford to finish the house and leave it, and then we don't get paid. Customers wait for two to three years, if they are lucky, to be paid. I'm ashamed to say I worked on their houses. They have recently changed their addresses and contacts because so many people are after them. They don't even answer our calls and we are left with the debt!"

Prushka has eight files on this company from eight different clients. It is understood there are a number of other suppliers chasing it. This company isn't a phoenix company it is a company that is technically insolvent.

Its modus operandi is finding new and unsuspecting suppliers, who it doesn't pay. It gets away with it because it isn't commercially viable for small creditors to issue a wind-up notice.

There are many other cases like this and the recent changes made to the Corporations law won't help suppliers, neither will the proposed changes involving similar name companies.

What is needed is a central registry for registering statutory demands to enable suppliers to check out companies and their history of paying debts. Right now, it is too hard for suppliers to find out which companies are notorious for not paying debts or are trading while technically insolvent.

The latest changes to phoenix companies tackles none of this. It is the second attempt to crack down on phoenix companies in two years. In 2010, the government beefed up the Australian Tax Office's powers to enable it to demand "security deposits" for existing and future tax debts if it suspects the business may be at risk of becoming a phoenix.

It had little impact, and the latest reforms look like they will do more harm than good for corporate Australia. Put simply, the new bill makes all directors at risk of being personally liable for a phoenix company's unpaid employee superannuation guarantee entitlements even if they were not a director at the time of the offence. This will create more red tape for corporate Australia yet doesn't get to the heart of the matter: the growing number of companies trading while insolvent due to a flawed system of debt collecting.

Mendelson has an excellent way to reduce the problem: compel companies to provide a "solvency statement" that states the names of directors and confirms that within the past 12 months the company has not been in receipt of a statutory demand. If it has been in receipt of demands, specify whether they have been challenged or paid. It doesn't sound that hard, but it seems to have escaped the Minister for Financial services Bill Shorten and the Gillard government.

aferguson@fairfaxmedia.com.au