On July 1, the Gillard government quietly slipped through a set of laws designed to crack down on phoenix companies - those that collapse one day with a pile of debts and, like the bird in Greek mythology, rise from the ashes with the same assets and customers using a slightly different name. The fraudulent practice enables them to avoid taxes, wages and other bills.
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 no intention of paying them.
The 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 phoenixing is epidemic in the building industry but 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 small-to-medium businesses than phoenix companies because there are more of them.
To put it into perspective, the Australian Tax Office 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 many open files where suppliers are chasing it for payment. On a product review website the company has attracted many 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 several other suppliers are chasing it. This company isn't a phoenix company, but a company that is technically insolvent. It modus operandi is finding new and unsuspecting suppliers, which 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 cases like this and the recent changes made to the corporations law won't help suppliers.
What is needed is a central registry of 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 ATO'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 net to the heart of the matter: the growing number of companies trading while insolvent due to a flawed system of debt collecting.
Mendelson has come up with an excellent way to reduce the problem: compel companies to provide a "solvency statement" that declares 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.
Frequently Asked Questions about this Article…
What are phoenix companies and why do they matter to everyday investors and small businesses?
Phoenix companies collapse with debts and then reappear under a new name using the same assets and customers to avoid paying taxes, wages and bills. The Australian Tax Office estimates about 6,000 phoenix companies exist, and phoenix activity is estimated to cost the economy at least $3 billion a year — a clear risk for suppliers, customers and investors exposed to those businesses.
How is ‘trading while technically insolvent’ different from phoenix activity?
Trading while technically insolvent means a company keeps operating even though it can’t pay its debts as they fall due. It’s different from phoenixing because these companies don’t necessarily collapse and reform — they simply juggle unpaid bills. Debt collectors estimate there are about 60,000 companies trading while insolvent in Australia, far more numerous than the roughly 6,000 phoenix cases noted by the ATO, and they can cause bigger harm to small businesses and suppliers.
Why is it so hard for suppliers and small creditors to recover unpaid debts from insolvent companies?
The debt-recovery process is slow and expensive: creditors often need a court judgment (which can take up to three months and cost around $1,000), then a statutory demand (about $800). If the demand isn’t satisfied within 21 days the company can be deemed insolvent and winding up is the next step — costing roughly $5,000. Because of time and cost, only an estimated 5% of creditors proceed to winding up, leaving many suppliers out of pocket.
What warning signs should everyday investors or suppliers watch for that might indicate a company is trading while insolvent?
Red flags highlighted in the article include repeated customer and supplier complaints, sudden changes to addresses or contact details, companies taking large upfront or “lock-up” payments but failing to pay trades or finish work, not answering calls, and multiple suppliers actively chasing the business for payment.
Have recent law changes cracked down on phoenix companies and insolvent trading?
The Gillard government introduced laws aimed at cracking down on phoenix companies (announced as slipping through on July 1). The recent bill also exposes directors to personal liability for unpaid employee superannuation entitlements — even if they weren’t a director when the offence occurred. However, the article argues these reforms are unlikely to address the core problem of the large number of companies trading while insolvent and the flawed debt-collection system.
How big is the scale of the problem of phoenixing and insolvent trading in Australia?
According to the article, the Australian Taxation Office estimates about 6,000 phoenix companies, while debt-collection agency Prushka’s Roger Mendelson estimates about 60,000 companies are trading while insolvent. Phoenix activity alone is estimated to cost the economy at least $3 billion a year.
What practical reforms have been proposed to help suppliers spot and avoid insolvent or phoenix businesses?
The article highlights two practical proposals: create a central registry of statutory demands so suppliers can check a company’s history of unpaid demands, and require companies to provide a solvency statement naming directors and confirming no statutory demand has been received in the past 12 months (or, if there have been demands, whether they were challenged or paid). These measures aim to give suppliers better transparency before they supply goods or services.
As an everyday investor, how could insolvent trading and phoenixing affect my investments and what steps can I reasonably take?
Insolvent trading and phoenixing can lead to unfinished projects, unpaid suppliers and reputational or financial losses for investors tied to those businesses. Reasonable steps based on the article’s content include watching for public complaints or multiple supplier disputes, being cautious about large upfront payments, requesting a solvency statement if possible, and avoiding suppliers or contractors with signs such as changed contacts, unanswered calls or many outstanding creditor claims.
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