Company Law: Fraudulent Phoenix Activity - Essay Example

? Company Law COMPANY LAW Fraudulent phoenix activity refers to the evasion of a company’s liabilities and tax. Such liabilities would include employee entitlements and occur via systematic, deliberate, and cyclic liquidation of corporate trading entities. This paper seeks to perform an IRAC analysis of fraudulent phoenix activity, whereby the issue, rule, analysis, and conclusion will be made. Issue Australian corporate law has always sought to reinforce commercial and entrepreneurial risk taking, since these are essential to the creation of wealth, as well as the continuous functioning of the market (Adams, 2012). Limited liability possessed by companies shield shareholders and directors from any costs related to the company’s failure. Genuine failure of business, which occurs even after a diligent management of a business, followed by a subsequent change of corporate entity, can be viewed as a legitimate utilization of the corporate form. Fraudulent phoenix activity, in its basic form, involves an entity carrying out its business via accumulation of debt with no intention of re-servicing the debt for wealth creation and giving a boost to the business’ cash flow (Hannigan, 2012). The corporate entity then liquidates in order to avoid being made to repay their debts. However, the business exists under a different name but is controlled by the same group of individuals. However, most fraudulent phoenix arrangements are more sophisticated than this. A typical arrangement of this nature is structured as follows: a closely held group is put up, consisting of various entities such as one, which plays the role of human resource management. The entity charged with hiring labor normally has one director who does not serve as the group’s ultimate controller. The entity has very few assets and minimal share capital. When the labor hire entity cannot fulfill its liabilities, it is put into liquidation or administration by the ATO. Another labor hire entity is put up, with the labor moved to work under the new entity, with the process being repeated with limited or no disruptions to daily operations. The financial benefits reaped from unpaid liabilities are then shared out among the whole group. An example of this involves a labor hire business with an annual turnover of thirty million dollars and negligible assets, which is made up of fragmented operations through fifty-three related companies. These companies lodged accurate BA statements but did not remit the amounts required under the PAYG system. The director of the single company then proceeded to liquidate all of the other companies in a matter of one week, moving his two thousand seven hundred strong work force into eight newly created entities and went on trading. The director then proceeded to flee the country with over eight million dollars in unpaid taxes. The labor hire firm continues its trade activities without complying with the set down obligations. Rule Australia’s regime of corporate law is based on the Corporations Act 2001, which provides for the separation of control and ownership and imposes specific duties on directors, aimed at ensuring that they stay loyal to the company (Macmillan, 2012). The duties that are expected from the director are, in addition to those they have, under general law. If a director gets involved in phoenix activities, then he or she breaches several director duties such as duties that concern proper information use, duty not to allow a company to keep accumulating debt during insolvency, and the duty of good faith. Fraudulent phoenix activity could also involve contraventions of part 5.8A provisions of the corporations ACT that aim to protect the entitlement of employees, as well as voidable transactions. During these circumstances, civil recovery mechanisms, coupled with other general law features, which seek to protect company members and creditors against operators with unscrupulous intentions, may be started (Pennington, 2011). However, the Act required several amendments as individual companies continued to find loopholes, with the Australian government inviting submissions from stakeholders (Pierce, 2012). This resulted in the release of the “Phoenixing and other Measures Bill 2012”, as well as the “Similar Names Bill 2012”. The Phoenixing Bill proposes to amend the Corporations Act 2001 to give the ASIC powers to address the activity. The bill, in particular, gives the ASIC administrative power to order abandoned companies to be closed down. This power is meant to be triggered if it appears to the ASIC that an organization cannot continue carrying out its business. This aim’s primary measure is meant to protect the entitlement of workers, being a range of reforms that were included in the Protecting Workers Entitlements Package, which was a federal election commitment that the 2011-12 budgets confirmed. Workers employed by a company that then goes on to fail are now enabled to seek recovery of various unpaid entitlements via the government GEERS. They can only do so, however, if the company has been placed under liquidation, which would not be of much help if the company’s directors just walked away without winding up the company. ASIC’s proposed power to order a company’s winding up will enable more workers to swiftly access GEERS. It also possesses the additional benefit of enabling the liquidator to investigate the abandoned company’s affairs, including misconduct such as phoenix activity. The additional set of measures contained in the bill are meant to act as cost-saving measures that are aimed at the facilitation of publication of notices concerning corporate insolvency on a publicly available website, rather than in the ASIC gazette or print media. The “Similar Names Bill 2012” proposed amendments to the Corporations Act that are meant to impose individual and joint liability on company directors for a company’s debt (Talbot, 2012). The company in question has the same or a similar name to a failed company’s pre-liquidation name, of which that person was a director for at least twelve months before it was wound up. The Phoenix Company incurs the debts that a director could be personally liable for within five years of the failed company’s winding up. The bill will only be applied to debts that are incurred after its publication and legislation. Directors cannot be held liable for the new company’s debts if the failed company has paid off all its debts. This is meant to act as an incentive aimed at encouraging directors not to walk away from failed businesses, while leaving a shell consisting of unpaid liabilities. In considering whether to grant exemptions, a number of factors need to be accounted for by the liquidator. First, there must be reasonable grounds in order to suspect that the company was bankrupt during the time, which the debts were incurred. Another factor to be considered by the liquidator is the consideration of how brazen the phoenix activity in a given case was. Specifically the extent to which the newly formed company assumes the assets, premises, employees, and contact details of the prior company and whether any omission committed by the directors could have created a misconception that the new company was one and the same (Talbot, 2012). Analysis Essentially, if a Phoenix Company is formed, then its directors will need to be confident with regards to the adequacy of its working capital and its trading health, since they may be liable for the new company’s debts for a minimum of five years. Therefore, this should cause concern for the corporate community since circumstances may come up whereby some of the directors are personally responsible for something that did not concern them. The directors will also question whether they are protected by the scope of getting exemptions and whether this process is expensive and time-consuming. Even a successful application, for exemption, for the failed company from the liquidator with no court cases is still subject to clause 596AL (7), which provides, for substantial payments, to be made to the liquidator for enabling an exemption, paid in full by the company’s director. Phoenix companies pose another problem in that they could use different names despite having the same clients, contact details, premises, employees, and assets. This happens when the new company wants to distance itself from the old company because its name had been tainted. The new company, thus, does not want to be affected by the image created by the old company. Therefore, it would appear that these phoenix companies would not be caught up when the new proposed laws are legislated into law. The “Similar Names Bill” also has another issue in that it only talks about situations where the new company utilizes a company’s name, which is similar to the old business or company name. If the new company were to use a business name that is similar to the old one, this would not be covered with the bill’s scope as drawn presently. Additionally, the Bill does look to define the point at which the line is drawn in terms of how similar the name requires to be to that of the old company for it to be seen as an association of the old, failed company. Whether this omission was deliberate or not cannot be determined, although it could be said that the Bill is seeking trouble by not providing better guidance to the corporate world, as well as the courts, on how to deal with and apply these laws. Conclusion It would be a much better idea if Treasury took a more calculated and measured approach to the Similar Names Bill’s finalization. These should include improved consultation with interested bodies and the public than was allowed with the earlier, and much better thought out, Phoenixing Bill, as well as a more structured manner of consideration for the potential gaps and ramifications of the bill’s shortcomings as framed in the present. Finally, on 27th of January 2012, the Australian government announced the release of the Personal Liability for Corporate Fault Reform Bill 2012, with closing dates for submission having been closed on 30th of March. This is meant to act as the first push for amendments to the Commonwealth liability legislation for directors. It also covers legislation for the treasury that does not deal with taxation. References Adams, Michael. (2012). Essential Corporate Law Australian Series. London: Routledge . Indian Investment Centre. (2012). Company law. New Delhi: Indian Investment Centre. Hannigan, Brenda. (2012). Company law. London : LexisNexis . Macmillan, Fiona. (2012). International Corporate Law, Volume 2. Oxford : Hart Pub. Pennington, Robert. (2011). Company law. London : Butterworth. Pierce, Andrew. (2012). A straightforward guide to company law. Brighton: Straightforward. Talbot, Loraine. (2012). Critical Company Law. London: Routledge. Read More