In our article Insolvency law reform – has the time come for seismic change? released on 24 July 2023, Andrew Blundell discussed the findings from the report handed down on 12 July 2023 (Inquiry Report) from the Parliamentary Joint Committee on Corporations and Financial Services inquiry into corporate insolvency in Australia (the Inquiry).
This is the third of our four thought leadership articles where we discuss relevant Inquiry recommendations. In this article we discuss the Inquiry report commentary on the impact of illegal phoenix activity on corporate insolvency. Our comments below should be considered in light of the Inquiry’s first and overarching recommendation for a reform the insolvency system following a comprehensive review of Australia’s insolvency law, encompassing both corporate and personal insolvency.
The Inquiry report considered the impact that illegal phoenix activity has on Australia’s insolvency system and that it has been a growing concern for governments, regulators, and the business community. Illegal phoenix activity refers to the practice of company directors intentionally liquidating their businesses to avoid paying outstanding debts, employee entitlements, and other financial obligations. Company assets are transferred for little or no consideration to a new entity which is established to continue the same or similar business, leaving no capacity to meet creditor claims. This unethical practice undermines the integrity of the business environment, leaving creditors unpaid, depriving employees of their rightful entitlements, and places honest businesses at a competitive disadvantage. The Inquiry has identified this inappropriate behavior as an issue warranting reform as part of the recommended comprehensive review of the insolvency system.
The Inquiry Report has identified the following areas warranting specific reform to combat illegal phoenix activity:
- Quantification of the prevalence and impact of this practice on the Australian economy, with improvements in data collection to assist the formulation of appropriate policies and regulations;
- Development of legislative solutions to strengthen the legal framework against illegal phoenix activity, including stricter director liability, better reporting mechanisms, and enhanced enforcement measures; and
- Formulation of measures that safeguard the interests of creditors, employees, and other stakeholders affected by illegal phoenixing.
Accountants play a vital role in working with business clients to operate ethically, with financial integrity and in compliance with the law. Implementing the following processes with clients will assist to minimise the negative impacts of illegal phoenix activity:
- It is essential to conduct thorough due diligence when onboarding new clients and reviewing existing ones to verify the legitimacy of their business operations, assess their financial health, and identify any red flags that could indicate illegal phoenix activity;
- Ensure your clients are prepared for potential changes in regulations and legislation aimed at curbing illegal phoenix activity;
- Engage with your clients to ensure they are aware of the consequences of illegal phoenix activity. Directors that fail to comply with relevant legal requirements may become subject to serious legal consequences; and
- Help your clients implement robust risk mitigation strategies to protect their businesses from being victims of illegal phoenix activity, including strengthening contractual agreements, monitoring cash flows, and adopting prudent financial management practices.
The Inquiry recommendation to undertake a comprehensive review of Australia’s insolvency system is anticipated to make significant inroads to address unethical illegal phoenix activity. Taking a proactive approach will enable advisers to provide valuable guidance to their clients helping them to navigate the changing regulatory landscape.
Cathro & Partners are experts in providing insolvency, restructuring and advisory services that help to create and to preserve business value. Cathro & Partners looks forward to working closely with both public and private practice clients as the insolvency framework evolves as a consequence of the proposed comprehensive review.
Cathro and Partners will continue to provide its insights into the Inquiry recommendations in future thought leadership pieces, breaking down the relevant recommendations that effect our clients.
