Phoenix company wound up following 'fictitious joint venture'

In insolvency and restructuring there is a special emphasis placed upon behaviour known as “phoenix activity”.  Phoenix activity is where a new company is created to continue the business of an existing company. Typically, this will involve a company entering into a transaction with another related entity for the sale of its assets. This allows business to continue, however the new company will not have any of the liabilities that the original business had such as obligations to creditors, the ATO or employees.

While there are several legitimate and legal forms of restructuring or reorganising a company, it is particularly unwise to simply enter into such a scheme without first checking its legality. The consequences of doing so are very severe including: liability for a breach of directors’ duties, ASIC penalties, penalties under the Director Penalty Regime of the Taxation Administration Act 1953, and breaches of the Fair Work Act 2009 if the scheme involves the avoidance of employee entitlements.

The recent case of Yeo v Alpha Racking Pty Ltd [2019] FCA 1338 provides a guideline of circumstances that indicate phoenix activity is occurring. The case concerned an application bought by the liquidators of a company known as Alpha Storage. The application sought the winding up of a company known as Alpha Racking as well as the appointment of the plaintiff liquidators as its provisional liquidators. This application was bought due to a suspicion that the assets of Alpha Storage were wrongly being transferred to Alpha Racking for the purpose of defeating creditors.

After reviewing the evidence presented by the liquidators O’Bryan J concluded that a strong case that the directors of Alpha Storage were engaged in a plan to strip the assets of Alpha Storage and transfer them to Alpha Racking had been established. His Honour held at [34] that the phoenixing activity included:

(a) the creation of a false joint venture agreement between the companies;

(b) attempts to have customers pay Alpha Racking — and not Alpha Storage — money they owe to Alpha Storage;

(c) the creation of what appear to be false financial records, including financial statements, for Alpha Racking and Alpha Storage;

(d) the transfer of staff from Alpha Storage to Alpha Racking; and

(e) the setting up of a new financial accounting package for Alpha Racking and the transfer to it of “open” purchase orders that are the property of Alpha Storage.

At [35] his Honour explained how the evidence of the case indicated phoenix activity was taking place:

First, Alpha Storage has issued invoices to third parties, showing that it was a trading entity and not a “labour hire” firm.

Second, security interests have been registered in the name of Alpha Storage on the Personal Property Securities Register and finance agreements exist between Alpha Storage and various financiers (ANZ Bank, Macquarie Leasing Pty Limited, Toshiba, PCP Finance), again showing that Alpha Storage was conducting a trading business.

Third, a “LinkedIn” page gives a description of the business activities of Alpha Storage and there is no reference to a joint venture.

Fourth, the debt owed to the Commissioner of Taxation includes a significant liability for GST which indicates that Alpha Storage operated a significantly sized business.

Fifth, there is no reference to a joint venture in any of the documents provided to or obtained by the liquidators, including the financial accounts and taxation documents of Alpha Storage.

Sixth, the partner from BDO Melbourne who was responsible for preparing Alpha Storage’s accounts and tax returns confirmed that no mention was ever made of a joint venture arrangement and that Alpha Storage traded in its own right.

Seventh, the documents evidencing the lease for the Dandenong South and Brisbane premises are in the name of Alpha Storage. These documents post-date the purported joint venture agreement. Further, the leasing agent of the Dandenong South premises was unaware of any joint venture.

Based on the above findings, his Honour agreed that a strong prima facie case of serious misconduct and potential fraud in the conduct of Alpha Racking’s affairs had been established. The application was therefore granted.

In addition to the Yeo case, the ATO and ASIC also include information on the warning signs of phoenix activity including:

  • the company fails and cannot pay its debts
  • the company changes its name to its Australian Company Number (ACN) and a new company is registered, often with a similar name to the old company
  • the directors or former directors transfer the assets from the old company to the new one for less than market value
  • the new company operates the same or similar business as the old company, sometimes from the same premises, using the same assets
  • the new company often uses the same bank account, advertising material, websites or contacts details as the old company
  • the people involved in managing the old company control the new company, either as the directors or controllers.

Sydney property developer jailed for phoenix activity

In a recent decision of the New South Wales District Court, a Sydney business man was sentenced to six years in jail and ordered to pay $1.8 million in reparations, after he was convicted of tax fraud relating to illegal phoenix activity.

On 25 January 2019, the court found that Benjamin Ensor had fraudulently lodged false Business Activity Statements on behalf of nine companies he was sole director of between 2008 and 2011.  Ensor subsequently used the money obtained from this practice to fund the development of five luxury apartments in Manly and to purchase a bevy of luxury items including a catamaran, a marina at Lake Macquarie and a new home.

It was also revealed that Ensor structured his companies to fraudulently obtain GST credits, reporting his business expenditure at more than $24 million in order to claim over $2.2 million in GST refunds. In doing so, Ensor created false invoices relating to project management services and high value excavators, trailers and trucks.

He also failed to report the sales of the Manly apartments on which he should have paid more than $1.5 million.

Ultimately, the ATO alleged that Mr Ensor’s actions saw him defraud the Commonwealth of $3.4 million.

The decision follows increased efforts to curb illegal phoenix operations, with ATO Assistant Commissioner Aislinn Walynn declaring that this case exhibits classic illegal phoenix behaviour, in which “companies were deliberately liquidated to avoid paying creditors and taxes”, whilst “new companies continued operating the same or a similar business with the same ownership.”

In doing so, she declared that the “result demonstrates the ATO’s commitment to detecting and prosecuting the most egregious tax crimes and should serve as a warning to those who think they can flout the law and get away with it.”

ARITA set to publish 4th Code of Professional Practice

Late last year ARITA released a consultation draft for the 4th edition of its Code of Professional Practice for Insolvency Practitioners, which serves to educate ARITA members as to their professional responsibilities and provide a reference for stakeholders to gauge the conduct of practitioners. Of the changes, perhaps the most significant is to the format of the Code, which features an overarching Code of Ethics and is then split into two separate codes; one for formal insolvency appointments and the second for all other advisory work.

Insolvency Services

This section of the Code has been drafted with reference to the proposed APES 330, and is to apply only to those working on formal insolvency appointments. The standard has been greatly simplified from previous editions, with much of the previous content shifted out to non-binding Practice Statements.

Advisory Services

This item is to focus on matters such as pre-insolvency work and safe harbour advising.

ARITA is currently reviewing feedback on the code, following a period of public consultation which closed on Monday.

WA businessman jailed for $890k phoneix activity

A Western Australian Phoenix operator has been sentenced to five years and four months in prison for fraudulently obtaining more than $890 000 through illegal phoenix activity. He was also ordered to repay the money.

The proceeding ensued after an extensive investigation by the Australian Tax Office which revealed that Western Australian businessman Sung Jae Cho had intentionally accumulated debt, liquidated his business to avoid paying the bill and then set up operation through a different corporate entity.  It was alleged that he also failed to report and remit the GST and Pay As You Go (PAYG) withholding while having sole and full control of the relevant entities.

The decision follows mounting scrutiny over the impact phoenixing operations are having on Australia's economy, which is estimated to cost the country between $1.8billion and $3.2 billion each year.

Assistant Commissioner Aislinn Walwyn claims this decision signals a "strong reminder to those involved in illegal phoenix activity that if you engage in this behaviour you will get caught." She warned that Australia's Phoenix taskforce will "continue to follow up phoenix operators despite their efforts to conceal their activities."

However the ATO believes the ruling significantly underscores the seriousness of the crime, asserting that it does not adequately reflect Mr Cho's conviction of 20 charges, spanning over 13 years from 1997.

ATO Commences Examinations to Identify Phoenix Activity

The Australia Taxation Office recently commenced public examinations in the Federal Court, in relation to a group of entities connected to pre-insolvency advisor Philip Whiteman. The examinations will review the suspected promotion and facilitation of phoenix activities and tax schemes.

ATO Deputy Commissioner Will Day has revealed that the examination will investigate over 45 service providers, clients and employees of these advisors and alleged ‘dummy directors’ of phoenix companies. In doing so, it has appointed Pitcher Partners as liquidators, who will investigate the affairs and conduct of the entities before further legal action is pursued.

The ATO has taken a strong stance on illegal phoenix activity in recent times, asserting that it “deprives employees of their hard-earned wages and superannuation entitlements, unfairly disadvantages honest businesses by undercutting prices and leaves suppliers with unpaid debts.”

The activity is estimated to cost businesses, employees and the government $5.13 billion per year, and so the ATO is committed to “detecting those who promote and facilitate illegal phoenix behaviour, and disrupting those who willingly engage in phoenixing.”

Federal Budget Introduces Anti-Phoenixing Measures

In the recent federal budget, the Government has vowed to combat illegal phoenix activity by reforming existing corporations and tax laws and granting the Australian Taxation Office additional power. Accordingly, the proposed changes are credited as complementing  the work of the Government’s Phoenix, Serious Financial Crime and Black Economy taskforces, with Federal Treasurer Scott Morrison asserting they will ensure small businesses “don’t get ripped off by other businesses who deliberately go bust to avoid paying their bills.”

Illegal phoenixing occurs when a company’s directors allow a business to collapse in order to avoid paying creditors, either through directors resigning or through the business going into administration. All too often the practice results in customers not receiving goods or services they have paid for, lost payments for small businesses and lost wages and entitlements for affected employees. Ultimately, it has an adverse impact on the economy, with illegal phoenix operators gaining an unfair advantage over honest businesses.

Under the proposed budget, the government has allocated $40million to be spent over the next four financial years, introducing new phoenix offences to target those who conduct or facilitate illegal phoenixing. Specifically, these measures endeavour to prevent directors from backdating their resignations, limiting the ability of directors to resign and restricting the ability of related creditors to appoint or remove external administrators.

Moreover, it will expand the ATO’s power to retain refunds where there are outstanding tax lodgements and will extend the Director Penalty Regime to include GST, luxury car tax and wine equalisation tax, making directors personally liable for the company’s debts.