Avoiding Dodgy businesses- those who utilise bankruptcy to not pay their bills

‘Phoenixing’ is a type of bankruptcy transaction that businesses often use to legally avoid their liabilities. These transactions, whilst technically legal, can have a debilitating impact on the company’s creditors. This article seeks to explain what a phoenix transaction is, how a phoenixed company may be identified, and what you should do to protect your interests against financial losses caused by phoenixed companies.

What is a phoenix transaction?

Phoenixing occurs where a company seeks to avoid its debts by transferring its assets (usually by sale) to a new company. By doing this, the owner of the original business can continue performing the same work with the same assets, without the burden of the original company’s liabilities. This is because the original company’s liabilities remain in the original company rather than being transferred to the new company. As a result, the original company becomes essentially worthless, as it no longer holds any assets, and therefore cannot repay its debts.

Creditors’ rights to bring legal claims for repayment lie against the company that incurred the debt. If a phoenix transaction has been executed, this means creditors can only claim against the old company, which has no assets and therefore cannot repay the debts, meaning creditors don’t get paid.

You might be thinking that such transactions are fraudulent, and therefore illegal. However, there is no Australian (or indeed American or British) legislation that directly outlaws phoenix transactions, meaning that a breach of the Corporations Act would have to be established before a creditor could recover against the business owner. Otherwise, the creditors’ rights can only be enforced by the now-worthless company.

How to identify a phoenixed company.

It’s unfortunately not uncommon for business owners to execute phoenix transactions several times. As a result, it’s always necessary to be cautious in determining which companies you trade with to maximise the probability of getting paid.

When the new company is registered, it cannot have the same name as the old company, as a result a phoenixed company will almost always have a name (business name, not trading name) that is subtly different from the old company. For example, when General Motors was bankrupted during the Global Financial Crisis, it was ‘General Motors Corporation’ that assumed the assets and operations of ‘General Motors Company’. It is therefore essential to verify the registered name of the business. This can be found on their licence (if applicable, e.g. a building licence) or on invoices or receipts they issue.

Before providing goods or services on credit, you should perform a search of the ASIC Business Name Register. This will help you identify whether a company of a similar name has existed previously. If the results of this search reveal companies with similar names and addresses, for which the status is ‘cancelled’, this is a strong indicator that phoenix activity has been conducted in the past. Additionally, a Creditor Watch search should also be performed. This will reveal any previous complaints of fraud or non-payment against a person or business, which is also a strong indicator of phoenix activity. Sync or Swim can assist you with these verification searches.

Additionally, if a company quotes a suspiciously low price in comparison to its competitors, that is also an indicator of phoenixing, as a lack of liabilities may mean that the company can provide the service at a lower price.

Aside from these factors, other indicators of phoenixing can only be discerned from knowledge of the business owner and staff. The following factors may indicate that the business may be intending to execute a phoenix transaction:

  • The owners are living a lifestyle seemingly in excess of what should be possible on the income they earn (for example, they make take expensive holidays or drive expensive cars);
  • Employees have their status changed regularly – this may mean permanent staff are converted to casual staff, or staff are laid off at short notice. A lack of permanent staff is a strong indicator;
  • Accounts are not paid on time, or are paid in incorrect amounts (this interferes with the reconciliation process in an attempt to cover up mismanagement);
  • Workers are paid irregularly or in cash, and superannuation payments are made late or not at all;
  • The business uses worn-out equipment; and
  • The owner offers a discount to work for cash.

If you can identify several of these factors in a business, you should exercise extreme caution.

Protecting yourself against phoenixes

The unfortunate reality is that unsecured creditors of phoenixed companies receive, on average, a maximum return of just 3% of what they’re owed. Therefore, the best prospects of a more significant return is to become a secured creditor. This means registering an interest against the company on the Personal Property Securities Register for goods you supply, either by sale or lease. Doing so will ensure you have priority if the creditor tries to on-sell the goods you have supplied, boosting your chances of recovery. There is a small fee involved for registering an interest, but it is more than worth it for high-value transactions.

Unfortunately, companies providing services are especially exposed, making due diligence checks on potential clients all the more important. On a related note, if you have a bad experience with a creditor, you should consider reporting this on Creditor Watch to assist other businesses avoid future losses through dealing with unscrupulous suppliers.

If you would like more information on spotting phoenixed companies, or need assistance navigating the Personal Property Securities Register framework, Sync or Swim can help.

If you have been the victim of a phoenixed company, you may be able to recover personally against the company owner if you can establish that they have breached the Corporations Act. A phoenix transaction may contravene either directors’ duties (e.g. to act with due diligence and in good faith) or constitute a voidable transaction (for example, a transactions involved in executing the phoenix transaction may amount to unfair director-related transactions). If such transgression can be proved, the Court may make a compensation order. However, actions under the Corporations Act are highly complicated and usually expensive, meaning they will need to be prosecuted by a lawyer (or ASIC). Performing due diligence on your creditors is therefore the best defence.

If you have been a victim of a phoenix transaction, or suspect a business of fraudulently executing a phoenix transaction, you should report it to the Inter-Agency Phoenix Forum. They can be contacted on 1800 060 062, or at phoenix@ato.gov.au.