When asset transfers cross the line into illegal phoenixing  

Shifting assets out of a struggling company might look like a way to save a business. But if creditors are left behind, directors could fall foul of the creditor-defeating disposition provisions – a key part of the Government’s anti-phoenixing regime.

Illegal phoenixing has long been in the sights of regulators. The classic scenario is familiar: a company is in trouble, its valuable assets or business are shifted elsewhere – often to a related entity – and the old company is left behind with the debts.

It sounds blatant – and sometimes it is.

My colleague Chris Baskerville dealt with a matter some years ago, before Australia’s current anti-phoenixing laws existed, that was about as clear-cut as they come. A company was being sued by an unhappy customer. Faced with that liability, the director transferred the company’s business and assets into a new company, effectively leaving the original entity – and its problem – behind.

It was classic phoenix behaviour and Chris pursued the transaction using the solutions available at the time. But had today’s creditor-defeating disposition (CDD) regime existed then, it’s exactly the type of transaction he would have looked at attacking as a CDD.

Not every case, however, is that obvious. And that’s why directors need to understand where illegal phoenixing, asset transfers and their duties to creditors can intersect.

The laws were designed to follow the assets

Creditor-defeating disposition might sound like another piece of insolvency jargon, but its origins are anything but academic.

CDD provisions came into effect in 2020 as a key part of the Federal Government’s anti-phoenixing reforms. Section 588FDB of the Corporations Act 2001 introduced the concept of a creditor-defeating disposition, targeting transactions where company assets are transferred for inadequate consideration and put beyond the reach of creditors.

The Government’s original reform package sought to “deter and disrupt illegal phoenixing” and more severely punish those who engaged in or facilitated it. And the resulting regime was deliberately given teeth.

It created a new category of voidable transaction, introduced civil and criminal consequences for those involved in prohibited CDDs and those who facilitate them, and gave ASIC an administrative mechanism to recover property for the benefit of creditors.

ASIC’s current guidance to directors is equally direct: directors have a duty to prevent CDDs – and disposing of company property for less than market value may put a director at risk of engaging in illegal phoenix activity.

In determining whether a transaction meets the test, the price paid is measured against the property’s market value and the best price reasonably obtainable in the circumstances. If the company received less than the lower of those amounts, and the transaction prevents, hinders or significantly delays the property becoming available to creditors in a winding up, it may constitute a CDD.

Putting the laws to the text

The CDD provisions were first tested in the Victorian Supreme Court in 2022 in Re Intellicomms Pty Ltd (in liq.).

The case involved the sale of the company’s business and assets to a newly incorporated entity controlled by the director’s sister, immediately before Intellicomms was placed into liquidation. The Court found the sale was a creditor-defeating disposition, describing it as having “all the hallmarks of a classic phoenix transaction”.

For directors, the significance is straightforward: courts will look at the commercial reality of where the assets have gone, what was paid for them and what has been left behind for creditors.

Since Intellicomms, the stakes have risen further. In June this year, ASIC brought its first criminal charge under the CDD provisions in an unrelated NSW matter. While the charge is yet to be determined by the Court, the action is a timely reminder that these laws have teeth.

When creditors enter the picture

There’s another fundamental issue that can get lost when directors are fighting to save a struggling business: their duties.

When a company is solvent, directors will ordinarily be focused on acting in the company’s best interests, which generally aligns with the interests of its shareholders. But the equation changes as insolvency approaches. As a company’s financial position deteriorates, the interests of creditors become increasingly important to the way directors discharge their duties. Directors can’t simply focus on preserving the business or shareholder value while making decisions that leave creditors worse off.

That’s particularly relevant when assets are being moved. A director might genuinely believe transferring equipment, intellectual property, customer contracts or even an entire business to another entity will preserve its value and allow operations to continue.

There’s another question that needs to be asked: “What does this transaction do to the creditors of the company those assets are leaving?” That’s often where the danger lies.

“We’re just restructuring”

In my experience, most directors aren’t setting out to illegally phoenix their company. They’re trying to keep the doors open, preserve jobs, protect a business they’ve spent years building – or they’re trying to restructure operations so at least part of the enterprise can survive.

However, good intentions don’t make an asset transfer safe. Consider a company under significant financial pressure that owns machinery worth $150,000. Its directors transfer it to another company they control for $30,000 so they can continue operating through that entity. They might regard that as saving the business – but a future liquidator may see a $150,000 asset transferred for $30,000, leaving the original company’s creditors with substantially less available to meet their claims.

That’s when the Federal Government’s anti-phoenixing laws – and the CDD provisions in particular – can come squarely into play.

Follow the assets

When I’m appointed as a liquidator and discover significant assets were transferred before my appointment – particularly to a related party – I want to understand exactly what happened.

• Was the asset independently valued?
• Did the company receive market value or the best price reasonably obtainable?
• Was it offered to anyone else?
• Why was it transferred – and why then?
• Who controlled the entity receiving it?
• Who ultimately benefited?
• And what was left behind for creditors?

No single answer necessarily proves wrongdoing – but together, they tell the story of the transaction. And where a distressed company has been stripped of valuable assets while its debts remain behind, you can expect a liquidator to look very closely indeed.

Advisers need to be alert too

Directors weren’t the only target of the anti-phoenixing reforms. The Government was also concerned about unscrupulous and untrustworthy pre-insolvency advisers and others helping distressed businesses shift assets beyond creditors’ reach.

The CDD provisions can therefore extend to those who procure, incite, induce or encourage a prohibited transaction. For directors, the message is simple: be wary of anyone suggesting you can move the valuable assets into another entity and leave the debts behind. Legitimate restructuring has an important role to play – but get reputable professional advice before the assets move, not after.

The bottom line

Illegal phoenixing isn’t always difficult to spot. Sometimes, as in the matter Chris handled years ago, the circumstances surrounding the transfer of a business and its assets are stark. Other situations are considerably greyer.

A director might genuinely believe they’re restructuring or saving the business. But if valuable assets are moved out of a distressed company for inadequate consideration and creditors are left behind, the anti-phoenixing laws may come squarely into play.

The key is remembering who your decisions affect. As financial distress deepens, creditors’ interests become increasingly important. Decisions about where assets go, what they’re sold for and what remains available to meet debts need to be viewed through that lens.

So before shifting assets out of a company in financial difficulty, stop and ask: what does this mean for the creditors we’re leaving behind? If the answer isn’t clear, get advice before the assets move. Because once a liquidator is appointed, following the assets is one of the first things we’ll do.

Assets transferred for less than market value or the best price reasonably obtainable. A business or valuable assets shifted into a new or related company. The original company retaining the debts while another entity receives its assets. No independent valuation or genuine market testing. Transfers while litigation, significant debts or other financial pressures are mounting. Transactions shortly before insolvency or the appointment of an external administrator. Poor or incomplete documentation. No clear commercial rationale for the transaction. Creditors left with fewer assets available to meet their claims.  Remember: ASIC says directors have a duty to prevent creditor-defeating dispositions and warns that disposing of company property for less than market value may put a director at risk of engaging in illegal phoenix activity.

Andrew Spring
Partner
Jirsch Sutherland

*Source: PwC, The Economic Impacts of Potential Illegal Phoenix Activity (July 2018), commissioned by members of the Australian Government’s Phoenix Taskforce. The estimate relates to the direct cost of potential illegal phoenix activity in 2015–16.