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Michael Murray is an Australian author and commentator on corporate and personal insolvency law and related policy and law reform, in Australia and internationally. No legal advice is offered or given.

The new law’s limitations in controlling phoenix misconduct

The new anti-phoenix laws, so welcomed in certain quarters, will come up against some business and personal behaviours that are resistant to control and that require more than the usual ‘let’s litigate’ responses.

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Amidst all the war like chest thumping from regulators, lawyers and liquidators[1] which are marketed as arming our warriors with new powers to go into battle to combat the evils of phoenix activity, there has been an unfortunate lack of input from disciplines that might have more usefully cautioned on the potential usefulness of the new law.

In the absence of that input, and with some moderate learning[2] and understanding myself, here are some qualifiers, for contradiction or acceptance.

Combating

The government marketers’ term – ‘combating’ phoenix misconduct – seems to refer to its pursuit and prosecution with a view to achieving the usual three aims – deterring phoenix misconduct, offering some sense of retribution to the victims and compensating their losses.

Would directors or advisers be deterred by the prospect of a penalty or worse?

As it has been wisely said

‘deterrence is paradoxical. Those who are most likely to be deterred are the least likely to need it and those who need it most are least likely to be deterred’.[3]

The deterrent effect of the chance of civil or criminal phoenix action being brought is problematic, in particular because it is

‘easy to do, cheap, highly profitable, relatively invisible and rarely pursued by regulators’.[4]

It is generally the case that deterrence works more effectively and with credibility if there are swift enforcement responses to clear offences.

Phoenix activity involves neither swift responses nor clear offences.

At the time of the commission of the unlawful phoenix conduct, the prospect of detection is remote, in time and risk, hard to detect, and the question of illegality can be clouded.[5]

At the moment, swift responses, or any at all, are impacted by directors being able to choose any name they like, and by dummy directors, shaded by fees for access to limited ASIC records, with trusts and other contrivances not revealed. The benefit of sunlight as a great preventive and disinfectant has not yet been accepted.

Well, just make the penalties higher

The level of penalty is less of a deterrent that the probability of detection; but raising penalties or prison terms is politically easier, with problematic marginal deterrence. Here, we have 10 years.

In any event, proportionality must prevail and over-tough penalties can also be counter-productive, leading to resistance and resentment. And in certain white-collar milieu, and SME businesses, criminal sanctions and penalties are less of a deterrent than the impact on reputation, morale, shame and such.

Assuming directors know about the potential consequences of the phoenix activity

Even if there were deterrence from a criminological perspective, there are countervailing behavioural influences in business. Directors don’t behave rationally, for two and more reasons – people often don’t anyway, and those in business can be even less rational. They decide on rule of thumb or intuition and take cognitive short cuts.

Presented with a phoenix option, directors may react in a variety of ‘biased’ ways, depending on their individual absorption of the law, which is variable and subjective, based upon their perception and acceptance of the illegality of their conduct.

As is clearly evident in politicians’ thinking, minds can place a greater value placed on immediate benefits – the new phoenixed company – than those costs which occur later – creditor and regulator action; and on things one is about to lose, like a business into which one has invested more than money.

Loss and blame

And that loss can be dramatic and total, and scrutiny and blame and discard can follow.

directors, those who led the business into insolvency, are meant to be sidelined. A liquidator takes full control of the business, and the creditors become the key stakeholders’.[6]

That fear of loss of control can serve to heighten an unrealistic commitment to a failing business, and deferral of taking unwelcome advice. The debtor in possession model that gives an incentive to directors to seek help earlier is not in favour.

Why wouldn’t a pre-packed phoenix be seen as a better option?

Right or wrong

Insolvency itself is morally mixed, with old ideas of punishment remaining in order to deter access to it – stigmatizing those who enter it, and even those who practise it.

And more so phoenix activity, with the regulators unable to agree on its detail and there being acknowledged a proper place for ‘good’ phoenixing, an aspect of ‘corporate restructuring’.

Such legal ambiguity allows individuals to construct self-serving interpretations of the law and the resulting unethical or unlawful behaviour can be rationalised and furthered by social norms among the ‘rife’ phoenixing behaviour of others.

Debtor directors are not alone in this. Creditors may act irrationally by rejecting a debtor’s superior commercial outcome, perhaps choosing a profitless liquidation because of outrage over a phoenixed pre-packaged sale that nevertheless preserves a going concern.

This law ‘sends a message etc’

Publicity of new laws followed by action taken by regulators and outcomes is important for deterrence but it requires some temperance. Demonisation and excessive and outraged retributive language of those to whom it is directed can be counter-productive.

AFSA refers to those who might give advice about phoenixing as

‘the unscrupulous, unregulated and unlicensed advisors who prey around the edges of the insolvency system … from the deliberate mercenary to the lazy incompetent …’

and ARITA refers to the

‘dodgy pre-insolvency advisor/phoenix facilitator’.

And then we have ASIC wanting, promising, to make life

‘a hellhole for white collar criminals’.

Destigmatising

Likewise, over-emphasising the frequency and extent of the illegality – a crisis! – is unwise, as in

‘the burgeoning crisis of phoenixing already costing the economy (and creditors) billions of dollars each year’, being ‘one of the most significant forms of white-collar crime in Australia’

and

‘liquidators report around 10,000 suspected cases of illegal director activity to ASIC each year. Yet very few dodgy directors etc …’

These can only serve to normalise or destigmatise the misconduct –

phoenixing is so common it can’t be all bad.

Stigmatising

And if directors see their conduct as falling within some norm, stigmatising them as crooks can prompt them to wear their conviction as a badge of honour and reject the legal rules that have rejected them; in particular if they see sports rorts, or tax and business abuses costing much more than the claimed <0.21% of GDP in phoenixing.[7]

In Australia, those in business who go bankrupt are denied returning to their business roles for 3 years, with failed corporate directors able to immediately start again.

Other aspects of the environment influence behaviour. If the commercial world suffers from employee abuse, tax evasion, unfair competition, and unfair unforeseen events, and political malpractice, a phoenix dodge looks far less unlawful, particularly if it ‘saves jobs’ and the business itself.

Retributivism

It remains to mention the separate need for punitive action, not to deter phoenixing, but to make a statement that the offender deserves to be punished, in direct proportion to their moral blameworthiness.

It makes some of us feel good.

Compensation

As to compensation, this is even less likely to be achieved than deterrence. Courts go to the length of promoting general deterrence and retribution by going through the financially fictitious and unproductive process of fining insolvent companies, despite the fact that the company has ceased to exist, a likely scenario in the phoenix world.

 No compensation moneys from the company but what about the directors or advisers?

The theory of individual deterrence relied upon by a judge is that

‘an even greater deterrent effect is likely to be found in the event that contraventions are proved by the imposition of pecuniary penalties on the individuals who are also respondent parties to the present proceedings. Companies may come and go phoenix-like but those who are disposed to cause a phoenix to rise may well be deterred if it is brought home to them that they can be penalised individually with all of the potential consequences in terms of insolvency in the event that pecuniary penalties are not paid’.[8]

For many the deterrent effect of it being ‘brought home to them’ that they can be penalised individually with all of insolvency’s consequences is limited, as we have been saying.

As well, in business, many or most either have arranged their affairs such they have no accessible assets or are so indebted by guarantees that being ‘penalised individually’ again would add little.

And even if funds or penalties were recovered, they would go only some way towards covering the liquidator’s, regulator’s and lawyer’s costs of what appears to be legally and factually complex litigation.

The new law

This does not mean the new law might not offer some use. As the ALRC says,[9] positive behavioural norms can be influenced by the ‘expressive role of a prohibition’.

‘An express prohibition will contribute to a clearer understanding of the delineation between acceptable business conduct and illegal phoenix behaviour in the context of failed ventures. The civil sanctions will serve to deter misuse of the corporate structure while criminalisation will add a layer of denunciation to this illegal conduct’.

While the ALRC accepted there were arguments that existing laws sufficed, such as for breach of directors’ duties,

‘the clarity and expressive power afforded by specific legislative proscription offers the most compelling way in which to regulate this type of corporate malfeasance’.

Nevertheless, the ALRC noted concerns around the

‘high evidentiary burden, lack of appetite for prosecution, and absence of clarity as to the underlying phoenix behaviour targeted by officials’.

The integrity of any new regulatory law relies upon its application and at some stage this law might be used and prove useful.

Who should action it?

Given its public law focus, it would be best applied by public funding through ASIC as a public regulator rather than by using creditors’ moneys through private liquidators.

Funding of actions should be sparing given the many other potentially more effective legal disrupters available, well documented already.

In the end, like crime generally, phoenix activity won’t be stopped any more than corporate abuse and fraud, but it might at least be limited.

Review

The new law, and its impact on business and tax compliance, must be reviewed in 5 years. ASIC and the ATO and others will no doubt be monitoring its effectiveness from day one.

———————-

[1] Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020

 

[2] LLB Dip Crim. See Regulation in Australia, Federation Press, 2017, A Freiberg, ch 13, and generally. ALRC Discussion Paper 87, Corporate Criminal Responsibility, 2019.

[3]   Freiberg.

[4] Phoenix activity – recommendations on detection, disruption and enforcement, February 2017, Anderson, Ramsay, Welsh and Hedges.

[5] See section 588FDB

[6] www.arita.com.au

[7] The Economic Impacts of Potential Illegal Phoenix Activity, PWC, 2018

[8] Murphy v Astute Projects Pty Ltd [2018] FCA 2118 at [24].

 

[9] Corporate Criminal Responsibility, Discussion Paper, 2019

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