The UK Insolvency Service has been granted new investigative and disqualification powers to regulate directors who ‘dissolve’ (in Australian terms, ‘deregister’) their companies to avoid paying their liabilities. This is under the Rating (Coronavirus) and Directors Disqualification (Dissolved Companies) Act 2021. If misconduct is found, directors can face serious sanctions, including court orders for compensation.[1]
Why that should be seen as a new and novel approach is a bit of a puzzle to my Australian mind, though it beats Australia’s free market approach.
This law is passed in the UK in the context of the just finalised UNCITRAL legislative guidance on MSE insolvencies, to which England and Australia were parties, which advises that attention is required in any insolvency law system to the ready dispatch of assetless companies. While many are truly defunct, such that an insolvency administration would serve little purpose, others may not be.
Australian company deregistration process
A company in Australia can be deregistered in either of two ways under the Corporations Act 2001:
- one, under s 601AA, where the members agree, the directors certify it has no relevant assets or liabilities, the company is not carrying on business and is not a party to any legal proceedings; or
- two, under s 601AB, where the directors do nothing, and in due course in default of its annual filing, fee payment and other obligations the company is deregistered by the regulator, ASIC.
As Australian law provides, a deregistered company then “ceases to exist”: s 601AD. But it can be reinstated.
Deregistration by default
It is on the 601AB cases that this article is focused, on some reasonable assumption they are failed insolvent companies. To do that, we need to go back a bit.
To have a company wound up in Australia, or the UK, involves work by a liquidator who necessarily expects to be paid. A director wanting to voluntarily wind up such a business in good faith will have to ensure there are assets remaining or provide money up front for the liquidator. In the UK, while the Official Receiver as a ‘free’ government service is available for court appointed liquidations, it is not available for voluntary liquidations. In Australia, with no government liquidator at all, both directors (voluntary) and creditors (court appointed) must front up with funds.
If the company is assetless and neither directors nor creditors want to throw good money after bad, the company may well not go through any liquidation process. There is no legal duty on either the creditors or the directors to do anything about an insolvent company save that it should not trade.
Based on the law, one need not look too far to understand why in Australia at least, far more companies go through 601AB default deregistration than are administered with some scrutiny – over 5 times as many.
Unlike the UK and NZ, Australia never adopted an official receiver role in corporate insolvency. Throughout the 20th century, up until 2017, we had a system of private “official liquidators” who were accorded a particular standing such that they were obliged to take assetless court appointments in return for also being appointed to more substantial matters which, in effect, subsidised the assetless appointments – ‘swings and roundabouts’ as it was called.
Throughout that period there was little mention let alone formal study of the extent to which liquidators funded assetless work. In the 1970s, an estimate was that 70% of court appointed liquidations were unfunded; a formal study in 2013[2] estimated that liquidators conducted unfunded work to the value of over A$48 million annually.
That 2013 study was said to be relevant in law reform in 2017, when the official liquidator role was abolished. The Australian government’s explanation for the removal of that role was a concern that liquidators’ unpaid costs in assetless liquidations were being borne by administrations with assets through higher charge out rates and that “concerns persist[ed] both within and outside the industry about the effects of this cross-subsidisation”.[3]
The government accepted that liquidators should not be expected to take an appointment without some guarantee of remuneration from creditors (or directors) and that this
“may mean a reduction in the number of assetless companies liquidated …”, that is, an increase in assetless companies being deregistered by default.
This might be seen as an ultimate market-based approach to insolvency – that the liquidation of assetless estates should be funded by creditors but if not, then directors might be expected to simply walk away – in due course, s 601AB comes into play and the company disappears. No red tape at all.
Significantly, any thought of having the government assume a role was not addressed.[4]
That change was made in 2017. There has been nothing further from government to ensure that the intended impact of that change addressed its concerns.
Phoenix misconduct?
This reform went through in the heated context of a military termed process of ‘combating’ – as the Australian government media writers describe it – against unlawful phoenix activity. Necessarily the way to deal with that problem was to pass laws that would fix it, such as the Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020.
More objectively, a $420,000 government funded research project[5] was suggesting better options. Its lead author saw the large numbers of deregistered companies as presenting a risk of “becoming the ‘black hole’ of directors’ misdeeds and unpaid debts, through phoenix activity or otherwise”.[6] And when confronted with an abandoned business, it was the employees and general unsecured creditors who lost out:
“They will need to fund the company’s liquidation themselves if they hope to recover anything of what they are owed, and risk further losses if it eventuates that company has no assets. As a result, many of these creditors do nothing, and the abandoned companies are eventually deregistered by ASIC for failure to return documents or pay annual fees.[14]
It was estimated at the time of those 2016 reforms that five times as many companies were deregistered by default, through s 601AB, as were deregistered following an external administration.[7]
“insufficient oversight of the deregistration process may be facilitating harmful phoenix activity was identified more than 20 years ago”
That research also noted the fact that
“insufficient oversight of the deregistration process may be facilitating harmful phoenix activity was identified more than 20 years ago …. [showing that] approximately 92% of Phoenix companies are deregistered under [s 601AB]. Effectively the [regulator] is unintentionally assisting Phoenix offenders to escape prosecution and detection by deregistering the company and closing off the trail. This is particularly the case in circumstances where debts may be many, but small and no creditor action is taken to place the company under administration”.
International
UNCITRAL’s Legislative Guide addresses what is no doubt a common issue, perhaps more so in countries with less legal and regulatory resources than Australia, or the UK. The Guide comments that any insolvency law needs to provide for some scrutiny of insolvent companies with few or no assets so as to uphold fair commercial conduct and good commercial governance. Otherwise
“(a)ssets can be moved out of companies or into related companies prior to liquidation with no fear of investigation or the application of avoidance provisions or other civil or criminal provisions of the law. …”.[8]
From the entrepreneurial directors’ viewpoint, UNCITRAL goes on to say that providing ready access for assetless proceedings
“may also encourage entrepreneurial activity and responsible economic risk-taking through the provision of a discharge and fresh start for entrepreneurs and others engaging in economic activities …”.
This is further emphasised in UNCITRAL’s 2021 MSME insolvency guidance where the issue of assetless administrations is the more prevalent.[9]
While many such companies may well be defunct such that little would be achieved by their full external administration, there is also much focus on unlawful phoenix activity in Australia. One government response has been to set up an impressively sounding Phoenix Taskforce Reducing illegal phoenix activity | Attorney-General’s Department (ag.gov.au) and a telephone hot-line.
No red tape
But being fair, the Australian government may have a point in its laissez faire response, consistent with its focus on the need to remove “red tape”, like liquidations or scrutiny of deregistered companies.
That could be explained in this way.
If Company A has ceased trading its business, having few if any remaining assets, but many creditors and employees, a creditor could wind up the company but it is generally not worth its while; directors likewise, balancing the trouble and expense and scrutiny of having a liquidator appointed with the option of just walking away and starting again.
Liquidation would not release the directors from their guarantees and other personal liabilities and would only prompt scrutiny. Nor would creditors be paid anything anyway. And liquidators can’t be expected to work for free.
Quietly moving the company’s limited remaining assets to a new venture in Company B would salvage at least some value.
A better approach
Alternatively, see Rethinking Australian Insolvency Law.
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[1] Crackdown on directors who dissolve companies to evade debts – GOV.UK (www.gov.uk)
[2] Phillips, A, An analysis of official liquidations in Australia, February 2013.
[3] Explanatory Memorandum to the Insolvency Law Reform Bill 2015 [9.53].
[4] The government did raise the idea of a government liquidator in 2017 in the particular context of phoenixing but the idea was not pursued: see Combatting illegal phoenixing, September 2017.
[5] Regulating Fraudulent Phoenix Activity (unimelb.edu.au)
[6] The Protection of Employee Entitlements in Insolvency – An Australian Perspective, MUP, Helen Anderson 2014, at p 94.
[7] Insolvency, it’s all about the money, [2018] U Melb LRS 6, Anderson; Phoenix Activity: recommendations on detection, disruption and enforcement February 2017, Anderson et al.
[8] UNCITRAL Legislative Guide on Insolvency Law, [73-74].
[9] UNCITRAL Legislative Recommendations on Insolvency of Micro- and Small Enterprises (2021) | United Nations Commission On International Trade Law
