Catching Pre-Insolvency Advisors: The Hidden Culprits of Illegal Phoenix Activity Article 2022

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Catching Pre-insolvency Advisors: The Hidden Culprits of Illegal Phoenix
Activity (2017) 35 Company and Securities Law Journal 486
Article · December 2017
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Australian National University
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1 Published in (2017) 35 Company and Securities Law Journal 486-502 CATCHING PRE-INSOLVENCY ADVISORS: THE HIDDEN CULPRITS OF ILLEGALPHOENIX ACTIVITY HELEN ANDERSON AND JASPER HEDGES* ABSTRACT The Australian Securities and Investments Commission and Australian Taxation Office arebecoming increasingly concerned about the role that pre-insolvency advisors play inpromoting illegal phoenix activity. Illegal phoenix activity occurs where the directors of acompany liquidate or abandon the company with the intention of avoiding its obligations andthen continue the same or a similar business via a new or related company. Pre-insolvencyadvisors who counsel directors to engage in illegal phoenix activity are subject to liabilityunder a range of corporate, labour and taxation laws, as well as licensing and professionalconduct rules. These advisors may be either qualified professionals, such as lawyers andaccountants, or unqualified “turnaround specialists”. This article explains how the existinglaws and rules apply to advisors and also suggests a number of legislative andadministrative reforms aimed at curtailing their participation in illegal phoenix activity, witha particular focus on early detection and prevention mechanisms. I INTRODUCTION It has become increasingly common in recent years, when illegal phoenix activity ismentioned, to hear reference to the involvement of pre-insolvency advisors.1 Behind thescenes, these insolvency ‘cowboys’ are alleged to strip the assets of a company and transferthem to a new entity, ready for their client to continue their business without the burden ofcumbersome corporate debts. Pre-insolvency advisors may be unqualified ‘turnaroundspecialists’ or qualified professionals, such as accountants and lawyers, as highlighted by thearrest of Mr Dev Menon, a principal of Clamenz Lawyers, for alleged involvement in a $130million tax fraud syndicate involving phoenixing and other corporate misconduct in May2017.2 In some instances, there is a further suggestion that the liquidator or voluntaryadministrator who does the official, visible external administration work may have colludedwith the pre-insolvency advisor, in order to attract future business.3 * Helen Anderson is Professor, Melbourne Law School, University of Melbourne, and Jasper Hedges isResearch Fellow, Melbourne Law School, University of Melbourne. The authors thank Professor IanRamsay for helpful comments on a draft of this article. Any faults in this article are the responsibility of theauthors. The research reported in this article was funded by the Australian Research Council: DP140102277,‘Phoenix Activity: Regulating Fraudulent Use of the Corporate Form’.1 See, eg, Australian Securities and Investments Commission (‘ASIC’), ASIC Strategic Outlook, October2014, 8.2 Fleur Anderson, Neil Chenoweth, Joanna Mather and Geoff Winestock, ‘The Inside Story of the $165mScam on the ATO’ (19 May 2017) The Australian Financial Review; Rachel Olding and MichaelaWhitbourn, ‘Lawyer Linked to $165m Tax-fraud Scam also Accused Over Alleged Car Rego Scheme’ (22May 2017) The Sydney Morning Herald; Katie Walsh, ‘Plutus Payroll Lawyers Prove Client-centric Mettle;and Corrs, Minters Missing’ (25 May 2017) The Australian Financial Review; Royce Millar and BenSchneiders, ‘Tangled Web: Plutus Law Firm Investigated Over Henry Kaye Land Bank Scam’ (25 May2017) The Sydney Morning Herald. The fraud was initially estimated at $165 million but subsequentlyrevised down to $130 million: Nassim Khadem, ‘Tax Commissioner Chris Jordan Launches ATO ReviewFollowing Fraud Case’ (30 May 2017) The Sydney Morning Herald.3 Australian Securities and Investments Commission v Franklin (liquidator), in the matter of WaltonConstructions Pty Ltd [2014] FCAFC 85; Australian Restructuring Insolvency and Turnaround Association

2 ‘Phoenix activity’ describes a process whereby the people who control a company (‘Oldco’)cause it to become insolvent, or abandon it, and then they continue running the same or arelated business through another company that they also control (‘Newco’). Newco, despitethe abbreviation ‘new’, may be a new company or an existing company, and it may be asuccessor company or a related company within a corporate group. Phoenix activity can belegal or illegal, which hinges on whether the controllers are engaging in phoenix activity withthe intention of defrauding those to whom the company has obligations. Such obligationsmay include debts owed to trade creditors, wages and entitlements owed to employees, taxesowed to revenue authorities, and penalties owed to statutory agencies or governments. Previous research has identified five categories of phoenix activity.4 The first is ‘legalphoenix’, often referred to as ‘business rescue’, which results in a better outcome forcreditors than letting the business come to an end.5 The second is ‘problematic phoenix’,which is legal but involves incompetent corporate management and repeated resurrection ofthe business that is harmful to creditors.6 Then there are three categories of ‘illegal phoenix’,depending on whether it involves an unpremeditated intention to defraud creditors arisingfrom financial difficulties (‘illegal type 1’),7 an intention to defraud creditors as part of apremeditated business model (‘illegal type 2’),8 or a premeditated intention to defraudcreditors accompanied by other illegal activity (‘complex illegal’).9 This article is concerned with the regulation of pre-insolvency advisors who are involved inthe illegal categories of phoenix activity, as it is perfectly legitimate for advisors to counseltheir clients on legal business rescues, and advisors should not be held to account forincompetent corporate management that leads to problematic phoenix activity. It is difficult to know the size of the unregulated pre-insolvency advice industry or thefrequency of wrongdoing within either the unregulated sector or amongst regulatedprofessionals. In relation to the former, the Australian Taxation Office (‘ATO’), a majorvictim of phoenix activity,10 has noted that[w]hen it comes to pre-insolvency advisors, they are just an unknown for us. They’reunregulated and they’re unseen until we actually become the victim of it. .... Going (‘ARITA’),‘Pre-insolvency Advisors Behaving Badly: The Profession’s View’ (2016) 28(3) AustralianRestructuring, Insolvency & Turnaround Association Journal 15: ‘[Liquidators] don’t want to bite the handthat feeds them. That I think goes to the crux of the issue.’ at 16, with the comment attributed to AdrianBrown, ASIC Senior Executive Leader – Insolvency Practitioners.4 Helen Anderson, Ann O’Connell, Ian Ramsay, Michelle Welsh and Hannah Withers, ‘Defining and ProfilingPhoenix Activity’ (Research Report, Centre for Corporate Law and Securities Regulation, The University ofMelbourne, December 2014) (‘Defining and Profiling Phoenix Activity Report’) 2.5 See ibid 8–10.6 See ibid 11–12.7 See ibid 15–16.8 See ibid 24.9 See ibid 27–28.10 Treasury (Cth), Action against Fraudulent Phoenix Activity: Proposals Paper (November 2009);PricewaterhouseCoopers and Fair Work Ombudsman (‘FWO’), Phoenix Activity: Sizing the Problem andMatching Solutions (June 2012); Australian Taxation Office (‘ATO’), Targeting Tax Crime: A Whole-of-Government Approach (July 2009) 16.

3forward, it would be far more effective if we were able to deal with this particularindustry at a known population level.11 Despite this lack of knowledge, the existence of these hidden culprits of illegal phoenixactivity has led to calls for action to deal with them. The 2015 Senate Economics ReferencesCommittee inquiry into insolvency in the Australian construction industry, for example,recommended that the Australian Securities and Investments Commission (‘ASIC’) shouldfocus enforcement action on pre-insolvency advisors,12 and should ‘publish a regulatoryguide in relation to the nature and scope of pre-appointment advice given or taken bycompanies.’13 This article starts in Part II by examining existing enforcement actions taken against, oravailable against, pre-insolvency advisors who give improper advice to directors ofcompanies, thereby facilitating illegal phoenix activity. These include actions under theCorporations Act 2001 (Cth) (‘Corporations Act’) as well as under labour and taxation laws.Professional sanctions for ethical breaches involving lawyers, accountants and insolvencypractitioners are also canvassed. It becomes apparent in Part II that there are already plenty ofways in which pre-insolvency advisor wrongdoing can be punished, yet the avenues availableunder the Corporations Act are little used and this wrongdoing appears to be increasing.14 Part III makes the case for a more sophisticated approach to the regulation of pre-insolvencyadvisors than the one presently adopted, which relies almost entirely on ex post enforcement.All the eggs should not be in the ex post enforcement basket. Because concerns have beenexpressed that pre-insolvency advisors operate in an unregulated environment,15 it mightsuggest that licensing to capture those advisors who are not otherwise regulated by aprofessional body is desirable. We argue that this is just one of several options that could beconsidered, not a reform that, on its own, could solve the problem. Rather, there should bemore emphasis on detection and prevention measures. In addition, we suggest two possibleamendments to current legislative provisions and one new provision. Pre-insolvency adviceshould be seen as a context in which improper behaviour can occur, rather than a target forenforcement itself. Indeed, this is the same argument that applies to phoenix activity moregenerally, where it is the wrongdoing of directors, rather than the fact that it takes place aspart of a ‘business rescue’, that should be the focus. Part III also suggests that broader measures against illegal phoenix activity, which make itmore difficult for miscreant directors to escape exposure, will have a positive flow-on effectin reducing the willingness of pre-insolvency advisors to be involved in breaches of the law. 11 ARITA, ‘Pre-insolvency Advisors Behaving Badly: The Profession’s View’ (2016) 28(3) AustralianRestructuring, Insolvency & Turnaround Association Journal 15, 16, with the comment attributed to ATOPhoenix Director Michael Seddon.12 Senate Economics References Committee, Parliament of Australia, ‘I just want to be paid’: Insolvency in theAustralian Construction Industry (2015) (‘SERC Construction Insolvency Report’) recommendation 40,[12.52]. See also ASIC, Report 511: Regulator Performance Framework – ASIC Self-assessment 2015–16(December 2016), [198]–[199].13 SERC Construction Insolvency Report, ibid, recommendation 41, [12.53].14 ARITA, above n 11, 16.15 See ATO, Phoenix Taskforce Continues to Put Pressure on Pre-insolvency Industry (4 April 2017)<https://www.ato.gov.au/Media-centre/Media-releases/Phoenix-Taskforce-continues-to-put-pressure-on-pre-insolvency-industry/#>: ‘“The legitimate insolvency industry has strong concerns about those who may bepromoting and facilitating illegal phoenix activity. Unlike registered liquidators, these so-called ‘specialists’operate in an unregulated environment and their behaviour undermines the whole industry,” Mr Cranstonsaid.’