ASIC recently issued a press release on the topic of phoenix trading and the commencement of proceedings against a number of directors of companies and a solicitor that advised them. Part of that release says:
“In late May 2008, ASIC commenced civil proceedings in the Supreme Court of New South Wales against eight company directors and the companies’ lawyer, .., over their involvement in alleged Phoenix trading.
ASIC claim that the directors of eight non-related companies (“Vendor Companies”), which were all in financial distress, transferred the business and assets of the Vendor Companies to new companies which were all controlled by the same directors for negligible consideration. The effect of these transactions was to remove the assets from the reach of unpaid creditors of the Vendor Companies whilst the businesses continued to operate under the name of the new companies. This is known as “Phoenix trading”. “
Phoenix trading is transferring a business from an insolvent company to a new company – leaving the creditors behind. It is a technique used by some people to hide and protect assets from creditors and to solely benefit themselves. This is clearly wrong and the Acts provides liquidators and trustees some powers to undo these transactions – I think that most practitioners would like these powers strengthened – and ASIC is very active in investigating and prosecuting the people involved.
But it is not uncommon for businesses to be sold before an insolvency estate commences and sometimes that sale is to a related party. Sometimes only a related party will pay money for that business.
One current case highlights this position. The Brisbane office is handling a liquidation (formerly a voluntary administration) where a sale of the business to a related entity occurred shortly before the appointment. The purchaser kept trading the same business from the same premises. Naturally the first thought was whether this was a phoenix company.
The transaction was examined from two angles.
Was proper and real consideration paid for the assets? If the assets themselves (as opposed to the business as a unit) remained in the liquidation, could they be realized for more than the consideration paid. In our case the answer was No. Most of the assets were financed and their value was less than the payout figures. The purchaser paid about 50% more than the realizable value of the assets acquired. The majority of the valuable assets of the company – not essential to the conduct of the business – were not sold.
What was the value of the business including goodwill? If the business was still with the company at the time of the appointment, could it be sold as a going concern, and if so, for how much? The business had been trading at a large loss for some years, had little in physical assets and heavily relied on four senior employees for its income. The business was not a saleable unit on the open market. Given that the cost of running the business was $250,000 a week (yes: a week) and that all of the assets (mainly factored debtors) were secured, any ongoing trading would be extremely risky if it was even possible, but once the business was closed, it was gone. The business had no profits to capitalize and no solid business unit that was saleable.
The last question was whether the creditors were better or worse off because of the sale? In this case the answer is Better Off. Not just from the consideration paid, but from an orderly collection of debtors etc (assisted by the purchaser), and the assumption of various employee debts. The directors where not benefitting themselves to the detriment of the creditors.
ASIC’s Executive Director of Enforcement, Jan Redfern, has stated that “Phoenix activity is a significant issue and ASIC has broadened its focus in relation to misconduct to include not only company directors but also others who are involved in, or help facilitate, such transactions.”
Somewhere between sales of the kind that we have just examined and the obvious improper transactions that are truly phoenix activities, there is a line that directors and their advisors must not cross. One of the first questions that directors will need to ask – and be able to prove – is who will benefit from the transaction? Is it truly the creditors from a better realization of the assets, or is it only themselves from ‘protecting’ assets from creditors.