The Supreme Court of Victoria is the first Australian court to test creditor-defeating disposition laws designed to defeat illegal phoenix activity: In this latest article, Maddocks Insolvency & Restructuring team unpack illegal phoenix activity, summarise the key takeaways from the recent case Re Intellicomms Pty Ltd (in liq) [2022] VSC 228 (Re Intellicomms), and consider implications for insolvency practitioners, companies and directors.

What is phoenix activity and why is it illegal?

The term ‘phoenix activity’ in this context means the illegal practice of disposing and transferring of a company’s assets to another entity for the purpose of avoiding the company’s obligations to its creditors. Federal parliament has described illegal phoenix activity as ‘immoral’, ‘unethical’ and a form of ‘stealing’ from Australian workers and businesses.

The Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020 (Cth) (Reforms)^[1] came into force on 18 February 2020 to ‘combat illegal phoenix activity’. Prior to the Reforms, phoenix activity only became ‘illegal’ when a director breached their duties under the Corporations Act. In simple terms, the Reforms:

• introduce a new type of voidable transaction called ‘creditor-defeating disposition’;
• provide that any person, whether a company director or business advisor, will be exposed to criminal and civil liability if they engage in conduct that results in the company making a creditor-defeating disposition;
• grants ASIC the power to make orders against a person who has received property as a result of a creditor-defeating disposition to return the property to the company, pay compensation equal to the value of the property to the company or transfer other property of equal value to the company; and
• create criminal offences for officers of a company and those who procure, incite, induce or encourage creditor-defeating dispositions (e.g. financial advisors and lawyers), if the person procures, incites, induces or encourages the company to make the disposition.

What is a creditor defeating disposition?

In summary, a creditor-defeating disposition is a disposition of company property for less than its market value (or the best price reasonably obtainable) that has the effect of preventing, hindering or significantly delaying the property becoming available to meet the claims of the company’s creditors in the winding-up. The transaction may be voidable if the company immediately becomes insolvent or enters external administration within the following 12 months.

Parliament’s express intent was that the circumstances of the disposition will be relevant to determining whether the disposition is a creditor-defeating disposition. For example, the financial circumstances of the company and the reasonableness of the steps the company took or should have taken to realise the value of the asset.

ASIC, either on its own initiative or at a liquidator’s request, has the power to make orders “undoing” the effect of a creditor-defeating disposition. A liquidator may also recover a creditor-defeating disposition by applying to the Court for orders. Creditors can, with the consent of the liquidator, bring their own proceedings for compensation arising from a creditor-defeating disposition.

A defence is available to both the civil and criminal penalty provisions if the disposition was made under a deed of company arrangement or scheme of arrangement, it was made by the company liquidator or it was made as part of a safe harbour restructuring plan.

In addition, it is a defence to a civil proceeding relating to a creditor-defeating disposition if:

• the defendant had reasonable grounds to expect the company was solvent at the time of the disposition;
• the defendant took all reasonable steps to prevent the company making the disposition; and
• in the case of a defendant that is a director, the defendant did not take part in the management of the company when the disposition was made as a result of illness or “some other good reason”.

However, a defendant cannot avail themselves of the defences in points 1 and 2 above if the disposition was made less than 12 months before the company entered external administration or the company ceased to carry on business altogether as a direct or indirect result of the disposition. A strict “good faith” defence is also not available.

What was the Court asked to consider in Re Intellicomms?

The background to Re Intellicomms is as follows:

• On 8 September 2021 (over a year after the Reforms commenced), Intellicomms Pty Ltd (Intellicomms) entered into a sale agreement with Tecnologie Fluenti Pty Ltd (TF) and sold a number of its business assets, including its intellectual property (Sale Agreement).
• Later that same day, a meeting of Intellicomms was convened at short notice by its sole director and Intellicomms was placed into creditors’ voluntary liquidation. There was no evidence that voluntary administration was considered. Intellicomms was left with debts in excess of $3.2 million.
• Two weeks prior on 25 August 2021, TF was incorporated. The sole director and shareholder of TF was a sister of the sole director of Intellicomms and was employed by Intellicomms as its financial and payroll administrator.
• One of Intellicomms’ major creditors, who was also a shareholder, was not notified of the shareholders’ meeting proposing to appoint the liquidators. That same creditor was interested in purchasing Intellicomms’ business. However, there was no evidence that Intellicomms had taken steps to sell the business to any third party.

The liquidators of Intellicomms (Liquidators) applied to the Court for relief in relation to the Sale Agreement, claiming it was a creditor-defeating disposition and a voidable transaction.

Very early in the judgement, the Court expressed the view that the Sale Agreement had ‘all the hallmarks of a classic phoenix transaction’ in that it involved the transfer of the assets of an insolvent company to an entity controlled by persons closely associated with it, leaving behind significant liabilities with no means to satisfy them. It was clear on the evidence that the sole director of Intellicomms had planned the sequence of events carefully in close consultation with her business management consultants.

The key issue was whether the $20,727.17 payable to Intellicomms under the Sale Agreement was less than the market value of the property or less than the best price that was reasonably obtainable for the property. This was made difficult to determine because the Court was presented with multiple valuation reports of Intellicomms, each with wildly different accounts of the value of the business: ranging from over $11 million in June 2020, down to $57,000 in September 2021.

What did the Court find in Re Intellicomms?

In reaching its decision, the Court noted that some of the valuation reports did not comply with various technical requirements under accounting standards. The Court’s focus then turned on what a prospective buyer of Intellicomms would have paid for the purchase of Intellicomms’ business.

The Liquidators provided evidence that:

• Intellicomms may have been insolvent for some time before entering into the Sale Agreement;
• they received correspondence from a secured creditor expressing its willingness to purchase the Intellicomms business, and provided an indicative purchase price between $500,000 and $1 million; and
• if the Liquidators were to undertake a sale campaign to sell Intellicomms’ business, it would be in the best interests of the creditors to invite the secured creditor, TF, and any other parties apparently interested in making an offer in relation to the assets transferred under the Sale Agreement.

With sufficient evidence that the purchase price of the Sale Agreement was less than the best price that was reasonably obtainable for the property, the Court was satisfied that the criteria for a creditor-defeating disposition had been met and that the disposition was a voidable transaction.

What are the implications for insolvency practitioners and companies?