Each year, financial mismanagement, poor business practices and bad luck take a toll on countless Australian businesses. When a business goes “belly up”, the owner(s) usually have a couple of options. One is just to wind it up and walk away. The other is to start over. For those who choose the latter, the question is how to do so without inadvertently engaging in illegal ‘phoenix activity’. This article discusses transferring the business of an insolvent company.
What is phoenix activity?
This is a process in which a new company is purposefully registered (created) to assume the activities of the failed or insolvent company. In other words, only the name changes. The new company and the old company are one and the same, and as such often remain under the control of the old directors.
Why is it illegal?
The illegality of a so-called phoenix scheme has to do with the reasons for the creation of the ‘new’ company. Often, directors of the original company deliberately register a new one so they can avoid the legal and financial obligations associated with the old one. For example, they may register the new company so they don’t have to pay their old employees. They may also do so to avoid paying taxes or creditors.
Examples of illegal phoenix activity
Or, to put it another way, illicit phoenix activity occurs when:
- A company can no longer meet its financial obligations; and
- the directors transfer its assets to another company; and
- the company that receives the assets has the same or a similar name; and
- the transfer occurs before control of the original company is given to an outside administrator, such as a registered liquidator.
By engaging in this type of scheme, directors accomplish two key objectives. Firstly they free the company from any outstanding financial obligations (debts), including any to the Australian Tax Office (ATO), contractors or employees. And secondly, they stay in business.
Another example of phoenix activity occurs when a business owner going through a corporate insolvency process:
- Transfers the assets from the insolvent company to another company;
- that he or she is the director of for, and for an unreasonably low price or for no price at all;
- to protect the company’s assets from being seized by creditors and/or the ATO;
- potentially in violation of their duties as a director.
Of course, these are basic explanations. In reality, these schemes are incredibly intricate, with numerous people or groups carrying out different aspects of the plan. And because this type of activity is questionable at best, participants often face criminal prosecution.
Legitimate restructuring of an insolvent company
Sadly, liquidation is a grim reality for many business owners. The good news is that there are ways to move on and stay in business without breaking the law. If liquidation is inevitable, you could simply sell the business assets, or you could sell the entire business to someone you know. Many directors prefer the latter because it allows business operations to continue.
There are several things that must be taken into consideration, however, and the transaction must be carried out accordingly.
Firstly, the transfer of business assets or the business itself should not be done solely to evade financial responsibilities. If it is done to avoid creditors, paying outstanding taxes, paying employees and so forth, it is considered illegal phoenix activity.
Secondly, you must make sure that the business and/or its assets are sold at market value. This means you must hire relevant professionals (with no ties to you or your business) to assess what everything is worth. Within this context, it is important that assets and liabilities are valued properly. This means depreciation should be taken into account. A qualified, independent, professional can easily make these determinations.
Another thing to keep in mind is that transparency is vital. This means you should make sure all aspects of the transaction are documented in accordance with relevant rules, regulations and policies. By making the documents readily available to authorities and the general public, you can also allay any suspicions of illegal phoenix activity.
Why sell to a related party?
By selling your business to someone you know, you may be able to secure a better price. This is because the buyer is already familiar with the business and its assets. Doing so also allows the business to continue, and allows for the retention of assets needed to make that happen. An added bonus for employees is that it allows them to keep working, which wouldn’t happen if liquidation came to pass.
Here’s what you could sell (transfer) in this scenario:
- The physical plant, equipment and motor vehicles;
- real property;
- intellectual property;
- customer lists;
- finance and lease agreements;
- employees and their benefits.
The bottom line
The bottom line is that there are legitimate ways to keep a business going if you’re facing liquidation. But without the proper legal advice, you could easily find yourself in a lot of trouble. McNamara Law has a solid reputation for providing high-quality legal advice and solutions across diverse industries, providing prompt, expert and cost-effective solutions for all commercial matters, including transferring business assets and avoiding the appearance of phoenix activity. Contact us on 1300 285 888to arrange a consultation today.