It’s easier to become a company director than it is to get a driver’s license, and researchers say it’s time to stop the unscrupulous using phoenix companies that are costing us billions.
What if someone told you that when your business is struggling and the debts are out of control that you can just shut it down one day and restart the next under a new name debt-free? Too good to be true? Not at all.
Such “phoenix” activity is costing the Australian economy over a $1 billion a year as unscrupulous directors and their advisers exploit the limited liability company structure to defraud their creditors, leaving suppliers, customers, workers and the tax office out of pocket.
The practice is so rife and difficult to prosecute that even when regulators are warned of dodgy phoenix transactions, not enough is being done, says University of Melbourne corporate law expert Professor Helen Anderson.
But a mammoth three-year investigation by researchers at the University of Melbourne Law School and Monash Business School has made 25 separate recommendations on how to clamp down on phoenix activity, including imposing identity checks on company directors. All directors would have to apply for a Director Identification Number that makes their director histories public, highlighting those directors involved in multiple business failures.
“It is hard to believe, but at the moment it is more difficult to obtain a driver’s license or a bank account than it is to become a company director – there are no identity or background checks,” says Professor Anderson who led the study.
It means it is difficult for the regulators to identify potentially dodgy directors with a history of business failures, making it easy for them to cover their tracks by simply falsifying their names or birth dates.
“The situation is causing terrible pain. Not only are small traders and consumers suffering significant financial damage as debts are not repaid and deposits are lost, but as a law abiding tax payer myself the cost in unpaid taxes drives me crazy,” she says.
Making Information Freely Available
“Dodgy directors are going under the radar where the regulators can’t join the dots. An identification number aims to address this by making it easier for ASIC and the ATO, as well as the public themselves, to identify potential phoenixers. And if people know they were being better tracked then they might think twice before undertaking phoenix activity,” Professor Anderson says.
Other key recommendations include that the regulator, the Australian Securities and Investment Commission, scrap the fees it charges for the public to search its company databases in order to encourage more transparency. It recommends that ASIC create a public register of disqualified directors and that ASIC make monitoring phoenix activity a higher priority.
There are also recommendations to increase the penalties for breaches of director’s duties which occur where there is deliberate liquidation of companies. It recommends the maximum civil penalty for breaching director’s duties be increased from $200,000 per offence to $500,000, while penalties for criminal breaches be increased from $360,000 to $810,000.
Phoenix activity is when a business is wound up or abandoned, only for a new company carrying on the same business to be created by the same people or their associates. It isn’t necessarily illegal and can be a legitimate way to rescue a business. But Professor Anderson says it becomes problematic when inept entrepreneurs are repeatedly failing and leaving creditors unpaid. It becomes illegal when people shut down businesses to intentionally defraud their creditors. It is these defrauders and the inept entrepreneurs that Professor Anderson and her colleagues want to target.
Professor Anderson says it is understandable that ASIC is struggling to enforce the law given it is receiving about 20,000 reports of misconduct each year from liquidators, and proving an intention to defraud is difficult. But she says one way around this is to give free access to ASIC databases that would empower the public to identify dodgy directors themselves.
“Phoenix isn’t a problem that we can enforce our way out of. Prevention is better than cure. We need to make it easier for people to do their own research. The casual phoenixers will then have to be more wary of getting caught.”
“The DIN and improved information access won’t stamp out complex illegal phoenix activity, but it will disrupt the practice and deter it,” she says. “At the moment phoenixers think they are invisible. This is a way of shining a light on them. The United Kingdom can provide company and director information for free. Why can’t we?”
Cost of Inaction
Making ASIC information free would cut into government revenue, but Professor Anderson argues that the cost is dwarfed by what phoenix activity is costing the country. She notes that ASIC runs at profit, earning around $850 million on a cost base of about $350 million a year, but points out that in 2012 PricewaterhouseCoopers estimated the cost of phoenix activity at $1.78 billion-$3.19 billion a year.
The Australian Taxation Office itself has estimated the cost at between $1 billion and $2.4 billion a year while according to the Productivity Commission there are 2,000-3,000 instances of phoenix activity every year.
As part of the research Professor Anderson and her co-researchers carried out interviews across business and government, talking to regulators, the police, government, liquidators, credit managers, business people and even the advisors who spruik phoenix activity to their clients. She says the temptation for people to absolve themselves of their debts by simply closing down and starting again is so alluring that it is in danger of becoming an accepted practice. She says there are already businesses out there that price their goods and services on the basis that they won’t be paying tax, effectively undercutting legitimate businesses.
“The opportunity to remove yourself from all your debt obligations by simply closing your company and starting a new one with no real consequences is just irresistible for some people,” she says.
Danger of Going Mainstream
Over twenty years ago, the Victorian Law Reform Committee concluded that “the problem of the phoenix company is common and perhaps endemic” and it should “not be ignored”. Yet the researchers point out that recent estimates of the economic cost of phoenix activity suggest that it’s still as rampant as ever.
Professor Anderson says a key reason why it is so difficult to stop phoenix activity is because closing down a failed business and allowing an entrepreneur to try again is perfectly legitimate. The challenge she says is to allow such legitimate business failures while stopping phoenix activity that involves intentional fraud. It is for this reason that the researchers are recommending the creation of a new “restricted” category of director. It would be slapped on those directors that have been involved in five business failures or more in a five-year period. These “restricted” directors would be listed in a public database and would face increased regulatory scrutiny.
“We don’t want to penalise people running limited liability companies unless they’ve done something wrong. Going into business involves some risk and we need to provide entrepreneurs with some protection. But we need to be able to identify and take action on the serial failures out there, whether people are doing it deliberately or not.”
The researchers also recommend that the government clarify the role and funding of liquidators who have a statutory duty to report to ASIC on business collapses. Professor Anderson says at the moment, because liquidators are only paid from any funds realised when a business collapses, they have no means to thoroughly investigate collapses where there is no prospect of being paid for their work.
The project produced three reports in all – the first profiled phoenix activity, the secondquantified phoenix activity, and the third sets out recommendations for curbing phoenix activity. The research team includes Professor Helen Anderson and Professor Ian Ramsay from the Melbourne Law School, Professor Michelle Welsh from the Monash Business School, and research fellow Jasper Hedges from the Melbourne Law School. The project was supported by an Australian Research Council Discovery Grant.