New government plan could make it much easier to recover bad debts

Finance-iconOne of the mooted reforms to insolvency laws could help to stop bad debts which accrue when companies deliberately put themselves out of business.

 

One of the grubbier business practices in Australia is the “phoenix scheme”, a method that sees a heavily-indebted company wind up to avoid liabilities, then very quickly afterwards start a new company that offers the same services. The new company often has the same Directors and employees as the old company.

Creditors of the first company find it harder to recover debts from the wound-up company and receive very few cents in the dollar of money they are owed.

David McCrostie, a commercial disputes partner at TurksLegal, says phoenix schemes are rampant, especially among companies with under $1million in liabilities.

“ASIC’s figures indicate that a staggering 75 per cent of all corporate insolvencies involve less than $1 million in liabilities. Phoenix activity is rife in this sector because as any experienced [insolvency] practitioner knows, it’s practically impossible to secure funding to recover these relatively modest sums. The upshot is a very large number of smaller unsecured creditors and statutory creditors such as the ATO currently have no realistic prospect of ever getting their money back”, McCrostie said.

“Phoenix activity has been a long-standing problem in Australia,” Crostie added. “It is simply plundering and pillaging by another name. It robs ordinary creditors and employees, puts legitimate businesses at an unfair disadvantage and places a huge burden on the economy and public purse.”

The good news is that the federal government is onto the practice and in late 2011 published a “Proposals paper: A modernisation and harmonisation of the regulatory framework applying to insolvency practitioners in Australia.”

That paper includes a section on insolvency issues that affect small business and mentions phoenix schemes as one of the practices worthy of reform.

The paper suggests it may be possible to reduce the use of phoenix schemes by introducing “The ability to take civil action to recover company property inappropriately dissipated prior to business failure and hold directors liable for insolvent trading”.

To fund such actions, the paper suggests small business should be able to access the Assetless Administration Fund, a pool of money retained by the Australian Securities and Investments Commission which “finances preliminary investigations and reports by liquidators into the failure of companies with few or no assets.” Already intended to prevent phoenix schemes, extending the fund to finance civil cases would give small businesses another way to recover funds from phoenix schemes.

TurksLegal’s Crostie likes the proposals and welcomes them, but warned that “the devil will inevitably lie in the detail. The challenge now is for Parliament to back these promising ideas with firm legislative action and bureaucratic change with real bite.”

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