A loose regulatory framework has allowed a proliferation of phoenix companies for improper purposes. Law changes made in 2007 have not addressed a number of the underlying issues and we think further changes are needed.
A phoenix company is created when the owners and operators of an existing company cease that company’s business and start a similar business, transferring key assets and personnel from the old company to the new but leaving the liabilities with the old company, which typically goes into liquidation.
No disadvantage arises for the creditors of the failed company if the assets are transferred at fair value. But often they are transferred at knock down prices, or for no consideration, with the specific objective of avoiding paying the creditors and defeating their interests.
According to the Ministry of Business, Innovation and Employment (MBIE), around 400 companies a year engage in phoenixing activity, with annual costs to unpaid employees, creditors and the tax base estimated at between $370m and $660m.
Three simple amendments could make a big difference.
One: accelerate introduction of corporate role-holder identifiers to help identify phoenix company activity. Encouraging information sharing among relevant government agencies and creating a transparent public reporting scheme.
Two: expand the reach of the phoenix company provisions beyond situations in which a new company is formed using the same or a similar name. Directors of a failed company already have commercial incentives to change the branding to avoid any stigma.
Three: increase the civil liability faced by directors in breach by allowing the courts to order that they repay some or all of the unpaid debts of the old, “failed” company (not just debts of the new, “phoenix”, company). Currently the liability does not move with the directors but remains with the creditors.
Mechanisms to assist with identification of phoenix activity
Australia legislated last year to make it mandatory for Australian company directors to have one unique director identification number (DIN), to be recorded by the Australian equivalent of the Business and Registries branch of MBIE.
The New Zealand government, and MBIE’s business policy team, have been considering something similar for some time now, and the Government is now aiming to introduce legislation before this year’s election to support the New Zealand system - to be called a ‘corporate role-holder identifier’ (CRI)1. The aim is to reduce the information asymmetry that current creditors and customers face when attempting to carry out due diligence of a company with which they propose to engage. It is straightforward to identify related companies but difficult to identify prior companies of existing directors.
While it is possible to search, by director name only, every prior directorship of a director, that is not always reliable. There will be company directors who share the same name. Or a director may register with different variations of their name (innocently or otherwise).
Ideally, from the perspective of creditors undertaking due diligence, a CRI would allow the Companies Office Register to easily demonstrate the history of company or limited partnership involvement for any given individual director.
That could be complemented by maximising the ability of government agencies such as IRD, MBIE and the SFO to share information indicative of phoenix company activity. Australia’s “Phoenix Taskforce”, established in 2014 to support such information sharing, appears to have been effective in increasing tax revenue collected from illegal phoenix operators.2 Enabling the public to more easily report phoenixing activity would also assist.
Somewhat innovatively, the Government propose to fund the approximately $6.7m estimated establishment costs of the CRI register from an allocation of proceeds of crime recovered under the Proceeds of Crime (Recovery) Act 20093.
Expanding the ambit of phoenix company provisions
A wider definition of phoenix company activity would capture the following elements: the “intentional transfer of assets from an indebted company to a new company to avoid paying creditors, tax or employee entitlements”, and the “deliberate, systematic practice of liquidating related corporate trading entities to evade tax and other debts built up in the name of the failed company”.
This would be consistent with the Australian approach, made to the Australian Corporations Act 2001 in early 2020, which included:
- Creating a new type of voidable transaction called a “creditor-defeating disposition”. The property must have been transferred for less than its market value or the best price reasonably obtainable for it. And it must have had the effect of preventing that property from being available to creditors in a liquidation;
- Granting 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
- Creating offences for officers of a company for procuring, inciting, inducing or encouraging creditor-defeating dispositions.
But New Zealand might also consider some additional features, including:
- The length of the relevant clawback period;
- Whether a presumption of a transfer for under market value should exist in respect of any transfer between a failed company and a new company with a common director (i.e. the onus is on the director to prove it was at fair value); and
- Capturing transfers where the company has not gone into liquidation.
Ultimately, bright-line tests and simple recovery processes will be required to make the regime workable and cost-effective, and for it to be an effective deterrent.
Amendments to other provisions
Liquidators already have powers to address directors transferring assets out of a company for undervalue/inadequate consideration. But these are rarely evoked because of lack of funding or because the recoveries may be less than the cost of the action.
That difficulty cannot be solved by legislation, but some simple changes can be made to reduce cost and make it easier for liquidators to bring such claims. Specifically:
- Allow claims for transactions at undervalue and inadequate consideration to be commenced by a liquidator issuing a notice to the recipient. It can be done by simply expanding the s 294 notice process (for insolvent transactions and voidable charges) to cover claims under ss 297 and 298. The recipient company will have 20 working days to object to the notice to avoid the transactions being automatically set aside; and
- In respect of s 298 (transaction for inadequate consideration to related parties), establish a “restricted period” (say, six months prior to the failed company’s liquidation), during which any transaction under s 298 is presumed to have been made for inadequate consideration. The recipient of the assets will then have the burden of proving that the transfer was for fair value. This change would be consistent with the clawback periods that had previously been in place in relation to insolvent transactions, before that clawback period was reduced to six months in 2020.
1. Cabinet Paper titled “Better visibility of individuals who control companies and limited partnerships”, dated 22 March 2022; regulatory impact statement - “Corporate registry identifier”, dated 22 March 2022.
2. Grant Hehir Addressing Illegal Phoenix Activity (Australian National Audit Office, Auditor-General Report No.32 2018-2019, March 2019) at .
3. Paragraph 8 of the Cabinet Paper at footnote 1.
This article is part of our regular publication Restructuring & Insolvency: Rescue & Recovery. Read the other articles in this series below.