Business not doing great? Seek advice at the earliest sign of trouble, but if it seems off, get a second opinion. Photo: Moon Safari.
Times are tough, with a lot of businesses going into administration, but experts warn liquidation isn’t always a clean break and getting it wrong can land you in hot water.
Legitimate insolvency might be the only answer for companies that can no longer meet their financial obligations, but Lancaster Law & Mediation lawyer Graham Lancaster says trying to game the system isn’t a clever exit strategy — it’s a fast track to trouble.
“Entering what’s called a Deed of Company Arrangement (DOCA) can be a legitimate tool for struggling companies, allowing them to satisfy creditors’ claims without going into full liquidation,” he says.
“If you use that DOCA proposal to liquidate a company, then manipulate or exploit the insolvency process to shed your debts while keeping the assets, contracts and staff by transferring them to a new company, that’s known as ‘phoenixing’.”
Recent action by Lancaster Law highlights the legal dangers of the practice: if done to defraud creditors, phoenixing can carry serious legal, financial and reputational consequences.
In a recent case tried in the NSW Supreme Court, a dispute arose after negotiations to buy out the defendant’s shares turned messy.
The parties had agreed to sell the business on the open market and implement a DOCA to jointly appoint a liquidator.
Behind the scenes, the defendant sought advice from a pre-insolvency firm on what they described as a “legal phoenixing arrangement”.
Graham says the defendant allegedly took steps to reduce the company’s value.
“He misled prospective buyers, issuing invoices through a subcontractor and inflating expenses,” he says.
“He wanted to make other parties uninterested, so he could present a higher offer, the idea being that if he drives down the value enough and puts in just enough to buy it himself, he’s effectively getting the business back under a new entity.”
The court found the defendant had breached directors’ duties in three ways: shareholder oppression, violating the sale agreement and breaching the Corporations Act.
Ultimately, the judge ordered $350,000 to be paid for the shares plus legal costs, underscoring the legal and financial risks of manipulative phoenixing strategies.
Graham Lancaster says the repercussions for illegal phoenixing activities can be serious and some have the potential to follow you around forever. Photo: NEG Photography.
There is a range of civil and criminal penalties under the Corporations Act if you do the wrong thing in the liquidation process.
Lancaster Law & Mediation associate Kane Fieldsen says liquidators have special powers to bring action for the recovery of unfair preference payments, uncommercial director actions, insolvency, trading claims and more.
The ATO has special recovery powers to issue director penalty notices, some of which hold directors personally liable for the company’s tax debts.
Additionally, depending on your industry and the nature of your breach, relevant regulatory bodies might take their own appropriate action.
Then, there’s the reputational damage.
“That can follow you forever and you may never be able to hold a directorship again,” Kane says.
“So, between potential action from shareholders, creditors, liquidators and the ATO, liquidation doesn’t always put everything to bed.”
When a business that a person has spent years building starts to struggle, it can be tempting to look for ways to revive it.
Kane says at the first sign of trouble, the earlier you look into administration, the more legitimate options there tend to be for a comeback.
But if your strategy is to try to salvage that company and have it rise from the ashes, it’s best to get legal advice about the risks of your proposed plan.
“It might not be the golden ticket you think it is and it can be hard to distinguish between good and bad advice, especially if you’ve paid a lot of money for it and it sounds informed and legitimate,” he says.
“If something doesn’t pass the sniff test, or if you ever find yourself asking ‘is this legal?’, always get a second opinion from a lawyer.”
For more information, visit Lancaster Law & Mediation.
