Further reforms to insolvency laws are now in effect, aimed at curbing illegal phoenix activity.  Included in these reforms are means intended to limit the voting power of related-party creditors who take an assignment of debts.

In accordance with the Federal Government’s proposed reforms to combat illegal phoenixing activity, in December 2018, amendments to the Insolvency Practice Rules (Corporations) Amendment (Restricting Related Creditor Voting Rights) Rules 2018 (“Amending Rules”) came into effect.

These amendments were, in effect, aimed at preventing phoenix operators from stacking votes at creditors’ meetings by assigning debts without valuable (or any) consideration to related creditors.  They then vote to appoint a ‘friendly’ insolvency practitioner who will in turn, fail to properly investigate the phoenix activity.

The predominant changes that came about as a result of these amendments were:

1. s. 75-95(1A), providing a requirement for insolvency practitioners to ask any creditor voting an assigned debt for evidence of the debt and the consideration for the assignment; and
2. s. 75-110(7), providing a regime by which the value of any related creditor vote of an assigned debt is to be calculated as the value of the consideration given for the assignment.

Challenges Resulting from the Changes

The introduction of these amendments, though welcomed by the insolvency profession, have caused some additional challenges for insolvency practitioners and creditors alike.

Namely, insolvency practitioners have since been required to determine whether a creditor is a related entity of the company, which can be difficult in circumstances where the company in external administration is, or is a subsidiary of, a listed company with a large shareholder base.

In addition, the changes may require debt investors to disclose sensitive information such as the price and payment structure to which the parties agreed.

In accordance with a Letter to Treasury by the Law Society of New South Wales regarding the draft legislation for the Amending Rules, the phrase “value of the consideration” in s. 75-110 (7) was considered too broad by its President, namely, that the phrase should be replaced with “the amount actually paid, prior to the meeting, in consideration of the assignment”.

The reasoning for this suggested amendment was that a related party may contract with a genuine creditor to pay, for example, twice the face value of the debt at some future point, but never actually pay that amount, however, insist on being admitted to vote for the greater amount on the basis that a promise of future payment is ‘consideration’.

It was also recommended that s. 75-110(7) be amended by providing that the voting value be limited to the lesser of the face value of the debt and the amount actually paid to prevent related parties paying over the odds for the assigned debts, potentially subject to a secret rebate or offset arrangement in order to increase their voting power.

In addition, it was also noted that the amendments do not address the approach of paying a creditor a fee or inducement to vote in a particular way, per Canadian Solar v ACN 138 535 832 Pty Ltd, In the Matter of ACN 138 535 832 Pty Ltd [2014] FCN 783.

Further Changes

It should be noted, however, that in addition to the Amending Rules, in February 2020 the Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020 (“Illegal Phoenixing Act”) was introduced, which provides a power for insolvency practitioners to recover property that is the subject of creditor-defeating dispositions, which is in line with their existing ability to claw back voidable transactions.

The Illegal Phoenixing Act also enhanced the personal liability consequences for illegal phoenix transactions by introducing both a civil penalty regime and criminal liability for creditor-defeating behaviour conducted by directors or pre-insolvency advisers.

The introduction of the Illegal Phoenixing Act also resulted in the introduction of s. 588FE(6B) to the Corporations Act 2001, which provides that creditor-defeating dispositions of company property are voidable if they are made while a company is insolvent or if they cause the company to become insolvent or enter external administration within 12 months of the disposition.

Furthermore, the Illegal Phoenixing Act also introduced s. 203AA of the Corporations Act to prevent the backdating of director resignations when such resignations are reported to the Australian Securities and Investments Commission (“ASIC”) more than 28 days after their purported occurrence.

It also provides that if a resignation would result in the company having no other directors, it will have no effect unless the company is being wound up.  This seeks to address illegal phoenix practices relating to backdating the effective date of director resignations to escape liability for a company’s actions following the effective date.