Chapter 5
Illegal phoenix activity and other misconduct
5.1
Phoenix company schemes have been a longstanding concern of
regulatory agencies, parliamentary committees and other bodies of inquiry.
Since 1994, at least six governmental inquiries have examined phoenix activity
in whole or in part. These inquiries include:
-
The Victorian Law Reform Committee, Curbing the Phoenix
Company—First Report on the Law Relating to Directors and Managers of Insolvent
Corporations, Report No 83 (1994);
-
The Law Reform Commission of Western Australia, Financial
Protection in the Building and Construction Industry, Project No 82 (1998);
-
The Royal Commission into the Building and Construction Industry
('the Cole Royal Commission'), Final Report (2003);
-
The Parliamentary Joint Committee on Corporations and Financial
Services, Corporate Insolvency Laws: A Stocktake (2004);
-
Fair Work Ombudsman, Phoenix Activity: Sizing the Problem and
Matching Solutions (PricewaterhouseCoopers, June 2012); and
-
The Inquiry into Construction Industry Insolvency in NSW ('the
Collins Inquiry'), Final Report (2013);
5.2
Despite the prevalence of inquiries and recommendations that
followed, illegal phoenix activity remains a significant issue within
Australia's construction industry. Indicative of the continuing difficulties is
the statement by the Melbourne Law School and Monash Business School Phoenix
Research Team in their October 2015 report: 'at present, the inconsistencies
and gaps in datasets relating to the incidence, cost, and enforcement of laws
tackling illegal phoenix activity render its accurate quantification
impossible'.[1]
This is concerning, because, as the ATO has remarked, illegal phoenix activity
is a 'serious threat to the integrity of the tax and superannuation systems'
and a 'serious financial crime'.[2]
5.3
This chapter examines the distinction between legal and illegal
phoenix activity and provide details on the incidence and effects of illegal
phoenix activity in the construction industry. It also assesses the efforts of
regulatory agencies to prevent and punish instances of the behaviour. In
addition, this chapter examines criminal and civil misconduct related to
insolvencies more generally. Chapters 7 to 12 will analyse the adequacy of the
current legislative and regulatory framework concerning insolvency.
What is phoenix activity?
5.4
Academics from the Melbourne Law School and Monash Business
School provided a background to the use of the term 'phoenix activity':
The concept of phoenix activity broadly centres on the idea
of a corporate failure and a second company ('Newco'), often newly
incorporated, arising from the ashes of its failed predecessor ('Oldco') where
the second company's controllers and business are essentially the same. These
are generally known as 'successor' companies. Phoenix activity can also arise
within corporate groups where an already established subsidiary takes over the
business of a related entity that has gone into liquidation.[3]
5.5
As this explanation suggests, 'phoenixing' is not in and of
itself illegal or inherently unlawful, but 'a side-effect of the use of the
corporate form and of limited liability; concepts that are fundamental to the
global commercial system'.[4]
In many cases phoenix activity can be 'entirely legal', especially, as
academics at Melbourne Law School and Monash Business School noted, 'if the
worth of the failed company's assets is maintained and the employees keep their
jobs and entitlements'—behaviour that in their mind should be less pejoratively
described as "legal phoenix activity" or "business rescue".[5]
5.6
Associate Professor Michelle Welsh, Monash Business School,
explained that, in the opinion of the academics at Melbourne Law School and
Monash Business School, there are five different categories of phoenix
activity.[6]
They are:
-
the legal phoenix or business rescue;
-
the problematic phoenix—in which a hapless entrepreneur presides
over business failures.
-
the illegal type 1—where an improper intention to transfer the
assets at undervalue is formed as the company is approaching insolvency;
-
the illegal type 2, or 'phoenix as business model'—where people
deliberately set up companies with the intention of phoenixing them; and
-
the illegal type 3, or 'complex illegal phoenix activity'—in
addition to setting up a company to avoid debts, these situations coincide with
some other forms of illegality, such as use of false invoices, GST fraud, or
money laundering.
5.7
Associate Professor Welsh noted that each type of phoenix
activity may require a different legislative or regulatory response.
Illegal phoenix activity
5.8
The fact that phoenix activity can be lawful presents
difficulties for regulators attempting to detect illegal phoenix
activity. This is even more so when it is both to be 'expected that a failed
business person will try to start their next business in the same field and
will want to buy assets from the failed company' and that it is commonplace in
certain industries, including the construction industry, 'for individual
projects to be carried out by separate companies'.[7]
These challenges are heightened by the absence of legislative definition as to
what constitutes illegal phoenix activity and the fact that no specific phoenix
trading offence exists under legislation that ASIC administers.[8]
Particularly, when as Associate Professor Welsh explained, it 'is probably not
a good idea' to create a specific phoenixing offence because 'it would be too
hard to define'.[9]
Corralling the illegal phoenix
5.9
This lacuna is not accidental but a result of the difficulty in
delineating between legal and illegal phoenix activity in practice. This
challenge has not, however, prevented regulators or other stakeholders from
developing indicia that, where present, suggest illegality may be occurring.
Central to each working definition is the concept of 'intent'.
5.10
ASIC first formulated a definition of illegal phoenix activity in
a research report published in 1996 entitled Phoenix Activities and
Insolvent Trading. ASIC's definition adapts that used by the Victorian Law
Reform Committee in its 1994 report, Curbing the Phoenix Company, and
draws a distinction between legal and illegal phoenix activity. Legal phoenix
activity 'involves the winding up of a company and the subsequent continuation
of that business in a new company, often with a similar company
name, structure and staff'.[10]
Illegal phoenix activity, however, generally involves abuse of the corporate
form by current or previous directors of the company to intentionally deny
creditors their entitlements. Characteristics of illegal phoenix activity
include:
-
the company fails and is unable to
pay its debts; and/or
-
directors act in a manner which
intentionally denies unsecured creditors equal access to the entity's assets in
order to meet unpaid debts; and
-
within some period of time soon
after the failure of the initial company (i.e. 12 months), a new company
commences using some or all of the assets of the former business, and is
controlled by parties related to either the management or directors of the
previous entity.[11]
5.11
The ATO also noted a number of indicia that suggest illegal
phoenix activity. These include:
-
the directors of the new entity are family members or close
associates of the director(s) of the former company;
-
a similar trading name is used by the new entity; and
-
the same business premises and telephone number (particularly
mobile number) are used by the new entity.[12]
5.12
ASIC summarised its working definition of illegal phoenix
activity:
By engaging in this illegal practice, the directors have
intentionally and dishonestly denied unsecured creditors (employees, providers
of goods and services and the ATO) equal access to their entitlement to the
assets of the company because these assets have been transferred to another
corporate entity for inadequate consideration.[13]
5.13
The Fair Work Ombudsman (FWO) employs a similar operational
definition of illegal phoenix activity. A 2012 report authored by
PricewaterhouseCoopers for the FWO, defines phoenix activity as:
Phoenix activity is the deliberate and systematic liquidation
of a corporate trading entity which occurs with the illegal or fraudulent
intention to:
-
avoid tax and other liabilities, such as employee entitlements;
-
continue the operation and profit taking of the business through
another trading entity.[14]
5.14
The ATO uses the term 'fraudulent' rather than 'illegal' when
describing unlawful phoenix activity. Their working definition is, however,
broadly analogous to that of ASIC and the Fair Work Ombudsman, describing
fraudulent phoenix activity as 'the evasion of tax and/or superannuation
guarantee liabilities through the deliberate systematic and sometimes cyclical
liquidation of related corporate trading entities'.[15]
5.15
For academics from the Melbourne Law School and Monash Business
School, intent is also critical in transforming otherwise legal phoenix
activity into illegal activity. Their submission noted:
The behaviour becomes illegal where the intention of the
company's controllers is to use the company's failure as a device to avoid
paying Oldco's creditors (who may include the company's employees and revenue
agencies) that which they otherwise would have received had the company's
assets been properly dealt with.[16]
5.16
In their Australian Research Council Discovery Project, 'Phoenix
Activity: Regulating Fraudulent Use of the Corporate Form', Helen Anderson et
al noted further:
The illegality of phoenix activity instead turns
predominantly on the intention of the company's controllers, whether the
company was phoenixed deliberately in order to avoid debts which may include
employee entitlements.[17]
5.17
The general harmonisation of working definitions across the
regulatory and academic field is positive. The ATO argued that a 'consistent,
shared, cross‑government agreement as to what constitutes phoenix
behaviour' is necessary to 'facilitate collaboration between agencies to share
information and to deal with higher‑-risk phoenix conduct'.[18]
This is true and there is room for greater harmonisation. However,
notwithstanding relatively analogous definitions, identifying illegal phoenix
activity in practice remains a problematic task. As Helen Anderson et al
explained, detecting and preventing illegal phoenix activity is challenging for
two primary reasons. First, critically, it is difficult to prove intention on
the part of the company's controllers.[19]
Secondly, illegal phoenix activity 'is not susceptible to precise modelling'
and the existence of certain factors is not determinative.[20]
Helen Anderson et al continued:
It is virtually impossible to identify illegal phoenix
activity from an incorporation of a successor company following a single
failure in the absence of documentary evidence such as written instructions
from advisors. Rather, the characterisation of illegal phoenix activity is
likely to come from the external observation of the conduct of specific
individuals involved in multiple corporate failures over a period of time.[21]
5.18
That detection is unlikely—or even impossible—after a single
corporate failure presents difficulties for regulators and participants within
the industry. It seems that deliberate insolvencies designed to unlawfully deny
workers their entitlements and the public tax revenue will persist.
5.19
ASIC acknowledged the difficulties in detecting illegal phoenix
activity and that it relies on various sources to detect such operation. In
particular, ASIC informed the committee that reports of alleged misconduct
concerning illegal phoenix activity come from the public and via statutory
reports lodged by external administrators.[22]
In ASIC's view, registered liquidators are important gatekeepers who have 'a
critical role in ensuring the integrity of the financial system and that
investors and financial consumers can have trust and confidence in the market'.[23]
5.20
Unfortunately, ASIC noted that unscrupulous liquidators and
business advisors 'can and do facilitate illegal phoenix activity'.[24]
This will be addressed further in chapters 7 and 12. As will also be noted
below, ASIC has had some successes in removing liquidators from acting for
companies where illegal phoenix activity has been suspected.[25]
Incidence of phoenix activity
5.21
The Cole Royal Commission into the Building and Construction
Industry found that 'there is significant [illegal] phoenix activity in the
building and construction industry, particularly in the eastern states'.[26]
The existence of illegal phoenix activity is not confined to the construction
industry, but, the CFMEU noted, anecdotally the industry is 'notorious for the
widespread use of [illegal] phoenix companies and some of the most flagrant
examples of the practice'.[27]
The Cole Royal Commission explained why this may be the case, noting that the
industry 'has particular characteristics which make it vulnerable to phoenix
company activity', including:
-
project based work;
-
competitive pressures;
-
cash flow problems;
-
lack of administrative skills; and
-
the limited asset base of contractors.[28]
5.22
The ATO also noted that in its experiences the 'economic
circumstances' within the construction industry and 'resulting social norms'
contribute to illegal phoenix behaviour. In their view:
...the tight margins across the industry, the longer payment
terms offered by larger businesses to sub-contractors and the market
competition for clients in the business-to-consumer component appear to
increase the likelihood of non-compliance and accidental or intentional
insolvency. In addition, the 'domino effect' impacts of insolvencies by an
entity higher in a supply chain can result in the businesses of suppliers and
subcontractors also failing, harming business owners and employees of those businesses
lower in the supply chain.[29]
5.23
Initial external administrators' reports lodged with ASIC support
anecdotal evidence of widespread incidence of illegal phoenix activity. These
reports document that alleged misconduct in the construction industry for contraventions
associated with illegal phoenix activity (ss. 180–184, 588G and 590 of the
Corporations Act) is 'significantly higher than all other industries' except
for the category 'Other (business and personal) services'.[30]
5.24
In addition to external administrators' reports, ASIC receives
reports of alleged misconduct directly from the public. ASIC informed the
committee that each year its Misconduct and Breach Reporting team receives
'some 13,500 reports of alleged misconduct and enquiries'.[31]
Table 5.1 below, details the number of reports of alleged misconduct regarding
allegations relating to illegal phoenix activity, disaggregated by provision of
the Corporations Act, for the financial years 2009–10 to 2013–14.[32]
Table 5.1: Statistics on
reports of alleged misconduct in the construction industry (2009–10 to 2013–14)
|
Section
|
FY09/10
|
FY10/11
|
FY11/12
|
FY12/13
|
FY13/14
|
Total
|
|
180
|
314
|
339
|
518
|
513
|
507
|
2191
|
|
181
|
167
|
144
|
215
|
274
|
280
|
1080
|
|
182
|
122
|
118
|
172
|
184
|
196
|
792
|
|
183
|
33
|
43
|
46
|
53
|
73
|
248
|
|
184
|
57
|
48
|
44
|
39
|
42
|
230
|
|
588G
|
896 civil
169 criminal
|
901 civil
164 criminal
|
1101 civil
125 criminal
|
1218 civil
109 criminal
|
1220 civil
75 criminal
|
5336 civil
642 criminal
|
|
590
|
32
|
31
|
37
|
23
|
25
|
148
|
5.25
The ATO also indicated that the incidence of phoenix activity in
the construction industry is high. Mr Michael Cranston, ATO informed the
committee that the ATO monitors 'about 20,000 groups...under the phoenix
umbrella', of which approximately 2000 are 'high risk and roughly 9,000 to
10,000 medium risk'.[33]
5.26
Not all submissions accepted that the incidence of phoenix
activity in the construction industry was considerable. The 2012 PwC report
prepared for the Fair Work Ombudsman, referred to a submission by the MBA to
that inquiry:
Master Builders indicated that there is still a
disproportionate amount of phoenix activity in the building and construction
industry and that they would hear of incidents on a monthly basis. They
indicated that subcontractors and smaller businesses were particularly
vulnerable to phoenix activity due to the high level of 'churn' at the lower
end of the building and construction industry.[34]
5.27
The MBA told the committee, however, that 'since the feedback
given to PwC for the purposes of the compilation of its report, Master Builders
has not been informed of phoenix activity with the regularity previously
noted'.[35]
Mr Wilhelm Harnisch, CEO, Master Builders Australia, reiterated this position
when appearing before the committee, stating that: 'phoenixing or insolvencies
are not at alarming high levels'. Mr Harnisch did note, however, that he did
not mean to say that any level is acceptable.[36]
5.28
Unfortunately reliable data is hard to come by. The absence of
detailed statistics concerning insolvencies examined in chapter 2 is mirrored
by an absence of statistics on illegal phoenix activity. Academics from
Melbourne Law School and Monash Business School noted that there 'is a general
paucity of reliable data concerning incidence and cost, and somewhat more
reliable data concerning enforcement actions undertaken by ASIC, the ATO and
FWO'.[37]
5.29
In an updated October 2015 report entitled Quantifying Phoenix
Activity: Incidence, Cost, Enforcement, the academics noted that an
accurate record remains impossible to ascertain. They explained:
While federal and state governments and regulatory bodies all
recognise that illegal phoenix activity is a significant problem, the Phoenix
Research Team's examination of data on the incidence of this activity
illustrates that no one has been able to accurately quantify the extent of the
problem.[38]
5.30
The academics reported that there are three primary causes for
the lack of reliable data on the incidence of illegal phoenix activity. They
are:
-
the lack of an illegal phoenix activity offence means that
statistics only capture breaches or suspected breaches of other legislative
provisions, in circumstances where phoenix activity might be present;
-
not all data is captured by regulators, and not all that is
captured is publicly available;
-
for a variety of reasons, much of the data produced by regulators
and others is only an estimate of illegal phoenix activity, and is not an
actual quantification of it.[39]
5.31
Associate Professor Welsh suggested that one way to increase data
on phoenix operators would involve better utilising liquidator reports. As
noted, external administrators are required to lodge reports to ASIC and to
indicate if they believe that has been any civil or criminal misconduct.
Associate Professor Welsh explained that 'it would be very handy if there was a
box they had to tick to say if they suspected there was phoenix activity going
on'.[40]
That is, regulators should be instructed to 'actually collect' data on
suspected illegal phoenix activity.[41]
Committee's views
5.32
The committee is concerned that no accurate quantification of the
incidence of illegal phoenix activity exists. Absent this threshold figure it
is impossible to identify the total economic and non–economic cost of illegal
phoenix activity in the construction industry. Although the committee
appreciates that it may be impossible to identify with precision the total
incidence of illegal phoenix activity—particularly when there is no legislative
definition of illegal phoenix activity—the committee believes that more can be
done to arrive at a more accurate figure. In particular, the committee believes
that regulators should collect data on alleged instances of illegal phoenix
activity.
5.33
Nevertheless, the committee is satisfied that the estimates of
the cost of illegal phoenix activity referred to above suggest a significant
culture of disregard for the law. This view is reinforced by the anecdotal
evidence received by the committee which indicates that phoenixing is
considered by some in the industry as merely the way business is done in order
to make a profit.
Recommendation 11
5.34
The committee recommends that ASIC, in consultation with
ARITA, work out a method whereby external administrators can indicate clearly
in their statutory reports whether they suspect phoenix activity has occurred.
For example, to serve as a red flag to ASIC, include a box in the reporting
form that external administrators would tick if they suspected phoenix
activity.
Effect of illegal phoenix activity
5.35
Many submissions discussed the considerable effect phoenix
companies had on individuals, the industry, entire communities and the public
purse. The CFMEU noted that a 'typical phoenix company will collapse owing
unremitted group tax, state payroll tax, superannuation contributions and
workers compensation premiums'.[42]
Likewise with general insolvencies, individuals affected may be supported by
public revenue—either through unemployment benefits or the FEG legislative
safety net.
Cost of illegal phoenix activity
5.36
The paucity of data also means that quantifying the total cost of
illegal phoenix activity is difficult.[43]
Academics from the Melbourne Law School and Monash Business School explained
that while some costs—such as the amount owed to employees or the ATO—are
easier to quantify than others, it is 'much harder' to quantify the cost of
detection and enforcement, or costs to the broader economy or competitors.
Amplifying these challenges is the difficulty in establishing whether unpaid
debt or other costs is 'attributable to improper behaviour, as opposed to
legal, proper business rescue.[44]
5.37
Nonetheless, regulators, industry professionals and academics
have all attempted to quantify the cost of illegal phoenix activity in the
building and construction sector.
5.38
ASIC and ATO both cited the findings of the 2012
PricewaterhouseCoopers report. That report considered the cost to employees,
business and government revenue from unlawful phoenix activity during the
2009–10 year. Although this report examined illegal phoenix activity across all
industries, it should be remembered that it is likely that the construction
industry accounts for the greatest incidence of illegal phoenixing.
5.39
The PwC report found 'the total cost (which excluded unpaid
Superannuation Guarantee) was estimated to be between $1.79 billion and $3.19
billion per annum'.[45]
The report further estimates that the annual cost of this activity is up to:
-
$655 million for employees—in the form of unpaid wages and other
entitlements;
-
$1.93 billion for businesses—as a result of phoenix companies not
paying debts or not providing the goods and services that have been paid for by
creditors; and
-
$610 million for government revenue—mainly as a result of unpaid
tax—but also due to payments made to employees under the Fair Entitlements
Guarantee.[46]
5.40
Staggeringly, these costs are not exhaustive. The report noted
that:
A range of impacts of phoenix activity on employees (such as
superannuation), businesses (such as unfair advantage) and government (such as
monitoring and enforcement costs) and the environment (such as avoidance of
regulatory obligations) have not been included in the modelling.[47]
Impact of illegal phoenix activity on
other businesses
5.41
The committee heard from a number of submissions and witnesses on
the impact of phoenix companies on other businesses. According to these
submissions, phoenix companies are awarded projects through
'net-of-tax-tendering': that is where companies tender quotes calculated on the
basis that they will not pay taxes. Although no submission or witness could
point to a concrete example of this practice, the number of times it was
referred to at public hearings across the country is concerning.
5.42
The Air Conditioning & Mechanical Contractors' Association of
Australia cited a report from one of its members that indicated that phoenix
companies were 'frequently winning jobs by tendering at artificially low prices
made possible by the competitive advantage they receive by not complying with
tax, debt and other obligations'. The member argued that:
In such circumstances, reputable companies are simply not
able to compete on price, and despite the unconscionable conduct of phoenix
company operators, clients can be enticed to simply transfer the contract to
the new company in order to take advantage of the lower costs on offer.[48]
5.43
Despite contending that the scale and incidence of phoenixing was
'not at alarming high levels',[49]
Mr Wilhelm Harnisch, CEO MBA, considered that net of tax tendering led to a
frequent complaint within the building industry—that there is 'not a level
playing field, and that the honest ones are being priced out of the market by
the dishonest ones'.[50]
5.44
Academics from the Melbourne Law School and Monash Business
School reported anecdotal evidence of net of tax tendering. They noted that in
these cases because the contract would be unprofitable without failing to pay
taxes, 'it is likely that the head contractor or client knows that the tender
does not allow for tax to be paid'.[51]
5.45
Mr John Chapman, South Australian Small Business Commissioner,
acknowledged that he had heard anecdotal evidence of this practice.
What I am more concerned about is when people are bidding for
jobs with zero margin or minus X per cent margin. Again, it is anecdotal
evidence that this is occurring. The question becomes: where are they going to
make their profit? That is by screwing down on the subcontractors and
suppliers.[52]
5.46
Mr Edward Sain, a construction industry consultant, informed the
committee that he too has heard of businesses 'going in at negative margins and
trying to screw it back out of the subcontractor'.[53]
5.47
The Melbourne Law School and Monash Business School referred to
some companies exploiting the labour hire model as another feature of illegal
phoenix activity. Under this scheme, labour hire companies are created purely
to accrue PAYG(W) and payroll tax debts. These entities are then liquidated
before either the ATO or state revenue offices are able to exercise their
enforcement powers: 'They are not proper labour hire businesses in the sense of
having employees on their books that perform work for many different
employers'.[54]
5.48
According to the Melbourne Law School and Monash Business School
academics, where the prevalence of illegal phoenix activity reaches 'a critical
point', it becomes impossible for reputable businesses to continue. They face
'a difficult choice between succumbing to the same illegal behaviour or else
risking being priced out of business.'[55]
Mr Brian Collingburn raised a similar point:
Phoenixing sub-contracting companies are profitable to
developers and lead builders because a contractor with an intention to phoenix
can profitably undercut honest contractors...This forces other developers and
construction companies to adopt the same methods.[56]
Non-economic effects of illegal
phoenix activity
5.49
In some circumstances, the non-economic effect of illegal phoenix
activity can be greater than general insolvency. The Collins Inquiry into
Construction Industry Insolvency in NSW maintained that the frustration and
anger expressed at the impunity of 'unscrupulous operators was palpable'. It
stated further:
Not only could the worst offenders in the industry simply
close up shop one day, leaving any number and amount of debts unpaid, and
opening up the next day under a different trading name, these were the same
operators who were gaining an unfair competitive advantage by undercutting
their rivals in the bid process.[57]
5.50
This understandable view was expressed by many witnesses across
the country. Mr Dave Holding explained that he looked into the background of Mr Dave Simmons,
the owner of The Simmons Group (TSG), a company that had entered administration
owing him $370,000.
I talked with TSG and they told me, 'Yes, we've gone into
liquidation. Knock yourselves out—the company's worth a dollar.' So I went to a
lawyer. The lawyer looked into it. Previous to that...we had already thought,
'It's getting further and further behind. Let's investigate him.' We discovered
that Dave Simmons was on the top 30 rich list in WA. He was worth $30 million
or something. He lived in Dalkeith. He has a nice boat. He has a nice farm down
south.[58]
5.51
Mr David Simmons rejected any allegations that he acted
dishonourably or in contravention of any laws.[59]
Curbing illegal phoenix activity
5.52
The majority of submissions that touched on illegal phoenix
activity contended that the continuing incidence of phoenix companies
demonstrates that the current legal and regulatory framework is unable to curb the
practice. Those submissions that considered illegal phoenix activity a pressing
problem were divided, however, between whether new legislation or more
resources for regulatory agencies was required to resolve this issue. This
section assesses the current regulatory framework designed to curb illegal
phoenix activity. Illegal phoenixing is a criminal offence. The following chapters
will explore in more detail potential reforms designed at reducing the
incidence and scale of insolvency and illegal phoenix activity.
Identifying illegal phoenix activity
5.53
The principal difficulty facing regulators in curbing illegal
phoenix activity is the first step of identifying and detecting the behaviour.
As noted above, phoenix activity is not necessarily illegal and, as the
submission from the Melbourne Law School and Monash Business School considered,
it might therefore be 'better thought of as a context in which illegality might
occur, rather than a problem in itself'.[60]
5.54
Unfortunately this makes detection and regulation difficult. As
Mr Len Coyte, Masonry Contractors Association of NSW & ACT, noted, regulation
is necessarily reactive rather than proactive:
With the phoenix operations, it is not the fact that they are
illegal as rescue‑and-recovery operations; they are illegal when the
intent is illegal. You have to wait until it has happened to make a complaint
and then have an investigation and then—very difficult in the courts—establish
the illegal intent, and this is where it is failing.[61]
5.55
The ATO explained that the effective regulation of phoenix
activity has considerable cost consequences:
...while the ATO is allocating resources to deal with the
systemic non-compliance by phoenix property developers, our approaches under
the current law are costly and resource-intensive, given the 'after-the-fact'
nature of current detection and collection mechanisms.[62]
5.56
In its view, the ability to curb illegal phoenix activity rests
on a legislative and regulatory framework that enables more proactive
engagement:
The ability to intervene in real time (or at least a timely
manner) would allow the ATO to more successfully address phoenix operators
before they redistribute profits realised from property developments in order
to fund the activities of other entities, future developments and to fund their
lifestyle without any significant fear of the consequences.[63]
5.57
In response, regulators have had to become more creative and
innovative. The ATO informed the committee that they have developed a risk
assessment model that seeks to identify suspected illegal phoenix operators.
The ATO's 'Phoenix Risk Model' provides a demographic and risk-based profile of
the overall potential and confirmed phoenix population. The Risk Model has
access to the ATO's Group Wealth System enabling the ATO to link associated
entities within private group structures suspected of illegal phoenix activity.
The ATO explained that by running these datasets against each other they are able
to 'more accurately identify which connected private groups and their
controlling minds may be illegitimately building their wealth through
fraudulent phoenix behaviours'.[64]
The analysis demonstrates that:
...there are around 19,800 phoenix groups (72% of which contain
at least one building or construction entity), with links to around 360,000
entities (17% of which are building or construction entities), of which 1600
have been rated as high-risk. These linked entities represent about $1.8
billion in debt owed to the ATO, although this is not all as a result of
confirmed phoenix behaviour.[65]
5.58
In relation to the construction industry more specifically, the
ATO has identified:
...3,355 individuals who have a history of insolvency in the
property development industry. These individuals have been in control of more
than 13,000 entities with more than $2 billion in debt written off by the ATO.
These insolvent entities have also previously claimed $1.3 billion in GST
credits in the past 4 years. The controllers of these entities and their
private groups form part of the ATO's phoenix risk population.[66]
5.59
The practical difficulties in detecting illegal phoenix activity
have propelled whole-of-government and federal responses. For example, the 2003
Cole Royal Commission recommended that the Commonwealth discuss with the States
and Territories 'appropriate methods of permitting their revenue authorities to
share information relevant to the detection of payroll tax evasion in the
building and construction industry where this does not already occur'.[67]
These steps are continually being refined.
5.60
One example of cooperation aimed at identifying illegal phoenix
behaviour was proffered by the Department of Employment. As the Department
noted, the administration of the Fair Entitlements Guarantee (FEG) does not
involve any regulatory role in addressing phoenix activity. However,
...as the nature of the FEG is to provide payment for unpaid
entitlements due to liquidation of the employer, the range of information
collected by the Department in administering FEG claims provides useful
intelligence data for detection of fraudulent phoenix activity.[68]
5.61
The Department of Employment informed the committee that it
provides to the Taskforce the 'names of insolvent entities and associated
directors under FEG where the same director has been involved in two or more
entitles paid assistance under FEG'.[69]
While this information does not imply that the directors or entities are or
have been involved in illegal phoenix activity, it is useful complementary information.
5.62
Regulatory agencies informed the committee that they are increasingly
acting in concert to close the net on illegal phoenix operators. ASIC noted the
newly established Phoenix Taskforce, which is intended to 'identify, design and
implement cross agency strategies to mitigate and deter fraudulent phoenix
activity'.[70]
This taskforce will allow government agencies to share data more easily and
help identify illegal phoenix behaviour. ASIC stated:
The Phoenix Taskforce is developing and using sophisticated
data matching tools to identify, manage and monitor suspected fraudulent
phoenix operators.[71]
5.63
Mr Bruce Collins, ATO, explained that the Taskforce's primary
responsibility is information sharing: 'an instrument by which the actual forum
can communicate'.[72]
The Taskforce is composed of the following agencies:
-
the Australian Taxation Office;
-
the Australian Business Register;
-
the Australian Securities and Investments Commission;
-
the Australian Crime Commission;
-
the Fair Work Ombudsman;
-
Fair Work Building & Construction;
-
the Australian Federal Police;
-
the Australian Competition and Consumer Commission;
-
the Clean Energy Regulator;
-
the Department of Employment;
-
the Department of Environment;
-
the Department of Human Services;
-
the Department of Immigration and Border Protection;
-
the Office of the Migration Agents Registration Authority; and
-
the State and Territory Revenue Offices.
5.64
The Taskforce does have some limitations. In particular, while
the prescription process allows the ATO to disseminate information to
participating agencies, it 'does not empower those other agencies to
disseminate information to the ATO or a third agency in the taskforce'.[73]
Mr Collins explained that this limitation is a result of confidentiality
provisions in legislation establishing each participating agency. He noted
further that the prescribed taskforce 'is a machinery provision within the tax
code, so it actually only applies to the ATO'.[74]
5.65
Mr Rob Heferen, Deputy Secretary Revenue Group, Treasury,
acknowledged that this information asymmetry is unhelpful.[75]
Mr Heferen informed the committee that Treasury and the ATO are working through
this issue currently 'to see what advice we can put to ministers'.[76]
5.66
Ms Sue Saunders, Fair Entitlements Guarantee, Department of
Employment sits on the Phoenix Taskforce. Ms Saunders explained that the branch
provides useful intelligence concerning businesses that fail to pay employee
entitlements which 'feed[s] into the other range of information that ATO and
ASIC are collecting that builds their risk profile around certain operators in
the industry'.[77]
5.67
The ATO informed the committee of two further whole-of-government
responses aimed at identifying and detecting illegal phoenix activity and the
networks of facilitators that support them—the Inter-Agency Phoenix Forum (the
Forum) and the Phoenix Watchlist. The Inter-Agency Phoenix Forum has led to
information sharing between the ATO, the Department of Employment and ASIC. The
ATO explained:
Outcomes from this Forum include sharing of information
between the ATO and Department of Employment where those accessing the Fair
Entitlements Guarantee scheme on multiple occasions have their ATO risk rating
increased and the ATO and ASIC working together on a network of liquidators,
tax agents and their clients who appear to be significant phoenix operators.[78]
5.68
The Forum comprises 17 agencies, meets every 'three to six
months'[79]
and has met 13 times from 29 June 2011 to 5 August 2015.[80]
The Department of Employment explained that through the Forum, the Department:
...provides information regularly to the Australian Taxation
Office (including names of directors, companies and total amounts paid where
the same directors are associated with two or more FEG cases) and the
Australian Securities and Investments Commission (including the names of the
directors, insolvency practitioners, companies and amounts paid for all FEG
cases). Feedback from both these agencies is that the data is very useful for
their intelligence gathering.[81]
5.69
The Phoenix Watchlist was established on 2 January 2015. It is a
register of known or suspected illegal phoenix operators accessible to
participating state and federal government agencies, including the ATO, ASIC,
state and territory revenue offices, the Fair Work Ombudsman and the Australian
Business Register. The ATO noted that it 'has already provided information
regarding 154 confirmed Phoenix operator groups with 2,184 linked entities
through the Phoenix Watchlist and is working to provide further information
over time'.[82]
5.70
Information sharing between regulators is often not sufficient to
detect illegal phoenix activity and regulators rely on information from the
public to detect and identify such behaviour.[83]
Mr Cranston, ATO, explained the ATO's position:
There are a lot of victims and people out there who know a
lot more than we do. I was on a panel and they asked, 'What is one of the big
answers for phoenixing?' I said: 'Come and talk to the regulators. Let us know.
You know more than us, and sometimes you can be a victim if you do not let us
know as quickly as possible'.[84]
5.71
Unfortunately, the CFMEU observed that many small contractors are
reluctant to go public with information that may assist regulators:
Unsecured creditors such as smaller subcontractors (and their
employees), usually bear the brunt of corporate insolvencies. In 2013–14, the
chance of an unsecured creditor receiving nothing from an insolvent company in
the industry was almost 92%. Yet many small contractors remain reluctant to go
public about the problem for fear of commercial consequences.[85]
5.72
These sobering statistics accord with evidence received by the
committee indicating that subcontractors experience intimidation or retribution
when seeking to rely on their rights under security of payments acts. This will
be addressed in more detail in chapter 8.
5.73
The ATO advised the committee that agencies are increasingly
regularising this information stream by developing industry engagement
strategies.
Whole-of-government approaches have seen agencies work
together both to engage industry players and to target fraudulent phoenix
behaviour. For example, the Australian Securities and Investment Commission,
the ATO, the Fair Work Ombudsman and Fair Work Building & Construction
(FWB&C) are engaging with head construction contractors through a head
contractors' round table discussion group to discuss how those contractors can
work with regulators to better manage the exposure of their projects to phoenix
operators lower in the contractor chain. Concurrently, ASIC, the ATO and
FWB&C are engaging with relevant head contractors involved in two
significant construction projects, regarding potential phoenix activity.[86]
Preventing and punishing illegal
phoenix activity
5.74
Identifying suspected illegal phoenix activity is only the first
step. In order to curb it, regulators must act swiftly to prevent its
occurrence and punish the perpetrators. The legislative measures available will
be addressed in greater detail in chapters 7 to 12, which are focused on
insolvency more generally; this section is specifically focused on measures to
prevent and punish illegal phoenix activity.
5.75
ASIC informed the committee that it undertakes certain proactive
initiatives to identify and combat illegal phoenix activity. ASIC noted that a
precursor for directors to engage in illegal phoenix activity was 'companies
experiencing cash flow problems'.[87]
ASIC stated that one means by which it could assess if companies were
experiencing cash flow problems would be to check the integrity of the payment
system from principal contractors to subcontractors. However, ASIC repeated
statements from industry participants recounted in greater detail below[88]
that the use of statutory declarations as a means by which principal
contractors prove that they have paid subcontractors for goods and services is
not working.
The endemic use of false statutory declarations in the
building and construction industry was highlighted in the Collins inquiry into
the construction industry in NSW.[89]
5.76
ASIC informed the committee that it has implemented a surveillance
campaign in New South Wales, Victoria and Queensland, 'that reviews the use of
statutory declarations as the means by which principal contractors pay
contractors for goods and services provided'. As at March 2015, it had
'identified eight cases where subcontractors have provided false statutory
declarations to principal contractors'.[90]
5.77
ASIC has also sought to prevent illegal phoenix activity through
proactive measures. Two of the more important mechanisms involve direct
engagement with directors placed in ASIC's at-risk population and the
'Proactive Transaction Review Program' aimed at external administrators.
5.78
According to ASIC, it has identified 'approximately 2,500
directors who met the criteria for triggering the director disqualification
provisions of the Corporations Act and who are currently operating over 7,000
registered companies'.[91]
ASIC informed the committee that it is currently financially risk-rating those
7,000 companies to 'identify directors who may contemplate engaging in future
illegal phoenix activity'. Using that information:
ASIC is actively engaging with directors whose companies are
at greatest risk of being placed in external administration and using coercive
powers to get information to determine if they will engage in illegal phoenix
activity.[92]
5.79
Interestingly, ASIC explained that the campaign has indicated
that 'many directors are not aware of their obligations in respect of illegal
phoenix activity'. As such, the program's aim is to raise awareness of those
obligations and change the attitude of directors.[93]
5.80
The 'Proactive Transaction Review Program' is structured
similarly. Following an external administrator's appointment to a company, this
program identifies the markers of illegal phoenix activity. The program aims
'to deter misconduct' by ensuring that external administrators are aware that
'ASIC monitors their appointments, reviews a company's circumstances at the
time of the appointment...and seeks details of their investigations'.[94]
Committee's views
5.81
The committee believes that more needs to be done to curb illegal
phoenix activity. As this chapter has noted, this requires detecting instances
of the behaviour—a challenging task. Nonetheless, the committee appreciates the
work of the ATO, ASIC and other governmental departments and agencies in taking
a proactive approach to identifying such activity. The committee considers that
whole‑of‑government information sharing is critical in identifying
illegal phoenix behaviour. To that end, the committee considers that more resources
should be directed to such measures and, where necessary, legislative
frameworks should be amended to promote information sharing. In particular,
consideration should be given to amending confidentiality requirements to
permit agencies participating in the Phoenix Taskforce to disseminate
information to the ATO.
5.82
The committee appreciates that industry participants are
generally the first to become aware of alleged illegal phoenix activity. In
light of the importance of information in identifying and detecting illegal
phoenix operators, the committee considers that more effort needs to be
expended in regularising information flows between industry participants and
the regulators. If industry participants are reluctant to inform the regulators
for fear of commercial consequences, confidential tip-off lines, or equivalent
measures, should be developed.
5.83
The committee is concerned that false statutory declarations are
signed and that evidence of such is not acted on by the proper authorities. The
committee will examine this failing in more detail and make appropriate
recommendations in chapter 9.
Recommendation 12
5.84
The committee recommends that consideration be given to
amending confidentiality requirements in statutory frameworks of agencies
participating in the Phoenix Taskforce to permit dissemination of relevant
information to the ATO.
Recommendation 13
5.85
The committee recommends that more resources, including
specific purpose budget appropriations be directed to whole–of–government
strategies aimed at preventing, detecting and prosecuting instances of illegal
phoenix activity.
Recommendation 14
5.86
The committee recommends that regulators increase
engagement efforts with industry participants aimed at increasing and enhancing
information flows.
Other criminal and civil misconduct related to insolvencies
5.87
In examining the incidence and nature of misconduct related to
insolvencies, it is important to remember two points: first, illegal phoenix
activity is a specific form of criminal misconduct; and second, not all
insolvencies are a result of criminal or civil misconduct. As chapter 2
demonstrated, initial reports lodged with ASIC by external administrators
illustrate a myriad of causes for insolvencies with outright fraud occurring
very infrequently. Nevertheless, fraud is not the only type of misconduct associated
with insolvency, and other, more prevalent causes of failure, including
inadequate cash flow and trading losses, may hide potential breaches of
criminal and/or civil provisions. This section examines the incidence and
nature of misconduct not amounting to illegal phoenix activity. Chapter 7 will
assess ASIC's effectiveness in prosecuting breaches of the Corporations Act.
5.88
Generally, contraventions of criminal and civil provisions may
not come to the attention of regulators during the ordinary management of a
business. However, under the Corporations Act, an insolvency event triggers a
requirement that an external administrator prepare and lodge a report with
ASIC, alerting the regulator to any potential misconduct.
Incidence of civil and criminal misconduct
5.89
The incidence of civil and criminal misconduct related to
insolvencies in the Australian construction industry is difficult to measure
precisely. Data presented to the committee by ASIC is gleaned from initial
external administrators' reports lodged with ASIC under s. 422, s. 438D or s.
533 of the Corporations Act. As noted in chapter 2, this data comes with
certain qualifications. In particular, as these figures are derived only from
initial reports they may not reflect an accurate picture of the true incidence
of civil and criminal misconduct. In some cases, the initial view of external
administrators may be incorrect and in other cases more complex criminal and
civil misconduct may have been missed.
5.90
The absence of precise statistics confirming the incidence of
criminal and civil misconduct is a concern for policymakers. In their
submission, academics from the Melbourne Law School and Monash Business School
informed the committee that they were performing a data collection exercise
that would hopefully shed light on this issue.[95]
5.91
The results of this exercise were reported in October 2015, in Quantifying
Phoenix Activity: Incidence, Cost, Enforcement. Unfortunately, this report
focused exclusively on phoenix activity, which includes some, but not all
instances of criminal and civil misconduct. The academics rely on ASIC's
figures in examining the incidence of misconduct.
5.92
ASIC's figures present a concerning picture. Analysing the
totality of ASIC's data, the CFMEU note that 'by number of potential
contraventions in each category, the construction industry ranks as the highest
or second highest of all industries for 2013–14 and has the second highest
overall total for that year in terms of both civil and criminal
contraventions'.[96]
In both alleged civil and criminal misconduct categories, the construction
industry is second only to the catch all category 'Other (business and
personal) services'.
5.93
Across all industries, in financial year 2013–2014 external administrators
lodged 9,459 reports (table 5.2). In 76.3 per cent of all reports lodged (7,218
reports), external administrators alleged some form of misconduct. On average,
two or three breaches were reported in each case alleged misconduct was
identified, resulting in 18,198 suspected breaches.[97]
Table 5.2: Possible misconduct identified in initial
external administrators' reports
(2013–2014)
|
Reported misconduct
|
No. of reports
|
% of reports
|
No. of breaches
|
|
No misconduct reported
|
2,241
|
23.7%
|
-
|
|
'Possible misconduct'
reported
|
7,218
|
76.3%
|
18,195
|
|
Total
|
9,459
|
100.0%
|
18,195
|
Nature of misconduct
5.94
Table 5.3 illustrates that of the 7,218 initial reports that
identified potential misconduct, alleged breaches of civil obligations were
most common (13,950 or 76.7 per cent of all reported misconduct).
Potential breaches of criminal obligations were divided between pre- and
post-appointment of an external administrator. Potential pre‑appointment
breaches were identified in 1,199 cases (6.6 per cent) and in 2,836 (15.6 per
cent) of cases post-appointment.[98]
Table 5.3: Categories of possible misconduct
identified in initial external administrators' reports (2013–2014)
|
Categories of possible
misconduct
|
No. of breaches
|
% of breaches
|
|
Alleged criminal misconduct
under the Corporations Act by officers or employees:
|
|
|
|
|
1,199
|
6.6%
|
|
|
2,836
|
15.6%
|
|
Alleged breaches of civil
obligations
|
13,950
|
76.7%
|
|
Other criminal offences
|
55
|
0.3%
|
|
Other possible misconduct
|
155
|
0.9%
|
|
Total
|
18,195
|
100.0%
|
5.95
ASIC has disaggregated statistics for alleged pre-appointment
criminal misconduct, and civil misconduct by industry. Table 5.4 illustrates
the potential breaches of civil obligations by section of the Corporations Act
for the financial year 2013–14 according to the construction industry and all
other industries.[99]
It illustrates that the construction industry averaged over one-fifth of all
possible breaches across all industries.
Table 5.4: Possible breaches
of civil obligations by section of the Corporations Act (2013–2014)
|
Section of Corporations
Act
|
Construction Industry
|
Total All Industries
|
Construction Industry
Percentage of Total
|
|
Section 180 Care and
diligence—Directors' and officers' duties
|
507
|
2,542
|
19.9%
|
|
Section 181 Good
faith—Directors' and officers' duties
|
280
|
1,302
|
21.5%
|
|
Section 182 Use of
position—Directors', officers' and employees' duties
|
196
|
900
|
21.7%
|
|
Section 183 Use of
information—Directors', officers' and employees' duties
|
73
|
295
|
24.7%
|
|
Section 286 and 344(1)
Obligation to keep financial records
|
782
|
3,486
|
22.4%
|
|
Section 588(1)–(2) Insolvent
trading
|
1,220
|
5,425
|
22.4%
|
|
Total for industry
|
3,058
|
13,950
|
21.9%
|
5.96
Table 5.5 documents the potential breaches of criminal laws by
section of the Corporations Act for the same period (2013–2014) pre-appointment
of an external administrator. It too compares the construction industry with
all other industries, indicating that, again, over one-fifth of all potential
incidences of criminal misconduct occur in the construction industry.[100]
Significantly, the construction industry has a considerable share (27.7 per
cent) of breaches of s 206A—'Disqualified persons not to manage
corporations'—across all industries.
Table 5.5: Possible
pre-appointment criminal misconduct by section of the Corporations Act
(2013–2014)
|
Section of Corporations
Act
|
Construction Industry
|
Total All Industries
|
Construction Industry
Percentage of Total
|
|
Section 184 Good faith, use
of position and use of information—Directors', officers' and employees'
duties
|
42
|
266
|
16.4%
|
|
Section 206A Disqualified
persons not to manage corporations
|
10
|
36
|
27.7%
|
|
Section 286 and 344(2)
Obligation to keep financial records
|
48
|
333
|
14.4%
|
|
Section 471A Powers of other
officers suspended during the winding up
|
4
|
26
|
15.3%
|
|
Section 588G(3) Insolvent
trading
|
75
|
381
|
19.6%
|
|
Section 590 Offences by
officers or employees
|
25
|
116
|
21.5%
|
|
Section 596AB Agreements to
avoid employee entitlements
|
1
|
5
|
20%
|
|
Other criminal offences under
the Corporations Act
|
12
|
47
|
25.5%
|
|
Total for industry
|
247
|
1,199
|
20.6%
|
5.97
Alleged post-appointment criminal misconduct 'relates to officers
of the company failing to assist external administrators subsequent to the
appointment of the external administrator'.[101]
ASIC does not disaggregate this data by industry so it is impossible to
ascertain the extent of post-appointment criminal misconduct in the
construction industry.
5.98
This section has set out the incidence and nature of criminal and
civil misconduct in the construction industry. Chapter 7 will assess ASIC's
effectiveness in enforcing obligations under the Corporations Act.
Committee's views
5.99
The committee is concerned that the construction industry
accounts for the second highest number of total alleged criminal and civil
contraventions of the Corporations Act. This fact highlights the importance of
a revamped legislative and regulatory framework that: better protects innocent
participants from unscrupulous individuals or individuals who inadvertently
breach their obligations; educates participants on their rights, obligations
and responsibilities under the Corporations Act; and—where
necessary—effectively prosecutes breaches. Proposed reforms will be addressed
in chapters 7 to 12.
5.100
The committee is particularly concerned at evidence that a
culture has developed in sections of the industry in which some company
directors consider compliance with the Corporations Act to be optional because
the consequences of non-compliance are so mild and the likelihood that unlawful
conduct will be prosecuted is so low.[102]
This culture is reflected in the number of reports of possible breaches of
civil and criminal misconduct by company directors in the construction industry
set out in the tables above. Over 3,000 possible cases of civil misconduct and
nearly 250 possible criminal offences under the Corporations Act in a single
year in the construction industry is a matter for serious concern. It points to
an industry where company directors' contempt for the rule of law is becoming all
too common.
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