TGIF 6 November 2020 – Illegal phoenix activity? Court confirms it’s difficult to identify - and plead

This week’s TGIF considers the case of Australian Securities and Investments Commission v Bettles [2020] FCA 1568, where the Federal Court of Australia confirmed the need for precision in making allegations of illegal phoenix activity.

Key takeaways 

• There is no such thing, per se, as ‘illegal phoenix activity’ and there is inherent difficulty in attributing content to that phrase.
  
  
• The dramatic allegory of the phoenix dying in flames and being reborn from the ashes is well understood. When determining whether conduct in relation to a business operation reborn from the ashes of a liquidated company constitutes ‘illegal phoenix activity’, the starting point is to identify the alleged conduct and demonstrate how it contravenes the Corporations Act. Only then can such conduct be described as ‘illegal phoenix activity’.
  
  
• An allegation that a person is ‘involved in’ a contravention of the Corporations Act requires precise identification of the particular conduct of a person alleged to be involved in a contravention of the Act, and how that conduct aided or abetted a contravention of the Act by others.

Background

In the case of Australian Securities and Investments Commission v Bettles [2020] FCA 1568, ASIC contended that the controllers of a group of companies (the MA Group) engaged in ‘illegal phoenix activity’. ASIC further contended that the liquidator, Mr Bettles, knew about this activity, and that Mr Bettles “aided and abetted the controllers in designing and implementing that strategy”, and therefore was a person involved in a contravention of provisions of the Corporations Act 2001 (Cth) (Act). 

On this basis, ASIC sought orders that Mr Bettles’ registration as a liquidator be cancelled and that he be prohibited from acting as a liquidator for a period of time.

Mr Bettles brought an interlocutory application to strike out ASIC’s Concise Statement and Supplementary Concise Statement (Statements) on the grounds that the two documents failed to make clear the precise conduct by Mr Bettles which was said to be conduct rendering him a person involved in a contravention of the Act pursuant to section 79.

ASIC’s allegations

By its Statements, ASIC alleged that the controllers of the MA Group engaged in eight classes of conduct that constituted ‘illegal phoenix activity’, including developing a strategy to transfer the income and assets of the MA Group companies to a new group of companies, selectively placing companies in the MA Group into liquidation, transferring staff from the MA Group to the new group, and redirecting income and entering into an uncommercial sale of the client book.  

ASIC alleged that the ‘illegal phoenix activity’ was conducted in contravention of sections 180, 181 and 182 of the Corporations Act, which require directors and other officers to discharge their duties with care and diligence, in good faith for the best interests of the corporation and for a proper purpose, and to not improperly use their position to gain an advantage for themselves or someone else or cause detriment to the corporation.

ASIC alleged that Mr Bettles, a liquidator for some of the companies in the MA Group, was a person ‘involved in a contravention’ pursuant to section 79 of the Act, in that he aided or abetted the alleged contraventions. 

Mr Bettles argued that the facts set out in ASIC’s Statements inadequately connected the alleged conduct to the claimed contraventions and should be struck out.

Meaning of ‘illegal phoenix activity’ 

In considering Mr Bettle’s application, Greenwood ACJ reviewed papers by the Commonwealth Treasury Department and academics on the meaning of ‘fraudulent’, ‘unlawful’ or ‘illegal’ phoenix activity. The effect of this consideration was to observe that there is a distinction between a legitimate use of the corporate form and ‘unlawful’ phoenix activity (where a corporate entity accumulates debts without an intention to repay the debt and then liquidates to avoid payment of the debt). 

While that might be easy to identify in its more basic form, alleged ‘illegal phoenix activity’ is often significantly more complex.

So when does the rebirth of an operation from the ashes of a liquidated company become ‘illegal’ or ‘fraudulent’?

Businesses getting into a position of doubtful solvency, or actual insolvency, as a result of poor business practices - and legitimately using the corporate form to restructure - is to be distinguished from ‘fraudulent’ phoenix activity. This type of activity involves the deliberate and systematic liquidation of corporate trading entities with the intention of avoiding tax or other liabilities, and the continuation of the operation of that business through other trading entities, debt-free. The key feature of ‘fraudulent phoenix activity’ is the intention to exploit the corporate form to the detriment of unsecured creditors.

Greenwood ACJ observed that there is inherent difficulty in attributing content to the phrase ‘illegal phoenix activity’.  His Honour explained that the question of whether the conduct described by the phrase ‘phoenix conduct’ is, as a matter of law, ‘unlawful phoenix activity’ is entirely determined by whether proof of the facts of the conduct makes good a contravention of a provision of the Act. 

His Honour stated that identifying conduct, and attaching a label of ‘illegal phoenix activity’ to it, jumps a step in the analysis. There is no such thing, per se, as ‘illegal phoenix activity’. Rather, the analysis is to identify the impugned conduct and explain why that conduct satisfies elements of a particular provision of the Act, therefore demonstrating contravention of the Act. Such analysis establishes a conclusion that the particular conduct is unlawful.  

Greenwood ACJ observed that, “it is not sufficient to set out a collection of facts over a period of time and describe the conduct falling within that large matrix of fact as ‘illegal phoenix activity’ on the footing that the matrix of fact engages contraventions of sections 180, 181 and 182.”  Alleging that someone was involved in a contravention of the Act involves identifying, with precision, the facts demonstrating conduct contravening the Act, and the facts which demonstrate that the relevant person is a person ‘involved in’ that contravention because the person aided or abetted that conduct.

Decision

Greenwood ACJ found that the Statements “did not … [identify] a sequence of facts which, if made good, demonstrate a contravention by particular persons of sections 180, 181 or 182 of the Act leading to a pleading that the defendant was involved in a relevant contravention in the sense of aiding and abetting that conduct.”  

For example, ASIC alleged that the controllers of MA Group devised a plan to engage in ‘illegal phoenix activity’ and that Mr Bettles knew of this activity and aided and abetted the controllers, in that Mr Bettles attended a meeting at which the matters were discussed. Those allegations of fact did not engage, by specific paragraphs of a pleading, conduct falling within the elements of sections 180, 181 or 182 on the part of the controllers, nor with a pleading that Mr Bettles aided and abetted a contravention by the controllers.

Comment

There has been a lot of commentary around ‘targeting illegal phoenix activity’. However, as the Court in this case emphasised, there is no such thing, per se, as ‘illegal phoenix activity’ and there is inherent difficulty in attributing content to that phrase. 

It seems the determining factor in whether phoenix activity is ‘fraudulent’ is the intention with which the activity is undertaken. What distinguishes ‘illegal’ or ‘fraudulent phoenix activity’ from legitimate corporate restructure is that deliberate liquidation occurs with the intention of avoiding liabilities and continuing the business in another corporate trading entity.

The analysis requires precise identification of the impugned conduct, and an explanation of how that conduct demonstrates a contravention of the Act. Only then is it possible to conclude that the conduct falls within the taxonomic phrase ‘illegal phoenix activity’.