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Illegal Phoenix Operations & Determining Right to Income

Robert Kite

22 Feb 2018

Illegal Phoenix Operations

Phoenix companies “rise from the ashes” with a new corporate structure that derives its assets (usually without providing adequate compensation for same), and director(s) from an old entity, leaving behind the debts of the old entity and giving the new entity a “clean slate”.

It is the illegal intentional actions of directors who implement the “phoenix operations” (in many cases, on the advice of others), that has lead to the Turnbull Government to introduce a package of reforms to deter and penalise those involved in such illegal phoenix activities.

According to a consultation paper released by the Hon Kelly O’Dwyer, MP in September 2017, phoenixing costs the Australian economy as much as $3.2 billion per annum.

The paper states that such activity “rips off” all Australians, including employees, creditors, competing businesses and tax payers.

The possible detection measures include the introduction of a Director Identification Number (“DIN”) to allow regulators to map relationships between individuals and entities as well as measures to deter, disrupt and penalise the core behaviours of phoenix operators, including advisors.
We will report further on developments as they are announced by the Government.

Two (2) Recent Cases

The Australian Securities & Investments Commission (“ASIC”) has recently published details of two (2) cases where they have successfully prosecuted directors for phoenix activities following reports to ASIC by the liquidators of the relevant companies.

In Queensland, a director pleaded guilty to breaching directors’ duties by “selling” assets at undervalue to another company of which she was also a director.

A Victorian man was convicted after he transferred assets from one company to another company (of which he was also a director), the day before the first named company was wound up.
It appears from the commentary noted above, that both the Federal Government and the ASIC in conjunction with Insolvency Practitioners are moving to limit as much as possible, the conduct of phoenix activities which comes at significant costs to the Australian economy.

Bankruptcy Case - Who Owns the Income?

In a matter recently decided by the Supreme Court of Victoria, the question was raised as to the right to sue for the recovery of a debt, where the party entitled to receive the debt is an undischarged bankrupt. This matter was recently considered in the case of Davey v Dessco Pty Ltd & Anor (Bankruptcy) [2017] VSC 744 (15 December 2017).

Mr Davey sought to appeal the decision of the Magistrates Court.

Background

This particular case represents an appeal from a Decision of the Magistrates Court.
The Plaintiff in those proceedings, Mr Davey, was seeking to recover funds owed by Dessco Pty Ltd ATF the Dessman Family Trust (“the Defendant”). The claim of Mr Davey arises from him having provided legal services for the benefit of the Defendant, thus creating the debt. At the time at which the services were performed, and the proceedings in the Magistrates Court were commenced, Mr Davey was an undischarged bankrupt.

Mr Davey’s pursuit of the claim against the Defendant were stayed by the Magistrates Court and costs were awarded against Mr Davey.

Appeal Proceedings

The key issues in considering the appeal, relates to the principle issue of who has the better claim, or entitlement to the funds said to be owed by the Defendant - the Bankrupt, or the Trustee of his Estate.

Any assets owned by a bankrupt which are considered to be divisible assets, both at the date of the bankruptcy, or those which devolve to a bankrupt whilst they remain an undischarged bankrupt, represents an asset of the bankrupt estate, which the trustee of that estate is entitled to receive.   

The alternative position to be considered is that the debt which Mr Davey was seeking to recover, represented income, which would otherwise be assessed for income contribution purposes.

In the circumstances, the Court had to determine whether the money that Mr Davey was seeking to recover represented income, and therefore represented funds that were rightly recoverable or payable to the bankrupt.  

In the alternative, the Court had to determine if the debt due, gives rise to an asset of the Bankrupt Estate (being an after acquired asset), and therefore represents an asset that the Trustee in Bankruptcy is entitled to recover on behalf of the Bankrupt Estate. (The Magistrates Court seems to have adopted this view when it ordered that Mr Davey’s pursuit of the claim against the Defendant be stayed, owing to a lack of standing of Mr Davey to bring the claim in the first instance).

The Court ultimately determined that any debt payable by the Defendant would represent income to the Bankrupt and the Bankrupt would be required to pay income contributions on those funds (subject to receiving same).

It follows that the debt did not represent an asset of the Bankrupt Estate, and therefore, Mr Davey had the standing to bring the proceedings against the Defendant.

The Court ordered in favour of Mr Davey, and provided orders that the Magistrates Court Order of 22 March 2017 (which stayed any proceedings by Mr Davey to recover the money from the Defendant) be set aside.






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