We understand the temptation. In the COVID-19 fallout, small and medium enterprise (SME) directors may start selling off company property for a cash injection, perhaps to pay a liability. Or, they may develop a plan to protect vital assets. But they need to beware. Without a clear-eyed view of the state of their business and an understanding of recent legislative changes, they could end up unwittingly committing an offence.
So, this month’s newsletter is focusing on a new offence and penalties that came into force on February 20 with the Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020 (the Act) - the creditor defeating disposition.
What is creditor defeating disposition?
A creditor defeating disposition is disposal of company property with the intent of making the value of the property unavailable to creditors in the event that the company is wound up.
This type of disposal is a common feature of illegal phoenixing and the reason why it’s been put under the microscope by lawmakers.
Illegal phoenixing follows a pattern. Companies’ assets are disposed of, often for reduced value, often to related entities, then the companies are liquidated with the deliberate intent of avoiding liabilities. The companies emerge again as different entities and employ the same strategy to avoid the next round of debts and liabilities.
What makes a disposition creditor defeating?
The legislation describes disposal of company property as creditor-defeating if:
- It was made for less than the lesser of either market value, or, the best price that could be obtained in the circumstances (for example, where a company’s need is urgent and that situation is known to potential buyers who then play hard ball on price), and
- The disposal of the property prevents, hinders or delays the property being available for the benefit of creditors when the company is wound-up.
There are other forms of creditor defeating dispositions such as:
- The company doing something that results in another person becoming owner of something that didn’t previously exist, for example, building a house for someone related to the company in some way.
- The company makes a disposition to a person who then pays a second person some or all of the value of the property. For example, the person pays some or all of the property value to a director or a person related to a director.
Selling non-core assets is a valid strategy for funding unexpected cash flow problems. However, it becomes a legal problem for directors, and a voidable transaction, if it is a creditor defeating disposition and:
- The transaction occurred when the company was insolvent during the 12 months prior to the beginning of winding up, or
- The company became insolvent because of the transaction during that same period, or,
- External administration commences in less than 12 months after the transaction as a direct or indirect result of it.
So timing is important. Directors and officers need to have their eye on the numbers, confidence that the company is solvent, and know that the asset sale won’t tip a fragile enterprise into insolvency.
Being a voidable transaction means that ASIC can, on its own initiative, or by request from a liquidator, make orders that the company property, the payment received for it, or other property equivalent in value to the payment, be returned to the company. An order or application to claw back the property or equivalent value can be made up to three years after a liquidator’s appointment.
Consequences for SME directors or officers, if found guilty of creditor defeating dispositions, can be liability to pay compensation equal to the value of the harm or property, disqualification, fines up to $420,000 for individuals or, at worst, 10 years’ imprisonment.
There are exceptions outlined in the Act for sale of company property in insolvency or a winding up. A disposal of company property is not creditor defeating if done:
- under a court-approved compromise or scheme of arrangement; or
- under a deed of company arrangement; or
- by an administrator; or
- by a liquidator; or
- by a provisional liquidator, or
- under a ‘safe harbour’ course of action.
It’s tricky enough running an SME in the time of COVID-19 without new legislation setting a trip wire for directors. Expert business advice could help them avoid mistakes that will cost them personally and professionally.
Shaw Gidley are experts in restructuring, turnaround and insolvency and provide free initial advice on these matters. Please contact our offices on (02) 4908 4444 or (02) 6580 0400.