Chapter 7
Action against directors
7.1
The Corporations Act provides incentives for directors to take
appropriate care. When directors fail to do so, in certain circumstances, ASIC
can seek criminal or civil penalties. This chapter provides an overview of the
current legislative and regulatory framework in which ASIC can take action
against directors. Where the framework is not working as intended or as
effectively as it could, it will suggest possible areas of reform. Evidence
from many witnesses and submissions underscored the importance of taking action
against directors in the fight against illegal phoenix operators and criminal
misconduct related to insolvencies more generally.
Disqualification of directors
7.2
Chapters 3 and 4 illustrated how insolvencies, whether
specifically connected to illegal phoenix activity or not, have considerable
economic and social effects on individuals working within the industry as well
as the broader community. Chapter 5 provided ASIC statistics that illustrated
the scale of criminal and civil misconduct related to insolvencies in the
construction industry. Where evidence indicates that insolvencies are connected
to criminal or civil misconduct, ASIC has the power, under s 206F of the
Corporations Act, to disqualify the individuals concerned from holding
directorships.
7.3
This power is 'protective'.[1]
Its primary purpose is to prevent individuals from continuing their anti-social
activities and does not reverse their effect by returning monies lost through
insolvency.
Legislative requirements
7.4
There are a number of conditions that ASIC must satisfy under s
206F. Before deciding to initiate proceedings against a person, that person
must have been an officer of two or more companies that have been wound up
(within seven years) and had liquidator reports lodged with ASIC under s 533(1)
of the Corporations Act for both failures. This process limits the pool of
directors ASIC can target. In addition to the two companies requirement, a
liquidator only lodges a report under s 533(1) in certain circumstances;
namely:
- a past or present officer or employee, or a member or contributory, of
the company may have been guilty of an offence under a law of the Commonwealth
or a State or Territory in relation to the company; or
-
a person who has taken part in the formation, promotion, administration,
management or winding up of the company:
- may have misapplied or retained, or may have become liable or
accountable for, any money or property of the company; or
-
may have been guilty of any negligence, default, breach of duty or
breach of trust in relation to the company; or
-
the company may be unable to pay its unsecured creditors more than 50
cents in the dollar;
7.5
Section 206F(1) sets out the minimum requirements to trigger
ASIC's power. However, in order to exercise that power, ASIC must comply with
the requirements under subsection (2). That is, ASIC:
-
must have regard to whether any of the corporations...were related to one
another; and
-
may have regard to:
-
the person's conduct in relation to the management, business or property
of any corporation; and
-
whether the disqualification would be in the public interest; and
-
any other matters that ASIC considers appropriate.
7.6
Thus, before ASIC can make a decision under s 206F, it requires
the liquidator to lodge a supplementary report with more substantive evidence
that supports the allegations made in their initial report. Mr Brett Bassett,
Senior Executive Small Business Compliance and Deterrence, ASIC, explained how
the system operates:
...in order for us to actually take a disqualification process
further, there needs to be sufficient evidence for us to put a matter before an
ASIC delegate and therefore for the delegate to actually make a decision, based
on the evidence that is provided, that somebody should be disqualified. We do rely heavily on the 533 reports that come through from
the liquidators for us to put that evidence before the ASIC delegates.[2]
Challenges in disqualifying
directors
7.7
However, as ASIC explained, there are two problems that arise.
First, the s 533 reports do not always meet the standard required for ASIC
to initiate an application for disqualification; and second, there are often
not enough assets available to fund a supplementary report to produce evidence
of a sufficient standard.
7.8
On the first point, Mr John Price, ASIC, argued that in many
cases, the initial external administrator reports do not meet appropriate
evidentiary standards to launch an application for disqualification:
It is with some regret that I say that many of those reports
do not actually seem to have much, if any, evidence to back up some of the
allegations made in them...It is clearly an undesirable situation that we have at
the moment. From my point of view, I would like to see the quality of those
reports improve—and quite markedly in some cases.[3]
7.9
Mr Bassett agreed. Mr Bassett noted that ASIC relies heavily on
these reports but 'in a number of instances there is not sufficient evidence'
to make a determination to seek disqualification.[4]
Mr Price considered that ASIC should work closely with liquidators and ARITA in
particular, 'to make it clear exactly what we are looking for to help us get a
more effective system overall'.[5]
The same suggestion was made by ARITA before in the committee's 2012 report
into the Performance of the Australian Securities and Investments Commission.[6]
7.10
On the second point, ASIC noted in its submission:
...companies that are wound up often have little or no assets
in liquidation which may prevent liquidators from carrying out further
investigations and lodging supplementary reports. This hinders ASIC's ability
to justify banning directors from managing companies.[7]
7.11
The Assetless Administration Fund (AAF), established by the
Australian Government in 2005, was intended to remedy this difficulty. The AAF
funds liquidators to undertake further investigations and prepare and lodge
supplementary reports to overcome such situations. ASIC noted that since
commencement of the AAF:
ASIC has paid grants totalling $7.9 million to prepare
reports concerning potential breaches of the Act and to assist director
disqualifications. There has also been an increase in the number of directors
banned in the three year period (198 disqualifications) after the AA fund
commenced, compared to the three years prior (99 disqualifications).[8]
7.12
The AAF caps funding at $7,500. Approval for funding over $7,500
may be given only where ASIC considers that the extent and nature of the work
proposed to be undertaken is necessary and justifies the additional cost, and
ASIC and the liquidator come to an agreement on the amount of funding.[9]
7.13
A complementary mechanism—the Liquidator Assistance Program
(LAP)—provides assistance to external administrators by helping them obtain
relevant books and records of a company. ASIC noted that LAP aims 'to ensure
directors of companies in external administration comply with their obligations
to provide information to the liquidator or ASIC about the companies they
manage'. Failure to do so may result in court action.[10]
Table 7.1 provides the details of LAP requests for the financial years 2009–10
to 2013–14. It indicates an increase in the compliance rate and corresponding
decrease in prosecutions.
Table 7.1: Summary of LAP
Statistics (2009–10 to 2013–14)
|
Year
|
Liquidator Requests
|
Compliance Rate
|
Directors Prosecuted
|
Offences Prosecuted
|
Fines
|
|
2009–2010
|
1563
|
33%
|
554
|
1010
|
$813,768
|
|
2010–2011
|
1386
|
40%
|
425
|
761
|
$873,562
|
|
2011–2012
|
1410
|
44%
|
402
|
817
|
$1.05 mil
|
|
2012–2013
|
1484
|
45%
|
528
|
966
|
$1.15 mil
|
|
2013–2014
|
1559
|
39%
|
314
|
609
|
$768,000
|
7.14
It is clear that the disqualification provisions under s 206F set
a high standard. However, as the CFMEU argued, it also appears that the
disqualification provisions have 'hardly been over-utilised'.[11]
7.15
Chapter 5 documented that in 2013–14, initial external administrators'
reports identified some 15,149 breaches of civil obligations and
pre-appointment criminal provisions across all industries. Of these, 11,100
potential breaches concerned provisions related to insolvency (ss 180–184, s
588G), with 2,393 of these (21.5 per cent) specifically concerning
the construction industry. And yet, ASIC has only disqualified an average of 69
directors (across all industries) per financial year since 2009–2010.[12]
7.16
It does not appear that the issue is simply one of inadequate
administrator reports under s 533. ASIC acknowledged that a significant number
of initial external administrators' reports confirm that the administrator has
documentary evidence to support alleged pre-appointment misconduct. In 2013–14,
this was the case in 47 per cent (4,446) of reports reflecting 10,945 alleged
breaches. In 33 per cent of these cases (1,483 reports), the external
administrator recommended further inquiry by ASIC.[13]
7.17
Noting the disparity between director disqualification and
reports of alleged breaches of directors' duties, Professor Helen Anderson has
argued that 'something should be done to match expectations with performance'. In particular, Professor Anderson has noted
that:
It is frustrating for insolvency practitioners to spend the time
completing reports in the full expectation that ASIC will not investigate
further or prosecute breaches for which the insolvency practitioners hold
documentary evidence.[14]
7.18
Professor Anderson continued, noting that:
If ASIC lacks the resources to pay proper attention to the
multitude of reports of suspected director misconduct, where a liquidator
claims to have documentary evidence in support, an alternative should be
devised...If it is a matter of capacity and resources, ASIC needs to make the
case for more funding.[15]
7.19
Echoing these complaints, the CFMEU commented:
...the most recent enforcement reports give very little
confidence that beyond a handful of high profile prosecutions, the general
duties provisions of the Corporations Act are being utilised in any
serious way against illegality, either in an insolvency context or otherwise.[16]
7.20
The committee heard from insolvency practitioners frustrated by
ASIC's low rate of enforcement actions. Mr John Winter, ARITA, agreed with the
position of Professor Anderson and the CFMEU. Mr Winter considered that ASIC
could do a better job enforcing existing legislation as 'the law is already
there and it can be enforced. It is up to ASIC to do it.'[17]
Mr Winter continued:
...in truth ASIC has a very limited success rate in trying to
track down and stop these sorts of people...liquidators make 18,000
recommendations to ASIC a year around director misconduct. Our contention is
obviously that that is the root cause issue. If directors were properly
targeted and followed up for their inappropriate behaviour, there would not be
any facilitation.[18]
7.21
Mr Glenn Franklin, Partner PKF Lawler, also indicated his
frustration with ASIC, though laid blame at resourcing levels rather than
desire. Mr Franklin noted that there are hundreds and thousands of
administrator reports that provide evidence of alleged misconduct but it is
'only on really large matters...that ASIC seems to be able to have the resources
to do much about it', and therefore in 'the vast majority of the
liquidations—and I am talking about probably more like 90-plus per cent of the
liquidations—ASIC is unable to provide further assistance'.[19]
7.22
Associate Professor Welsh, Mr Winter, Mr Franklin and Mr Peter
Vrsecky, Partner PKF Lawler, further commented on the relationship between enforcement
and culture. Mr Winter considered that as a result of the low level of
enforcement 'a culture has developed that says to directors that the
consequences of misconduct are mild if by some remote chance they are actually
pursued for those actions by the regulator.'[20]
Mr Winter explained:
...in stark contrast, in New Zealand or in the UK, every day
there are announcements of substantial actions against directors that send a
market signal that says that the regulator will pursue people who undertake this
illegal activity. We do not get that market signal here in Australia.[21]
7.23
Mr Franklin, Mr Vrsecky and Associate Professor Welsh, made
similar comments—ASIC needs to send a market signal. Mr Franklin reiterated
that there is generally no further action for small companies,[22]
while Mr Vrsecky explained that smaller companies get 'swept under because of a
lack of resources'.[23]
Associate Professor Welsh agreed with the statement that, in consequence,
people can establish several companies in order to illegally phoenix and be
confident that nothing will happen.[24]
ASIC's high profile list
7.24
Notwithstanding these complaints, ASIC informed the committee
that it has identified approximately 2,500 directors who meet the criteria for
triggering the director disqualification provisions of the Corporations Act and
whom against which credible allegations of illegal phoenix activity exist.
Those 2,500 directors are currently operating over 7,000 registered companies.[25]
Mr Bassett referred to this group as a 'high target list'.[26]
7.25
Mr Bassett explained further that ASIC does not investigate all
2,500 directors within this high target list. Rather, ASIC targets the
highest-risk directors.
In respect of the 2,500, we are not simply going through each
of those. We are using the expertise of an external credit-scoring agency to
help us risk‑rate each one of those targets on a monthly basis. On a
monthly basis we are getting the highest 20 or 40. That number keeps turning
over, if that makes sense. So we are consistently targeting the high-risk ones.[27]
7.26
Mr Bassett continued, informing the committee of the outcome of
this strategy:
...we have identified seven live instances of what we call an
illegal phoenix activity. Five of those matters have been referred for ASIC
enforcement action and two of those matters have been proactively referred over
to the ATO for action or consideration by them. [28]
7.27
ASIC informed the committee that its proactive approach to
preventing illegal phoenix activity extends to the high target list of 2,500
directors. Mr Bassett noted that between 2013–14 and 2014–15, ASIC spoke to
over 250 of these directors. This education campaign has had positive results:
Firstly, it raised awareness of what illegal phoenix activity
was for a number of those directors who had previously said that they had no
idea or no knowledge of what it was to engage in illegal phoenix activity.[29]
7.28
Secondly:
in those instances where we have gone and spoken to
directors, if the company has still gone into liquidation the allegations of
misconduct in respect of mismanagement of the company, fraudulent transfer of
assets et cetera have decreased, which is obviously a positive because they are
not necessarily trying to defraud unsecured creditors.[30]
7.29
In light of ASIC's low rate in disqualifying directors, some
witnesses suggested that the Corporations Act could be amended to provide for
the automatic disqualification of directors who preside over a prescribed
number of corporate failures that lead to very low returns to unsecured
creditors after liquidation. Mr John Price, ASIC, informed the
committee that such a proposal has previously been considered by Treasury, but
there were 'a number of concerns raised'.[31]
In addition to broader questions around procedural fairness, witnesses
considered that setting the prescribed number of corporate failures and the
level of 'very low returns' would be problematic.[32]
7.30
Another suggestion was proffered by Associate Professor Michelle
Welsh. Associate Professor Welsh noted that legislation in Ireland prohibits an
individual from holding more than 20 directorships at the same time. Similar
legislation could be introduced in Australia in order to limit the ability of
individuals to use the corporate form to disguise their illegal phoenix
activity. As Associate Professor Welsh explained however, any such reform would
also require greater transparency or oversight in identifying company
directors: 'you would need to have that in place with something like the
director identification number, because otherwise I could have 20 as Michelle
Welsh and 20 as Michelle A Welsh'.[33]
7.31
In any case, simply disqualifying all 2,500 directors who meet
the triggering conditions will not ameliorate this issue entirely. Mr Bruce
Collins, Assistant Commissioner Risk and Strategy, Public Group and Internationals,
ATO, explained that taking action against directors only deals with the 'demand
side of the equation without looking at the supply side'. In Mr Collins' view,
the focus should be on higher-risk entities—'the people involved in serial
insolvencies, the people who advise them, the people who help set up those
structures and actually implement them'.[34]
7.32
The CFMEU explained further why focusing on the demand side will
not be entirely effective. The union noted that 'experience has shown that
phoenix operators have little difficulty in arranging for family members,
friends or business associates to take on the role of director of a company in
which the phoenix operator, disqualified or not, remains the true guiding
hand'.[35]
Mr Dave Kirner, Assistant Secretary CFMEU SA, reiterated this concern at the
Adelaide hearing on 21 September.[36]
7.33
Although the CFMEU referred specifically to unlawful phoenix
operators, some submissions suggested that the problem of unlawful shadow
directors is not confined to illegal phoenix operators. These submissions
argued that greater information sharing between regulators and the creation of
a beneficial owners register would significantly strengthen the ability of
regulators to detect illegal phoenix behaviour. This will be addressed in chapter
12.
Committee's views
7.34
The committee is concerned that external administrators spend
significant amounts of time preparing reports under s 533 of the Corporations
Act documenting evidence of alleged breaches of directors' duties that appear
to go nowhere. Whether the reports are not up to a sufficient standard to
commence investigation, or the volume of reports overwhelms the resources of
ASIC, this outcome is unhelpful. In particular, it contributes to a feeling
among insolvency practitioners, academics and participants within the
industry—including potentially unscrupulous directors—that ASIC fails to take
enforcement seriously. The committee reiterates its view noted in its 2014
inquiry into the Performance of the Australian Securities and Investments
Commission that ASIC should work closely with ARITA in order to make clear
to external administrators what it requires in s 533 reports in order to launch
an investigation.[37]
7.35
The committee is also concerned at the apparent low level of
enforcement actions undertaken by ASIC. Data examined in this chapter and chapter
5 suggests that there are a considerable number of high-risk individuals
breaching criminal and civil provisions of the Corporations Act. The committee
appreciates that it is impossible to prosecute all breaches and that effective
targeting and prosecutorial discretion is required. Nevertheless, the committee
considers that in the absence of increased enforcement actions, a culture of
compliance will be difficult to instil.
7.36
The committee understands that the low level of enforcement
actions frustrates participants within the construction industry. However,
proposals to limit the number of directorships an individual can hold
concurrently, or to automatically disqualify individuals involved in a
prescribed number of insolvency events, are both unlikely to help reduce
insolvencies and potentially infringe procedural fairness. The committee
considers that greater regulatory oversight and transparency concerning the
identity of company directors will have a similar outcome without infringing
important rights protections. For this reason the committee prefers the
introduction of a Director Identification Number as recommended by the
Productivity Commission in its draft report into Business Set-up, Transfer
and Closure, as a necessary transparency measure. This will be addressed
further in chapter 12.
Recommendation 16
7.37 The committee reiterates Recommendation 17 of the
Economics References Committee’s June 2014 report of its inquiry into the
performance of ASIC in these terms: 'The committee recommends that ASIC, in
collaboration with the Australian Restructuring Insolvency and Turnaround
Association and accounting bodies, develop a self-rating system, or similar mechanism,
for statutory reports lodged by insolvency practitioners and auditors under the
Corporations Act to assist ASIC identify reports that require the most urgent
attention and investigation'.[38]
Recommendation 17
7.38 The committee recommends that ASIC look closely
at its record on enforcement and identify if there is scope for improvement,
and if legislative changes are required to advise government.
Recommendation 18
7.39 The committee recommends that the government
ensure that ASIC is adequately resourced to carry out its investigation and
enforcement functions effectively.
Director Penalty Regime
7.40
Disqualification is not the only response available. The Director
Penalty Regime originally introduced as part of the Insolvency (Tax
Priorities) Legislation Amendment Act 1993, but substantially amended in
2012, aims to ensure that directors cause their companies to comply with
certain taxation and superannuation obligations. The ATO explained that:
...the director penalty regime applies a legal responsibility
to directors to ensure the company meets its pay as you go withholding and
superannuation guarantee obligations. Once a director penalty notice is issued
to them, directors may become personally liable to a penalty equal to unpaid
PAYG withholding or superannuation guarantee amounts. The intention of the
regime is to encourage directors to ensure the company is lodging and paying on
time.[39]
7.41
Significantly, former directors remain liable under the regime
for penalties equal to debts incurred up to the date of their resignation. The
ATO informed the committee that in 2013–14, 'the ATO issued Director Penalty
Notices in relation to just over 1,500 businesses in the construction industry'.[40]
7.42
Despite the apparent successes of this regime, the Australian
National Audit Office notes that this number represents only 2.8 per cent of
companies with superannuation guarantee charge liabilities.[41]
7.43
Ms Cheryl-Lea Field, ATO, acknowledged that the legislative
amendments have not been an unqualified success. Ms Field noted that the ATO
has 'seen an increase in disclosure of liabilities' but 'only a small increase
in obligations actually being paid'.[42]
Nevertheless, Ms Field argued that the regime enables the ATO to 'at least be
aware of the liabilities and bring our actions at an earlier stage'.[43]
The ATO did not provide a specific amount of superannuation that has been
recovered through the penalty notice process.
7.44
As noted, the director penalty regime covers PAYG(W) and
superannuation guarantees, not GST. The ATO explained that this means it
'cannot make directors personally liable for their special purpose vehicle's
GST obligations—allowing phoenix property developers to intentionally plan to
evade those obligations.'[44]
The ATO noted that they 'remain open to improvements to the system that would
make collection of GST liabilities from phoenix property developers easier'.[45]
7.45
There was additional support among some submissions to tighten
the operation of the director penalty regime,[46]
and extend it to cover other company debts.[47]
Committee's view
7.46
The committee considers that the Director Penalty Regime has been
an important legislative reform in extending the ability of the ATO to ensure
that directors comply with their obligations to pay employee entitlements.
Nevertheless, the committee appreciates that the regime could be utilised more
broadly, and has failed to recover a significant amount of outstanding
liabilities. Of more concern, however, is the fact that the regime does not
cover GST liabilities, allowing unscrupulous property developers to
intentionally avoid their GST obligations. The committee believes that further
consideration on this point could be conducted by the Legislative and
Governance Forum for Corporations, the body with oversight of corporate and
financial services regulation.
Recommendation 19
7.47
The committee recommends that the Legislative and Governance
Forum for Corporations give consideration to recommending amendments to the
Corporations Act to ensure that the Director Penalty Regime covers GST
liabilities.
Transactions entered into in order to avoid employee entitlements
7.48
Section 596AB of the Corporations Act prohibits transactions
entered into with the intention of preventing the recovery of employee
entitlements or depriving employees of their entitlements and imposes a
criminal sanction for breach. The idea behind this provision is
admirable—providing an incentive for directors to protect the property of
employees.
7.49
However, despite being enacted in 2000, this provision has never
been invoked. Further, in its submission ASIC did not include this provision as
an offence that may be breached as part of illegal phoenix activity.[48]
It is not clear whether this oversight is a cause or consequence of s 596AB's
desuetude.
7.50
The committee notes further that a 2004 Report by the
Parliamentary Joint Committee on Corporations and Financial Services
recommended that a review of s 596AB be undertaken in order to determine
its effectiveness in 'deterring companies from avoiding their obligations to
employees'.[49]
That review has never been undertaken.
7.51
The committee's attention was drawn to Professor Helen Anderson's
The Protection of Employee Entitlements in Insolvency: An Australian
Perspective. In chapter 2 of her book, Ms Anderson examines a series of
clear instances of conduct where the facts fell within the reach of s 596AB but
it was not invoked. Anderson notes that while 'it can never be fully
ascertained to what extent the law has deterred employers from that conduct...in
the absence of a single prosecution...its deterrence value is highly doubtful'.[50]
Mr Michael Murray, ARITA, agreed, considering that s 596AB may not be 'as
an effective provision as was originally anticipated', noting further that 'it
is certainly a section that you do not see much in law reports'.[51]
7.52
Mr John Winter, CEO ARITA, agreed that s 596AB has been little
used. Mr Winter informed the committee that in 2012–2013 insolvency
practitioners reported 13 alleged criminal breaches of s 596AB and claimed to
hold documentary evidence in 12 of those cases. According to Mr Winter, 'it
appears that ASIC took no action on those'.[52]
7.53
Professor Anderson proposed amending s 596AB in three important
ways:
-
remove the requirement to provide subjective intention;
-
introduce a parallel civil penalty contravention in similar
terms; and
-
extend the application of the section to all forms of external
administration, not merely liquidation.[53]
7.54
The CFMEU supported Ms Anderson's proposed amendments, submitting
that 'fifteen years is more than enough time for a statutory provision to prove
its uselessness'.[54]
Committee's views
7.55
The committee supports the object of s 596AB of the Corporations
Act but is concerned that it has failed to achieve its purpose. The absence of
a single prosecution under s 596AB is telling. The committee supports Professor
Helen Anderson's proposal to: remove the requirement to provide subjective
intention; introduce a parallel civil penalty contravention in similar terms;
and extend the application of s 596AB to all forms of external administration,
not merely liquidation.
Recommendation 20
7.56
The committee recommends that section 596AB of the Corporations
Act 2001 be amended to:
-
remove the requirement to prove subjective intention in
relation to phoenixing offences;
-
introduce a parallel civil penalty contravention in similar
terms; and
-
extend the application of the section to all forms of external
administration, not merely liquidation.
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