Chapter 10The role of government agencies in insolvency and responses to misconduct
10.1As canvassed elsewhere in this report, the Australian Securities and Investments Commission (ASIC) is responsible for the regulation of the corporate insolvency system, while the Australian Financial Security Authority (AFSA) oversees the personal insolvency regime.
10.2Other government agencies often play key roles in corporate insolvency, most notably the Australian Taxation Office (ATO) and the Department of Employment and Workplace Relations (DEWR) through the Fair Entitlements Guarantee Scheme (FEG). While the involvement of these two agencies is of the nature of a creditor, rather than a regulator, both have access to tools other creditors do not to protect their interests.
10.3This chapter will focus primarily on the regulatory activities of ASIC and the ATO (other than in respect of insolvency practitioners, which is discussed in chapter 8). Arguments concerning a possible expanded role for government in the Australian insolvency framework are discussed in chapter 9.
Regulation of corporate insolvency
10.4In this inquiry, much consideration was given to the role and effectiveness of ASIC as the regulator of Australia’s corporate insolvency framework, most notably in response to its enforcement activities and its utilisation of reports provided to it by insolvency practitioners in particular.
10.5The following paragraphs consider:
ASIC’s regulator activities and approaches to enforcement;
reporting obligations of liquidators; and
specific enforcement issues, including:
insolvent trading; and
illegal phoenixing.
ASIC’s activities and approaches to enforcement
10.6ASIC told the committee that its activities in the field of corporate insolvency extend to:
assessing applications for funding under the Assetless Administration Fund (AA Fund);
appointing reviewing liquidators to conduct a review in relation to the external administration of a company, including of the registered liquidator’s conduct, and report to the registered liquidator and ASIC;
assisting registered liquidators to obtain a Report on Company Affairs and Property (ROCAP), information and/or books and records of a company under external administration via the External Administration Compliance Assistance program and prosecuting directors who fail to assist an external administrator;
liaising with registered liquidators regarding director and third-party misconduct investigations;
winding up abandoned companies under Pt 5.4C of the Corporations Act to enable former employees to recover unpaid entitlements via the fair entitlements guarantee scheme and appointing liquidators to these companies funded through the AA Fund;
granting eligible applicants requests for authorisation to conduct public examinations;
assessing numerous insolvency related court applications;
assessing applications for extensions of time or other relief;
assessing and, where applicable, granting requests for the voluntary suspension or cancellation of a registered liquidator’s registration;
reviewing and, where relevant, granting the renewal application for the registered liquidator’s registration;
providing information to Schedule 2 Committees convened for registration and disciplinary matters as required…and representing ASIC in AAT proceedings relating to applications to be registered as a liquidator or registered liquidator disciplinary appeals.
10.7A range of witnesses commented on the frequency and nature of matters on which ASIC pursues enforcement action. Acknowledging that ASIC is required to respond to a broad remit on scarce resources, a number of inquiry participants expressed dissatisfaction with ASIC’s responsiveness to serious matters reported to it.
10.8The Australian Restructuring Insolvency and Turnaround Association (ARITA) said that very few of the 10,000 suspected cases of illegal director activity that are reported to ASIC by liquidators are ever prosecuted. It raised questions about ASIC’s enforcement priorities, stating ‘ASIC has notably taken more action recently against directors who make false statements on forms lodged with it to voluntarily deregister their companies than directors reported by liquidators’.
10.9Some inquiry participants stated that they knew personally of cases where suspected serious misconduct had been reported by liquidators to ASIC, but no enforcement action had followed.
10.10Mr Richard Fisher, consultant to Ashurst Australia and a former Commissioner on the Harmer Report, stated that this issue is long standing, and resolution of it would require consideration of a different model for corporate regulation.
10.11The Business Law Section of the Law Council of Australia (BLS LCA) recorded that it had received anecdotal reports that ‘SME directors appear to consider ASIC to be somewhat ineffective in respect of pursuit of poor corporate behaviour by SME directors’.
10.12The BLS LCA also questioned whether ASIC’s funding was adequate and enabled the agency to meet the standard expected of it by the Australian public:
It's often said in response that you can't expect the corporate regulator to investigate every instance of corporate misconduct. If you asked the Australian public whether it was acceptable to investigate five per cent of home break-ins, or two per cent of armed robberies, I'm not sure whether they'd be happy with that. So the question of the extent to which ASIC is funded to take proper action and properly investigate corporate misconduct has to be asked.
10.13The Australian Council of Trade Unions (ACTU) submitted that ASIC has:
…a longstanding reputation of not prosecuting breaches of directors’ duties with sufficient vigour. Extra resources also need to be committed to building out inter-agency cooperation with the ATO, AFSA, Austrac, FWO, Federal Police, Border Force (amongst others) in order to more closely monitor high risk industries and combat related sharp practices such as phoenixing, modern slavery abuses, tax avoidance and wage theft.
10.14Mr Michael Brennan, Liquidator and Bankruptcy Trustee at Offermans, encouraged the government to give ASIC more direction on prosecuting breaches of insolvent trading laws:
Overall, our insolvency laws are very good and with some cleaning up would be more than capable of continuing without wholesale change. What is required is a policy directive from Government to focus prosecutions where most breaches are occurring. By weight of numbers, the offending cohort are [Micro, Small and Medium Enterprise] MSME directors and advisors. Nothing will better destroy that narrative that ASIC is ineffective in this space (and that there are no ramifications for flaunting director rules) that seeing more average Australian directors feel the full weight of the law.
10.15ASIC acknowledged that it does not undertake a formal investigation of every matter that is brought to it. It explained that it considers a wide range of factors when deciding whether to investigate and possibly take action in a specific case ‘to ensure that we direct our finite resources appropriately’.
10.16ASIC stated that the specific factors that influence whether ASIC will choose to respond to a breach change depending on circumstances and the focus of enforcement activities at the time. However, four issues form part of that consideration:
preventing or addressing significant harm to consumers, markets or the financial system;
the benefits to the public from enforcement, including where there is significant public interest or concern;
whether there are issues specific to the case which warrant us pursuing action; and
whether there are any alternatives to formal enforcement action or investigation which would, on balance, be more efficient— such as engagement with stakeholders, surveillance, guidance and education.
10.17ASIC also highlighted that it is one of the widest remit regulators in the world and works with whatever budget is provided to it. However, it acknowledged that choices have to be made in relation to resource allocation. Mr Warren Day, Chief Operating Officer at ASIC explained:
Could we do more if there were more resources allocated for our own decisions? Absolutely. But we think that, with the resources we've got, focusing on liquidator conduct, assisting small business, engagement with small business, supporting small business by taking enforcement and compliance action—small-business industry groups say to us all the time they actually want to see action, because the No. 1 group that often causes harm to other small business is small business. So we think that we give a good telling with what we've got. Obviously, through a review like this, it may be said that there probably needs to be more focus by ASIC in certain spaces, and that might cause a conversation we can have with government in relation to our funding mix.
Reporting obligations to ASIC and the regulator’s response
10.18Related to concerns about ASIC’s enforcement approach were discussions about the relative benefit achieved by the existing reporting obligations on insolvency practitioners compared to the burden imposed by them.
10.19A significant point of contention in the inquiry was ASIC’s utilisation of and responses to reports provided to it in accordance with its statutory duties. Reporting obligations to ASIC arise for insolvency practitioners under various provisions of the Corporations Act. Three such provisions, namely sections 422, 438D and 533 require liquidators to report misconduct on the basis of an appearance of misconduct, or if there will be returns to shareholders of less than 50 cents in the dollar. ASIC told the committee that these reports:
…provide [it] with valuable information to support our regulatory actions. They provide the basis for successful enforcement actions and enable ASIC to ban company directors with a history of failed companies from managing corporations.
10.20ASIC explained that it assesses initial statutory reports provided to it against ‘confidential criteria’ in order to determine whether further information is required or whether a finding of no further action will be made. If further information is required, that would take the form of a supplementary report. If ASIC does not request a supplementary report, ASIC told the committee that a liquidator still has discretion to lodge one. In 2021–22, of the 3,767 initial statutory reports submitted, ASIC requested supplementary reports in relation to 593 (or 16 per cent) of them. This compared to the previous financial year, in which 704 (or 19 per cent) of the 3,810 initial statutory reports resulted in a requirement for a supplementary report.
10.21ARITA raised concerns about the process adopted by ASIC to select which of these initial statutory reports are to be further considered in the form of a recent example:
We've recently lodged a report with ASIC. Within 45 seconds we got a 'no further action' response from ASIC—so, clearly, they've got an AI system in the background that's automated that reviews the reports, and you get an instantaneous response that no further action is being undertaken in relation to that particular report.
10.22ARITA stated that such an experience is ‘a common theme across all liquidators’, and occurred both in instances of minor breaches of the Corporations Act due to a lack of expertise, as well as more significant occurrences of fraudulent behaviour and malfeasance.
10.23ARITA added that efforts to liaise with ASIC to improve the likelihood of instances of what liquidators perceive to be serious matters being highlighted have been unsuccessful and continue to be very difficult to achieve. It explained:
The system is designed so that you submit your report through the electronic portal and you get a response back via email. The system is not designed for you to then contact someone at ASIC to discuss particular reports. Yes, that happens in the background at times but that's not the way ASIC is designed.
10.24This experience with ASIC was contrasted to the experience with AFSA:
With AFSA, if you have misconduct that you believe you've uncovered and wish to report, AFSA actively encourages practitioners to ring them and discuss putting in offence reports. So you know, before you go to the effort of putting in that report, if the regulator has, shall we say, an interest in looking at that matter.
With ASIC and corporate matters, liquidators are required to put in a report for any misconduct. As Senator Scarr mentioned, it could be a lack of maintaining books and records, which is a common instance across pretty much every appointment. You have to put in that report to ASIC. Unless you're paying more than 50c in the dollar, you are required to lodge that report. So the magnitude of reports going through ASIC is significantly more than in the corporate space.
10.25The committee heard that high profile matters, including where there is a big company failure, tend to come to ASIC’s attention, however ARITA said that a majority of reports, which concern phoenixing in the small to medium end of the economy, tend to receive the AI generated ‘no further action’ response.
10.26The estimated cost of preparing these reports was put to the committee as around $5,000, and increases depending on the circumstances of the liquidation.
10.27The reporting obligations were supported by some key stakeholders. The Association of Independent Insolvency Practitioners (AIIP) argued that these reports ‘are disciplined on liquidators to actually do their job–to go in, look at the file and report back’. Mr Stephen Hathaway, President of the AIIP, explained that the reporting requirement was introduced because not all liquidators were completing statutory reports. He emphasised that they ‘are absolutely essential’ and explained:
But, to move away from not doing them, I think it would be—for the society to understand what happened to that company and for the government to understand what happened to that company. Someone later on will be able to understand whether that box was just closed and nobody ever looked.
I think it would only encourage phoenixing activity, asset moving and asset stripping. We're the last resort to say, 'Hang on, he just keeps moving the assets along and leaving behind a pool of misery.' Some liquidator jumps in front of us and says, 'No, that's enough. We're taking you to court. We're going to freeze your assets until you go back.' I've got one with $35 million worth of tax owed. It's a property developer in the western suburbs of Sydney. Unless someone jumps in and stops them, they just keep going. They'd still be building these wretched buildings that are falling down.
10.28The ATO drew attention to how it and other agencies used liquidator reports to address illegal phoenixing:
Due to the pervasiveness of the risk, it is not possible for any regulator to eliminate Illegal phoenix behaviour. However, intelligence sharing and data driven approaches provide greater opportunities to detect and deal with this behaviour. As part of the Mid-Year Economic and Fiscal Outlook (MYEFO) 2019-20, the government provided additional funding to ATO and ASIC to establish better data sharing, data fusion and improved analytics capabilities. Data fusion integrates ASIC data sets including liquidator Initial Statutory Reports with ATO data, which then undergo analytics and modelling to identify illegal phoenix activity.
The importance of the information reported by Registered Liquidators to ASIC in relation to illegal phoenix cannot be underestimated. This information is integral to the effectiveness of our data fusion program and therefore in detecting illegal phoenix activity.
10.29The BLS LCA said that it is not convinced that the extent of ASIC’s enforcement activities is an indication that the misconduct reports should not be required. It explained:
The disadvantage of removing the obligation to do the work is relatively obvious. Less investigation will lead to even less concern by bad actors about misconduct, and likely cause an increase in misconduct levels…It may be that more enforcement activity is necessary.
10.30ASIC suggested that consideration could be given to raising the threshold for misconduct reporting. It noted that the current requirements compel registered liquidators to undertake the work and incur costs to report matters ‘where there is not, and never will be, sufficient and adequate evidence to enable any enforcement action to be taken’.
10.31ASIC stated, however, that there is a public policy question that any movement to raise the threshold should be weighed against. It identified that raising the thresholds could result in some offences going unreported and a loss of intelligence for ASIC, the ATO and other agencies who draw on that data. It also highlighted that even if intelligence about a director is not be used in the first instance, interest in it may increase should subsequent reports be made about the same director.
10.32ASIC did, however, acknowledge that there is a cost involved for insolvency practitioners:
I know it's frustrating for liquidators, because they'll say, 'I did a lot of work and I gave you this report,' and then they'll say nothing happened. But some of it is about effectively pulling together a database of antecedence so that when we see other things go wrong, we can say, 'This person should sit out the game of being a director for a period of time until they can show they can improve.'
Committee view
10.33The committee is concerned about the time-consuming ASIC reporting requirements for liquidators and that, in some cases, automatic software is responding rapidly to reports with no subsequent follow-up. The committee is concerned that unnecessary costs may impact liquidator business models. The committee, like many stakeholders, is left wondering whether better outcomes would be achieved if there were far fewer forms being lodged, but those that were required were dealing with far more material issues.
10.34The committee acknowledges that, inevitably, a trade-off needs to be made in determining the balance between the cost of reporting and the benefits arising. The committee notes that there are direct benefits, where ASIC undertakes follow-up action and indirect benefits, where the information contributes to the cache of data on the insolvency system that ASIC and other agencies can use. The committee considers that now would be an appropriate time for the costs and benefits to be examined in some detail to provide an appropriate basis for future policy and legislative settings.
10.35The committee recommends that the comprehensive review consider whether the current statutory reporting obligations for insolvency practitioners are best serving the integrity, efficiency, and efficacy of the Australian corporate insolvency framework, including (but not limited to):
the ability of the Australian Securities and Investments Commission (ASIC) to appropriately process, utilise and respond to initial statutory reports on current resources; and
the appropriateness of existing reporting thresholds, having regard to their regulatory value as well as the burden imposed on insolvency practitioners.
The committee further recommends that in the interim, the government and ASIC consider whether any timely changes can be made to the regulations on reporting thresholds, and ASIC’s response to insolvency practitioner reports.
Reporting obligations to creditors
10.36Concerns about ASIC’s current reporting obligations imposed on insolvency practitioners extended to reports to creditors. ARITA told the committee that while it recognised the need for transparency in the insolvency process, particularly with respect to small business creditors, it observed that ‘the vast majority of creditors do not read the reports provided and find the quantum and complexity of material overwhelming’. It stated:
Instead of the reporting providing insights to inform creditors, the extensive reporting often leads to active creditor disengagement in the insolvency process, most of whom are just interested in how much money they will receive.
10.37ARITA called for a review of the current reporting requirements in order to ‘identify and recommend the reduction and/or elimination of unnecessary regulatory burdens’. An example of a reporting obligation that ARITA proposed be improved is the requirement to report about dividends to be given in certain external administrations under the Insolvency Practice Rules (Corporations) 2016. ARITA compared these requirements under the Corporations Act against provisions of the Bankruptcy Act 1966 (Bankruptcy Act) (see Figure 10.1 below).
Figure 10.1 Comparison of reporting obligations – Corporations Act versus Bankruptcy Act
Source: ARITA, Submission 36, p. 40.
ARITA suggested that the prescriptive reporting requirements under the Corporations Act could be replaced with a simpler format such as those under section19 of the Bankruptcy Act. In its view, any reduction in the amount of information provided to all creditors would be offset by the right of existing creditors to requestion information from appointees.
Insolvent trading
10.38Concerns were raised during this inquiry about the operation and enforcement of insolvent trading laws. Inquiry participants noted that despite these laws, ASIC statistics demonstrate that a significant majority of companies entering external administration have continued to trade and incur debts for months despite being insolvent. Both Associate Professor Mark Wellard and Mr Nick Pilavidis from the Australian Institute of Credit Management (AICM) pointed to ASIC’s 2018-19 statistics (consistent with the 2021-22 statistics), which records that in both periods, 71 per cent of initial statutory reports of external administrators reported insolvent trading.
10.39Associate Professor Wellard added that during the latter period, external administrators assessed that insolvency had occurred more than two years before their appointment in 45 per cent of these cases. He added:
In 29 per cent of cases, up to $250,000 worth of debt had been incurred compared to the reported estimated asset position of less than $10,000. In 13 per cent of cases, between a quarter of a million dollars and $1 million worth of debt had been incurred compared to, again, an estimated asset position of less than $10,000.
10.40Associate Professor Wellard said that in his view, much of the disenchantment vocalised about the insolvency system, be it in respect of liquidator remuneration or proceeds of preference claims not being returned to creditors, ‘is caused more by the reality that many company balance sheets are leveraged into oblivion well before a liquidator arrives on the scene’.
10.41Associate Professor Wellard stated that this issue, in his view, has exceeded beyond simply being an enforcement issue. He explained:
For financially distressed SMEs that end up in liquidation, antecedent—that is, pre-appointment insolvent trading—appears to be mainstream rather than exceptional. Whether it's because directors don't know how or where to get the relevant advice they need, whether it's because they're unaware of the duties that are owed by a company director, whether it's simply human nature in some cases to ignore the inevitable or whether it's genuine hardship cases the committee heard about yesterday, the reality is that many directors are trading on their companies and incurring debt at a point long past when the business has ceased to be viable. This is bad for creditors, it's bad for our economy and…sometimes it's bad for the wellbeing of the directors themselves.
10.42Associate Professor Wellard identified addressing insolvent trading as a good place to start if the objective is to improve returns to unsecured creditors. He suggested measures to address insolvent trading, including legislating consequences for directors whose companies generate minimal returns to general unsecured creditors, and automatic disqualification for directors in two liquidations with minimal returns. He stated that at the very least, review of insolvent trading should be front and centre in a comprehensive review.
10.43Taking firmer action on insolvent trading was also supported by Narrow Road Capital, who described that, at present, ASIC rarely prosecutes insolvent trading. The AICM expressed a similar view, stating that the non-existent enforcement of insolvent trading means that directors are not deterred from continuing to trade whilst insolvent. This comes at a direct cost for creditors and lessens the chance for business turnaround at the end of an insolvency process.
10.44ASIC conceded that more could be done to address insolvent trading, but it identified that ‘most of the time insolvent trading might stop a director, but it might not get any money back’.
Wrongful trading
10.45During the inquiry, consideration was given to possible changes to the ‘insolvent trading’ threshold, perhaps to mirror the ‘wrongful trading’ standard as is presently applied in the United Kingdom.
10.46ASIC expressed its awareness of questions about whether the current insolvent trading provisions are achieving their objectives. It suggested that these provisions could be an area for further consideration, particularly in relation to how they impact the ability of businesses experiencing financial difficulty where the safe harbour provisions may not be available. ASIC proposed a number of matters that could be the subject of such consideration, namely whether:
the threshold for criminal insolvent trading is appropriate
it is appropriate to differentiate between the size of companies based on liabilities (similar to the small business reforms)
some monetary thresholds to individual debts incurred should be applied
certain classes of liabilities should not be included.
10.47The ‘wrongful trading’ standard is higher than the civil ‘insolvent trading’ standard which currently exists in Australia. According to ASIC, it applies to situations where ‘a company’s directors have continued to trade when they knew, or should have concluded, that there was no reasonable prospect that the company would avoid insolvent liquidation or insolvent administration’.
10.48This matter was also considered by the 2021 Review of the Insolvent Trading Safe Harbour. In its final report published on 23 November 2021, the Review Panel concluded that it was beyond the scope of its task to consider whether Australia’s prohibition on insolvent trading should be replaced by the ‘wrongful trading’ or another model. However, noting that such a change would have ‘significant ramifications’, any such proposal ‘should be the subject of in-depth consideration and consultation’. The Review Panel stated, however, that despite the operation of the safe harbour provisions, there remain ‘significant queries about the underlying effectiveness of the prohibition, and its interaction with corporate governance, risk allocation and other legislative obligations of directions’. Those difficulties, it stated, ‘arise because of the starting position of the duty: directors are liable for all insolvent trading, unless carve-outs or defences apply’.
10.49In the Review Panel’s view, ‘the appropriateness of that base position (from a policy perspective) is worthy of being questioned’. It added:
To the extent a ‘wrongful trading’ model can achieve similar policy objectives while also clarifying and simplifying the concept of insolvent trading from the perspective of directors, is, at least on its face, appealing. However, its appropriateness within the Australian jurisdiction must be considered.
10.50Associate Professor Wellard encouraged lawmakers to reconsider and reformulate the legislative settings that will:
encourage directors to satisfy themselves that their companies are adequately capitalised when regard is had to the scale of the operations and the level of the commitments into which they are proposing to enter.’
10.51The Australian Institute of Company Directors (ACID) suggested that a comprehensive review consider:
…amending the threshold of the insolvent trading director duty to ‘wrongful trading’—that is, that the threshold for director liability would require (as it does in the United Kingdom) actual knowledge or negligence that there was no reasonable prospect of the company avoiding liquidation and they did not take steps to minimise losses, as opposed to the current lower threshold in Australia of a reasonable suspicion in the mind of the director that the company was insolvent…
Committee view
10.52From the evidence it has received, the committee is concerned that the current insolvent trading regime is not working effectively to prevent companies from becoming deeply insolvent before they enter formal insolvency or restructuring pathways. At this point it is hard to determine what the root causes behind the problems are. However, the evidence suggests that likely causes include weaknesses in the legislative provisions and lack of enforcement by ASIC. Both those potential causes may contribute to ineffective deterrence in the face of strong cultural incentives for directors to avoid acting until too late.
10.53As discussed in other chapters (for example, in chapter 11 on voidable transactions and unfair preference claims), deeply insolvent trading distorts other parts of the insolvency system. The committee, therefore, suggests that one of the top priorities for the proposed comprehensive review should be to address the ineffectiveness of the insolvent trading regime, its enforcement, and the distorting impacts on other parts of the insolvency system.
10.54The committee recommends that the comprehensive review examine the operation of the insolvent trading regime and its impact on the broader corporate insolvency framework.
Illegal phoenixing
10.55The majority of Australian business do the right thing and comply with Australia’s taxation and corporate insolvency laws. However, there is a proportion of the population that choose not to comply, with some using illegal phoenix activity as part of their business operating model. It occurs when a new company, for little or no value, continues the business of an existing company that has been liquidated or otherwise abandoned to avoid paying outstanding debts, which can include taxes, creditors and employee entitlements. Illegal phoenix activity is a serious financial crime. It is perpetrated by some in an opportunistic manner to retain business and personal assets. In other cases, it involves organised criminal networks, assisted by professional enablers and facilitators.
10.56Illegal phoenixing causes significant harm to the community. Employees miss out on wages, superannuation and entitlements, suppliers and subcontractors are left unpaid, and governments miss out on tax revenue. It is estimated by the ATO that the impact on businesses and employees is between $2.85 billion and $5.13 billion annually. In addition to the direct impact, illegal phoenix activity creates an uneven playing field, where honest businesses who pay their tax, superannuation, suppliers and subcontractors, are not able to compete.
10.57The risks arising from illegal phoenixing are not static nor confined to certain industries or locations, although it is prevalent in the property and construction, labour hire and security industries. The controls implemented to respond to illegal phoenix activity must continually adjust and respond to evolving behaviour and methodologies used by phoenix operators.
10.58Noting the difficulty in defining illegal phoenixing, the ATO provided the following information on how it distinguishes between illegal phoenixing and the legitimate winding up of businesses:
Illegal phoenixing is usually deliberate and serial liquidation of companies and inappropriately transferring assets to a third parties.
Illegal phoenixing can also be opportunistic, companies get themselves into trouble and they move the assets into a new business so they can start up again, as a way of taking an advantage.
There are also some instances where someone is in business, they liquidate in a lawful manner and then they start a new business up in the industry that they were in. They actually haven't done anything wrong, they haven't shifted assets, they've gone through the process, but generally speaking the person might be in a particular industry—that's their skill and expertise—and then they move on, and they've had a business failure, but they never repeat that.
10.59The extent to which illegal phoenixing remains prevalent in the Australian economy, despite the implementation of recent reforms aimed at addressing this issue, was discussed during the inquiry. The summary view provided by participants is that phoenixing activity continues to occur, and, while more time is likely required to properly assess the impact of the recent reforms, stronger regulatory action is likely to be required.
10.60The recent reforms, implemented with the passage of the Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020, were twofold:
the legislation introduced a new category of voidable transaction, namely the creditor-defeating disposition. This allowed liquidators to pursue transactions wherein a company had disposed of assets effectively below their true value; and
liquidators could seek a determination from ASIC that the relevant disposition was creditor-defeating. Any recipient subject to such a determination would need to prove in court that it was not.
10.61Mr Ben Sewell commented on the lack of data around the frequency and costs of phoenix activity in Australia and suggested that any quantifications of these figures are likely speculative.
10.62Evidence to this inquiry raised questions about the effectiveness of the scheme, and ASIC’s enforcement activities in respect of it. ARITA told the committee that ‘the market needs stronger signals that poor director behaviour won’t be tolerated’.[66] It said that ‘[s]trengthening the legislation is part of this, a dedicated engagement-focused regulator is the other’.[67] The need to strengthen the anti-phoenixing regime with more regulation was supported by other stakeholders such as the Construction Forestry Maritime Mining Energy Union (CFMMEU) and Southern Steel Group.
10.63The BLS LCA recommended that ‘consideration should be given to the effectiveness of, and any potential improvements to, the creditor-defeating disposition regime, including the administrative process by which ASIC may made orders about creditor-defeating dispositions’. Expanding upon its position before the committee, the BLS LCA emphasised that there is a need for the enforcement of consequences under the scheme for it to be effective, noting that while the legislation itself is a disincentive, ‘it doesn’t necessarily make much difference unless people also see that the consequence will be real’.
10.64The BLS LCA noted that while the limited reported legal cases and ASIC determinations on creditor-defeating dispositions does not necessarily tell the whole story about the effectiveness of the reforms, reflection was warranted to determine whether the regulatory scheme was really working.
10.65The Australian Institute of Credit Management (AICM) and the Housing Industry Association (HIA) supported the introduction of a statutory definition of illegal phoenixing behaviour in order to clarify what is and what is not illegal behaviour.
10.66ARITA suggested that the following reforms should be pursued:
substantially more enforcement actions need to be taken against directors and facilitators of illegal phoenixing;
more needs to be done to strengthen existing anti-phoenixing tools within the law rather than creating quasi-duplicate mechanisms. This is consistent with the Australian Law Reform Commission’s (ALRC) recent recommendation that ‘offence and penalty provisions in corporations and financial services legislation should be consolidated into a smaller number of provisions covering the same conduct.’
an actual ‘phoenixing’ offence needs to be created. Its absence hinders any effective communication strategy to drive cultural change to call out and mitigate this behaviour.
a lack of adequate funding and documentary evidence available to liquidators will continue to hamper the effectiveness of the reforms, including the ability of ASIC to make any recoveries via the administrative recovery regime.
10.67ARITA, like a number of other inquiry participants, recognised that part of the response to address illegal phoenixing involves addressing the harms posed by pre-insolvency advisors. Further discussion about this issue, including proposals to address it, is available from paragraph 8.88 in chapter 8.
Director identification numbers
10.68The recent anti-phoenixing reforms also included requirement for directors to obtain a Director Identification Number (Director ID). The Director ID program is part of the Australian Business Registry Services (ABRS) which is managed by the ATO. Mr Ben Sewell described the Director ID reforms as follows:
It is a process where you get a unique identifier and it goes to your tax agent. Basically there is no way that you can commit fraud with writing your name down on a company or corporation or fudging the date of birth or the name.
10.69While the initiative remains in its early stages, the general sense from inquiry participants is that the Director ID program will be a useful mechanism for combatting illegal phoenixing. However, further sentiment amongst submitters indicated that this will not be a cure-all mechanism. For example, ARITA said that ‘[i]t is not a silver bullet, but it's an incredibly important tool in the shed’.
10.70Mr Russell Morgan noted that while the recently implemented Director ID initiative ‘is a step to combat phoenix companies’, such a measure, while capable of identifying regular phoenixers, does not appear to be directed at directors who engage in one-off phoenixing behaviour.
10.71The Electrical Trades Union (ETU) suggested that there is a gap that exists in identifying and defining straw directors and imposing penalties where directors have been appointed either without that person’s knowledge or who don’t exist. The ETU stated that while the Director ID reforms will go some way to addressing those issues, they haven’t gone far enough.
10.72The BLS LCA observed that it is a generally accepted view that the introduction of Director ID requirements is a welcome and potentially useful reform. However, it questioned why this registry sits within the ATO, rather than ASIC. It stated that ‘[a]t least at first impression, the addition of an additional regulator into the company officer registration space is likely to create inefficiency’.
Committee view
10.73The committee notes that additional time may be necessary to properly ascertain the effectiveness of the anti-phoenixing reforms. However, the committee is of the view that a further review, after an appropriate amount of time, may be necessary to determine whether additional administrative or enforcement mechanisms are needed to ensure the reforms are meeting their objectives.
Australian Taxation Office (ATO)
10.74This section discusses:
the ATO’s roles in corporate insolvency;
ATO assistance to businesses during the pandemic;
how vigorously the ATO pursues insolvency-related debts;
the ATO as a model creditor; and
ATO suggestions for reform.
The ATO’s roles in corporate insolvency
10.75An insolvency process of a company will often involve the ATO, as most companies will have some tax liability. The ATO indicated that the Commissioner of Taxation plays two roles in the insolvency system. The first role is acting as administrator of the tax and superannuation systems to recover debts until insolvency. The second is post-insolvency involvement as a major creditor. The ATO indicated that its approach to debt recovery and insolvency is measured and cautious, and it seeks to work with businesses on tailored solutions.
10.76Once a company enters insolvency, the ATO's role largely goes from the administrator of the tax and super systems to that of an unsecured creditor. Historically, the ATO has been a creditor in three-quarters of company insolvencies and is often the largest and sometimes the only creditor.
10.77The ATO noted that its tax collection mechanisms could bring issues to a head for struggling companies. The ATO will usually issue a Director Penalty Notice (DPN) before taking liquidation proceedings if the company’s debts are under the pay-as-you-go tax provisions, superannuation guarantee charge, or Goods and Services Tax (GST). It is not uncommon for directors to initiate insolvency following the ATO issuing a DPN.
10.78A standard DPN can be remitted by the company paying the debt or appointing a liquidator, a voluntary administrator, or a small business restructuring practitioner. Each of these appointees is required to be a registered liquidator. The directors often choose to appoint a registered liquidator when the company cannot pay the debt (or agree to a payment arrangement). It has not been possible to accurately estimate how many appointments of liquidators are indirectly triggered following the issue of DPNs.
10.79Where a tax debtor does not propose or adhere to an acceptable proposal to pay a tax debt, the ATO may issue a creditor’s statutory demand. If the tax debtor fails to comply with the demand (pay, secure or compound the debt), the company will be presumed to be insolvent, and the Commissioner may, in appropriate circumstances, commence winding up proceedings.
ATO assistance to businesses during the pandemic
10.80During the pandemic, the ATO helped businesses, including:
deferring of payment and lodgment dates;
allowing businesses to vary their payment instalments;
remitting interest and penalties;
withholding enforcement actions, including DPN and wind-ups; and
pausing enforcement activities that lead to insolvency appointments.
10.81As the pandemic pressures on business eased, the ATO resumed its activities. In March 2022, the ATO commenced an awareness campaign by contacting company directors via letter to inform them about their potential personal liability for company tax debts under the DPN program. An awareness letter differs from a DPN as it notes that the ATO is considering acting if the company does not actively manage their debt. Following the DPN awareness campaign, between July and September 2022, the ATO issued 7,523 DPNs, compared to 125 DPNs issued over the same reporting period in the previous year. The ATO indicated that in late 2022 it was on average issuing 150 DPNs each business day and increasing. Pre-COVID, the ATO issued fewer DPNs, averaging around 52 each business day in the 2019 financial year.
10.82Historically, the ATO has been a creditor in 74 per cent or around three in four company insolvencies. The ATO the largest creditor and sometimes the only creditor. However, the ATO suggested it is a relatively minor initiator of corporate insolvency appointments. The ATO suggested that most corporate insolvency appointments are initiated by the directors of the corporate entity or another creditor. ARITA disputed the ATO view as follows:
I'm a little surprised at the ATO's position that they're a minor player in the insolvency market. That's simply not true. Even if you look at their graph for the wind-ups that occur, it shows that they're doing about 50 per cent of them. That is the long-term historical perspective. The ATO were the primary organisation to initiate wind-ups pre-COVID. Their absence from the market is what shut down the level of insolvency over the course of the last couple of years, alongside stimulus. They act as the principal signaller to the market about whether or not a company is in distress. Indeed, it has changed creditor behaviour, because most other creditors were reliant on the ATO taking that wind-up action.
How vigorously the ATO pursues insolvency related debts
10.83Some witnesses raised concerns that when the ATO does not take strong action to enforce tax debts, companies that would otherwise be triggered to enter insolvency do not, causing larger losses to other creditors. For example, MrJonathan Rochford from Narrow Road Capital, made the following observations:
…I want to encourage the committee to reassure the ATO that they should collect their debts in full and on time. The ATO typically collects GST and pay-as-you-go taxes after the business has received them or withheld them. As the business should already have the money, there is no reason it should not be able to pass it on to the ATO promptly. Without the ATO taking swift action to recover debts, insolvent businesses can continue to trade, fleecing their customers, employees, trade creditors and taxpayers.
10.84Mr Michael Brennan (Offermans) also argued that the ATO taking a stronger role in enforcing debt associated with insolvency has broader impact on the market:
I think the ATO needs to lead the discussion on the fact that paying tax is an obligation. It seems to be an opt-in opt-out sort of situation these days. I just think we need to get back to a scenario where, regardless of what's happening in the broader community, tax needs to be paid because that money is used for vital public good. You do have a market distortion where some businesses aren't paying tax and some are. I know that seems overly harsh. It's certainly been the case that the ATO drive insolvency. They can deny it for whatever reasons. I think that the data shows that, when the ATO is seeking tax recovery, businesses that aren't performing either go and get firmer advice on how to perform or end up looking at how they exit the ecosystem. Those assets then get redeployed to other businesses. I think that's the massive part of the ATO's tradition that it needs to reclaim—accept the fact that it's not going to be popular and that it's a vital part of driving the way businesses operate.
10.85Mr Grant Morris, National Credit Manager at Southern Steel Group held a slightly different view, noting that the ATO is still readjusting its practices following the pandemic:
I thought some of the comments were interesting, such as some of the comments about whether the ATO should be stepping in and taking action. I think it's fairly common knowledge at the moment that the ATO hasn't been taking action in terms of insolvencies and winding up companies. I think the reports I've seen as recently as in the last two or three days show that that action is just starting, although we're still a long way behind what the historical levels were in terms of pursuing debts and so on. I personally don't see it as the ATO's responsibility to decide whether they have the opportunity to collect somebody's debt. I think that's more a Treasury issue and a government big-picture type of issue. I don't think it's the ATO's responsibility. Isn't there something like $55 billion in collectable debt outstanding at the moment?
10.86The BLS LCA noted a diversity of views within its membership on the effectiveness of the ATO in its role and how vigorously it should pursue debts in potentially insolvent companies. The BCS LCA indicated that its members are in general agreement that a hard-line enforcement approach to collectable debt may increase corporate insolvencies and have impacts on the economy, businesses, employees, and individuals that are not in the national interest and that the ATO must take a nuanced approach that differentiates between different risks in this area and seeks to get the balance right between enforcement and support.
10.87The ATO annual report indicates that significant collectable debt has accrued during the pandemic, increasing from $26.5 billion at 30 June 2019 to $44.8 billion at 30 June 2022, up $18.3 billion or 69 per cent. The small business sector has $29.3 billion of collectable debt (more than 65 per cent). The largest type of tax debt is activity statement debt (e.g. Business Activity Statement (BAS) instalments), amounting to $29.7 billion, over 66 per cent of collectable debt.
10.88The BCS LCA drew attention to the significance of the debts owed to the ATO in the context of the federal budget. Australia's projected deficit in the government's October 2022 Budget was $36.9 billion. That means that the total collectable debt at the same time exceeds the deficit, and the small business collectable debt represents almost 80 per cent of the deficit.
10.89KPMG also commented on the balance to strike for the ATO between collection activities and business support. It's often tax office action which is the thing that puts pressure on the company to do something. In the absence of pressure to do something, it's human nature to do nothing, and if they do nothing, then the problem goes down the road further. The ATO could play a part in encouraging companies to face their problems sooner, which would allow insolvency practitioners more latitude to rescue the company, save the jobs and hopefully produce a better return for the creditors.
10.90AICM told the committee that other credit providers, who do not have the same access to information, rely mainly on the expectation that if the ATO hasn’t taken enforcement action, the entity is viable and will continue to provide credit. AICM stated that the post-COVID debt levels are a ‘significant concern to credit professionals’ because it is a hidden risk to them, and the suspension of enforcement activity during the emergency period caused increased uncertainty. While it supported calls for the ATO to be consistent with enforcement proceedings, AICM also supported the ATO, aiding viable businesses. However, it argued that this approach must be accompanied by greater transparency to assist credit providers in making informed decisions.
10.91AICM suggested expanding the disclosure of tax debt measures as follows:
Amend the threshold amount from $100,000 to $10,000, or provide a mechanism for regular review of this threshold amount.
Information be included on credit reports for five years from the date of disclosure, and during this period, it is updated in the same manner as any other commercial default.
10.92The BCS LCA recommended that consideration should be given to whether the ATO’s armoury of various enforcement mechanisms remains appropriate. The BCS LCA also suggested steps that could be taken outside insolvency to improve the collection of tax:
increasing public education to articulate risk factors to match ATO action with those which are high risk or lower risk;
increasing ATO collection and enforcement activity for high risk debt;
making payment plans more attractive for lower risk debt;
increasing small business tax debt advisory support and education;
establishing more support for struggling industry sectors; and
considering the feasibility of tax system changes to bring forward the date of payment of tax withholding instalments to when payment occurs.
ATO as a model creditor
10.93There was also some discussion during the inquiry about whether the ATO should be a model creditor. This discussion was promoted by ARITA, who recommended that:
in addition to being a model litigant as required under the Legal Services Directions 2017, the ATO must be required to act as a model creditor at all times, and that its compliance with both requirements be reviewed annually by the Inspector General of Taxation.
10.94The model litigant requirement, which applies to the Commonwealth and Commonwealth agencies, obliges these parties to ‘act honestly and fairly in handling claims and litigation brought by or against the Commonwealth or an agency of it’. This obligation includes (among other things):
dealing with claims promptly and not causing delay in the handling of claims and litigation;
acting consistently in the handling of claims and litigation;
not taking advantage of a claimant who lacks the resources to litigate a legitimate claim; and
not relying on technical defences unless the Commonwealth’s or the agency’s interests would be prejudiced by the failure to comply with a particular requirement.
10.95 ARITA explained the characteristics of a model creditor as follows:
not abstaining from voting at meetings;
attending all meetings, whether by sending a staff member or by providing a proxy to the Chairperson;
supporting resolutions about appointee remuneration wherever it is for necessary work, properly performed;
not taking advantage of external administrators who have insufficient resources to pursue a claim against it;
not seeking to prioritise the ATO’s position above other ordinary unsecured creditors;
ensuring requests for information made in accordance with creditor rights are reasonable in the circumstances;
reporting potential breaches of the law to relevant regulators. For example, where the ATO identifies a derelict company that should be deregistered but does not seek to liquidate the company for commercial reasons, it should nevertheless advise ASIC that the company should no longer be registered.
10.96The ATO’s statutory priority as a creditor in insolvency was abolished in 1993. However, ARITA argued that the ATO has used other powers to get ahead of other unsecured creditors and is therefore not following the pari passu principle.
10.97Professor Harris agreed that the ATO should be a model creditor. He explained that during his research, he received feedback from practitioners that indicated confusion about the role of the ATO in liquidations: ‘Is it a commercial creditor or is it a policeman?’.
10.98The BLS LCA recommended that consideration should be given to binding legislative guidance governing the way the Commissioner should exercise enforcement rights and the Commissioner's attitude to votes at creditors' meetings and to legislating the application of judicial review rules to the Commissioner's decisions at creditors' meetings.
10.99The ATO responded that it is bound to comply with model litigant obligations, which include principles such as promptness, avoiding unnecessary litigation, consistency and being cost-effective. The ATO indicated that it abides by those principles in its role as the administrator of the tax and superannuation systems and when acting as a creditor. The ATO uses the Practice Statement Law Administration 2011/16 (PS LA 2011/16) regarding insolvency, which guides ATO officers and the public on how the ATO votes in creditors' meetings and what the ATO considers. The ATO is also bound by the broader Taxpayers' Charter, which is about treating taxpayers fairly, reasonably, and honestly, as well as the requirement for ATO officers to apply the APS Code of Conduct. While the practice statement doesn't currently cover small business restructuring, the ATO follows the principles of the PS LA 2011/16 when it assesses restructuring plans as well.
ATO suggestions for reform
10.100The ATO declined to provide suggestions for insolvency reform to the committee, indicating that:
'The ATO is separately engaging with the Department of Treasury, which is responsible for providing policy and law advice to Government concerning potential reform opportunities to improve the operation of the corporate insolvency system.
Committee view
10.101The committee notes that the ATO felt it could not include suggestions for reform in its submission to such a critical policy inquiry. While the committee acknowledges that departments and agencies must take the appropriate care in their work for the government of the day, the committee considers that government departments and agencies should be able to contribute to inquiries by identifying areas of policy where issues have arisen that need reform. The committee notes that departments and agencies have access to rich information on such matters. The committee, therefore, encourages the ATO and Treasury to add such information to their submissions in future.
10.102The committee observes that inquiry participants had varying views on whether the ATO should take a hard line on insolvency-related debt. Some inquiry participants have identified the significant impacts on the rate of insolvencies in the economy of the ATO adjusting how vigorously it pursues insolvency-related debts. In particular, the committee notes that the ATO provided significant relief to businesses during the pandemic. The committee also acknowledges the broader economic and social importance of the ATO's capacity to vary its approach, and that capacity can assist the country in responding to economic shocks, such as the shock created by the pandemic. The committee considers it would be appropriate for the comprehensive review to analyse and make recommendations on the overall economic and social benefits and costs of ATO relief to potentially insolvent companies in hard economic times, in the context of the impacts on the purposes of the insolvency system.
10.103The committee notes suggestions that the ATO acts as a model creditor when participating in insolvencies as a creditor. The committee notes that the statutory priority for the ATO as an insolvency creditor was removed in 1993. However, it was suggested to the committee that the ATO may use other powers to get ahead of other creditors in some circumstances. The committee notes that the ATO responded, indicating how it applies model litigant obligations and the Practice Statement Law Administration 2011/16 (PS LA 2011/16), which requires that the Commissioner will neither prejudice other creditors' entitlements nor accept that other creditors can prejudice the Commissioner's entitlements.
10.104The committee considers that there should be no harm in the ATO following a model creditor guideline if such guidelines were available. Hence, the committee is recommending that the ATO consult, act on and publish model creditor guidelines, consistent with its model litigant obligations.
10.105The committee recommends that the comprehensive review analyse and make recommendations on the overall economic and social benefits and costs of Australian Taxation Office relief to potentially insolvent companies in hard economic times, in the context of the impacts on the purposes of the insolvency system.
10.106The committee recommends that the Australian Taxation Office consult, act on and publish model creditor guidelines, consistent with its model litigant obligations.