Illegal phoenix activity is costing us billions – here’s how it could be stemmed

Identifying repeat offenders doesn’t have to be complicated. Image sourced from Shutterstock.com

A proposal designed to stop illegal phoenix activity being actively considered in New Zealand could be similarly adopted in Australia, potentially saving billions of dollars.

Illegal phoenix activity – which involves directors intentionally liquidating companies after shifting their assets to new (“phoenix”) companies to defraud taxation authorities, trade creditors and employees – is widespread in Australia.

A Productivity Commission report last year found there were between 2,000 to 6,000 phoenix companies operating in Australia, costing A$1.8 billion to A$3.2 billion per annum.

Likewise, a Senate Economics References Committee inquiring into the Australian construction industry found illegal phoenix activity was a problem “throughout the economy” and one that suggested “a significant culture of disregard for the law”.

I lead a research team from the University of Melbourne and Monash University that has been investigating ways to regulate phoenix activity. We recommend directors be forced to undergo a 100-point identity check – just as they do when opening a bank account or obtaining a passport – before they are allowed to act as a director or start a new company.

The issuing of a Director Identification Number (DIN) would enable tracking of directors that have been involved in multiple failed companies. It would also reveal fictitious directors, currently the bane of credit rating agencies and the Australian Taxation Office. Requiring would-be directors to quote their DIN on applications to incorporate companies would let ASIC build a valuable database of directors’ corporate histories, helping it to identify repeat offenders and candidates for disqualification from managing corporations.

Take the case of Melbourne builder Frank Nadinic, who told a Senate inquiry he had unintentionally registered 32 to 33 companies using three different versions of his name. ASIC has power under the Corporations Act to disqualify directors who are involved in two or more failed companies within the past seven years. A DIN may have prompted ASIC to investigate the status of the companies Mr Nadinic had registered, whether any of them had failed, and if so, whether disqualification would be an appropriate regulatory response.

Another company director, Mark Frederic Byers, was disqualified in July 2016 from managing companies. He was suspected of engaging in illegal phoenix activity, insolvent trading and breaches of directors’ duties in relation to four failed companies. Byers has since been banned from managing companies for five years. He is listed on ASIC’s disqualified directors’ database under three different versions of his name and with three different entries for his address.

While illegal phoenix activity is most prevalent in the small to medium business sector, the cost of individual phoenix cases can still be significant. For example, the seven companies operated by disqualified directors Peter and Terry Panayi failed with an estimated total deficiency of assets of more than A$9 milllion.

A Director Identification Number would also potentially minimise the costs of multiple corporate failures resulting from misconduct other than illegal phoenix activity. Take Ian Douglas Christiansen, who, according to ASIC, was involved in the failure of fifteen companies with estimated total deficiencies of approximately A$330 million. Christiansen was disqualified for a suspected breach of directors’ duties and failure to keep financial records.

In such a situation, a Director Identification Number would signal to ASIC that it may be appropriate to carry out an investigation. If it did so at an earlier stage it could significantly mitigate the losses resulting from repeated corporate failures.

The Productivity Commission has endorsed our proposal, as have a range of professional industry associations, and it was also recently recommended by the New Zealand Insolvency Working Group (Measure 3). Countries as diverse as India and Estonia have implemented director verification procedures.

The Director Identification Number is just one of a range of measures that our research team will ultimately recommend to combat illegal phoenix activity. But it is an important first step toward protecting taxation authorities, trade creditors and employees from this widespread and damaging practice.