The corporation law assignment about Phoenix Company Essay Example

Corporation Law Assignment

Question 1

Identification
of Legal issues

Topsy twins, Gracie and Tasia, formed a company after winning My Kitchen Rules (MKR) program in 2015. The twins went ahead to form a company to operate their restaurant that specializes in exotic seafood cuisine. They are both directors of Neptune’s Prize Seafood Restaurant Pty Ltd which each being a 50% shareholder. The fortune of the restaurant declines leading to financial difficulties after subsiding of the MKR buzz that propelled its performance. Gracie is taken ill and takes time off overseas and is not involved in decision making. The financial challenges of the company escalate. Despite the challenges, Tasia purchases new refrigeration system on the behalf of the company. Gracie realizes that the company is likely to go into liquidation. They decide to cease trading under the old company’s name and change it to Poseidon’s Prize Seafood Restaurant Pty Ltd and later they form another company (Neptune’s Triumph Seafood Restaurant Pty Ltd) with each having a 50% shareholding. They are both directors. On the part of liquidator of Poseidon’s Prize Seafood Restaurant Pty Ltd Can action be brought against the directors with regard:

1. to the debt incurred by Neptune’s Prize Seafood Restaurant Pty Ltd; and

2. Transferring Poseidon’s Prize Seafood Restaurant Pty Ltd and assets to Neptune’s Triumph Seafood Restaurant Pty Ltd for no consideration?

Relevant law

At the verge of insolvency there is change in interest. The residual interest of the members or shareholders in the assets of the company does not precede the interest of the creditors who are paid from the assets. This has to be demonstrated in a shift in the substance of duties of directors whereby when exercising their functions they have now to put the interests of the creditors first (Olivares-Caminal, Rodrigo, et al, 2011). The company has to immediately cease trading and safeguard the assets firstly in the interests of creditors. The company should not equally take new borrowings or sell any of the assets. Rigorous investigation after liquidation can lead to financial penalties, directorship ban or even a prison sentence. Upon ceasing trading, company directors have to call meeting of shareholders and 75% of the shareholders according to value have to agree to wind up the company (Goode & Royston, 2011). A liquidator can be appointed at this stage. A meeting of creditors is called to inform them of the decision reached. Directors attend the meetings to answer questions from creditors. It is in this meeting that a statement of affairs that describes the financial position of the company is presented.

The principle has been applied in Australia and the United Kingdom and cannot be any different in the anywhere else. The High Court of Australia in the case Walker vs. Wimbome (1975) 137 CLR 1 stated that it has to be emphasized that in discharging their duties, the directors have to take into account the interests of shareholders as well as creditors. Failure by directors to cater for the interests of creditors will imply adverse repercussions for them and the company. The principle that the interests of the creditors become very pertinent at the onset of insolvency has been increasingly acknowledged in case law (Marshall & Ian, 2012). The general agreement is that the duty of directors is owed to the company as opposed to the individual shareholders or its creditors. In the case of Kuwait Asia Bank EC vs. National Mutual Life Ltd [1991] it was stated that the directors do not by the reason only of their position as directors own any duty to creditors or the trustees for creditors of the company. How they act at the onset of solvency decides the extent of their personal liability through their decisions. According to the Companies Act section 282 the court may appoint directors as special managers to help the liquidator especially in voluntary winding up.

The responsibilities of directors during company liquidation have to be managed sensitively. Failure to follow the stipulated way can lead to accusations of unlawful or wrongful trading down the line. This can lead to a penalty, disqualification of a director or personal liability for part of the debts of the company. Once the company becomes insolvent, it has to cease operations immediately and ensure safeguarding of assets for the creditors’ interests (Goode & Royston, 2011). It is important for directors to act responsibly at the moment they realize that the company is sliding into insolvency for the purpose of avoiding the personal liability threat. A company’s director that is wound up due to insolvency can be personally liable for part of its debts as adjudged by the court if the case of wrongful trading is established. The House of Lords in the case of Winkworth vs. Edward Baron Development Co Ltd [1987] the directors owe the company and its creditors a duty to make sure that the company’s affairs are administered properly and that its property is not exploited or dissipated for the benefit of directors themselves at the disadvantage of the creditors.

Application

Tasia and Gracie acted in their own interest when carrying out their role as directors. Gracie was taken ill and did not take part in decision-making while abroad. Tasia did not do anything even after sensing the company was at the verge of insolvency (Marshall & Ian, 2012). Instead Tasia purchased a new refrigeration system and a tandoori stove with the aim of enhancing business. Upon her return and realizing that the company could be liquidated, Gracie suggested forming a new company and cease trading on the old name. There were all signs that Neptune’s Prize Seafood Restaurant Pty Ltd was in the verge of insolvency considering the huge unpaid tax liability, banks refusing to give credit, suppliers demanding payment upon delivery and several court summons being issued (Olivares-Caminal, Rodrigo, et al, 2011). Tasia should have conducted Gracie and immediately ceased trading upon sensing signs of insolvency.

Unfortunately Tasia acquired the ne refrigeration system and stove at cost of $100,000. They could have conducted the services of a liquidator to help them in wounding up in order to avoid personal liability as directors. Instead they changed the name of the company, formed a new company called Neptune’s Triumph Seafood Restaurant Pty Ltd and Neptune’s Prize Seafood Restaurant Pty Ltd ceased to trade. The new company took over the assets of the old company and did not pay anything for plant and equipment or goodwill. There is no effort to secure the assets of the Neptune’s Prize Seafood Restaurant Pty Ltd for the interests of the creditors (Goode & Royston, 2011).
The directors considered their own interests as main shareholders in their own company.

Conclusion

The directors are personally liable for the debts incurred by Neptune’s Prize Seafood Restaurant Pty Ltd and their personal property can be seized to recover the debts. The assets owned by the old company (Neptune’s Prize Seafood Restaurant Pty Ltd) should have been liquidated to pay creditors.

Transferring Poseidon’s Prize Seafood Restaurant Pty Ltd business and assets to the new company for not consideration is wrong and the directors are liable for their actions and have to be sued for recover of these assets.

Question 2

Introduction

Phoenix activity happens where the business of a company that is failed is transferred to a second company (often newly incorporated) and the second controllers of the company are the same as the controllers of the first company. Phoenix activity could be both illegal as well as legal. Phoenix activity becomes illegal where the intention of the controllers is to shift the assets to the successor company from the predecessor company in order to avoid liabilities like employee entitlements, unsecured debt, taxes, adverse court fines and judgments (Anderson, 2015). Illegal phoenix activity has adverse and unfair consequences. The employees lose entitlements and wages, and creditors are left in debt. Most of the creditors are small businesses. Further, there are unpaid tax liabilities which have a detrimental effect on tax revenue. Illegal phoenix activity is prevalent since it is largely invisible, quick to accomplish and usually very profitable (Marshall & Ian, 2012). There is need for current laws concerning illegal phoenix activity to be changed to avoid directors getting away with mischief and harm they do to creditors, employers and the government. This paper discusses the need for current laws concerning illegal phoenix activity being changed to encourage transparent and deter creditors, government losing money and employee entitlements.

Discussion

Illegal phoenix activity if left unchecked has the capacity to undermine revenue base of Australia as well as competitive level playing field. It is not right for legal business operators to be driven out of business by those directors engaging in illegal phoenix activity. A legal environment that discourages fraudsters has to be created to enhance trust in business dealings. Minimizing business distrust due to harmful phoenix activity can bring down the cost of finance as well as make it more prevalently available. When less tax revenue is fraudulently avoided, the society and economy gain (Anderson, 2015). When the number of employee entitlements lost due to harmful phoenix activity is reduced, there is less reliance on Fair Entitlements Guarantee hence availing government resources for other investments.

It is important to make sure that those people engaging in illegal phoenix activity have to be punished severely to avoid recurrence. It is very essential to detect all phoenix activity by requiring the directors to have identification numbers which should be visible to the public and make incorporation of new companies more transparent. Increasing the penalties for failing to assist and inform liquidators will deter harmful illegal activity. There must be heavy penalties prescribed for directors who are found guilty of engaging in illegal phoenix activity (Welsh & Anderson, 2016). Disqualification of directors who engage in illegal phoenix activity from holding public office will deter the practice of fraudulent phoenix activity.

New laws have to make phoenix activity not easy to accomplish. One weakness in regulation to deter and prevent illegal phoenix activity it is not easy to determine the intentions of the controllers. Some of the directors form new companies just to leave unpaid creditors behind. Business entry, transfer and exit regulation have to consider both the inept serial entrepreneurs as well as illegal phoenix operators that are deliberate (Anderson, 2015). Changes to Corporations Act and Taxation Act have to impose heavy penalty on the fraudulent directors. In the current Corporation Act there is no specific provision which makes phoenix activity illegal. Nevertheless, directors face severe consequences if they are involved in fraudulent phoenix activity that breaches sections 183 and 180 inclusive of the Act (Australian Government 2009). The Australian experience concerning phoenix activity can be referred to as war of attrition against phoenix activity as opposed to ultimate deterrent.

The government has tried to launch legislative attacks against the practice of phoenix activity. Phoenix activity is simply evasion of tax and other liabilities like employee entitlements using deliberate systematic and cyclic liquidation of associated corporate trading entities. It is not good to allow unscrupulous directors to continue trading on using the new companies while creditors are left grappling with debts and employees’ entitlements are lost. The laws need to be changed to nab the fraudulent directors from continuing business operations before dealing with the mess they left behind in the old company (Anderson, 2015). It is of great essence to make phoenix activity easily detectable to avoid creditors, employees and government being caught unawares.

Conclusion

Illegal phoenix activity has with no doubt left many creditors languishing in deep credit troubles while employee entitlements are lost. The government loses revenue due to fraudulent phoenix activity that is meant to leave the creditors behind. The current laws leave many loopholes that allow fraudulent directors to get away with atrocities that they commit in the other peoples’ livelihood. If something is not done, the government, creditors and employees will continue to lose what is owed to them due to fraudulent phoenix activity. In many circumstances unscrupulous directors engage in phoenix activity with the aim of leaving behind the debts owed to credits, avoid tax and escape employee entitlement. The current laws are not sufficient enough to deal with illegal phoenix activity and have been described as war of attrition that can only realize very little positive result. Heavy penalties for directors found engaging in harmful phoenix activity will help in deterring fraudulent directors. It is high time that the government implemented the proposed new laws to help mitigate the plight of the creditors and employees who are left stranded after an illegal phoenix activity orchestrated by fraudulent directors. It is not good for innocent people to suffer for the selfish interest of the fraudulent directors.

References

Australian Government (Treasury), Action against Fraudulent Phoenix Activity: Proposals Paper, 2009, p2 at 1.1.2.

Anderson Helen, ‘Phoenix Activity – A Context not a Crime’ (2015) 27(2) Australian Insolvency Journal 35.

Goode, Roy, and Royston Miles Goode. Principles of corporate insolvency law. Sweet & Maxwell, 2011.

Olivares-Caminal, Rodrigo, et al. «Debt restructuring.» Business Law Review 8.9 (2011): 228.

Welsh Michelle and Anderson Helen, ‘The Public Enforcement of Sanctions against Illegal Phoenix Activity: Scope, Rationale and Reform’ (2016) 44 Federal Law Review 201.

Winkworth v Edward Baron Development Co Ltd [1987] 1 All ER 114,

Walker v Wimborne (1975) 137 CLR 1

Marshall, Shelley D., and Ian Ramsay. «Stakeholders and directors’ duties: Law, theory and evidence.» (2012).