It has been reported that the Australian Securities and Investments Commission, Australian Tax Office and Fair Work Building and Construction have recently begun cooperating to crack down on builders liquidating their companies to avoid repaying creditors including the Tax Office, employees, and contractors. In particular, the Tax Office is compiling evidence given to it by a number of large construction firms for the purpose of determining whether criminal charges should be laid against directors who instigate phoenixing activity.
By way of background, a company is typically an entity whose owners (the shareholders) have what is called ‘limited liability’. This means that a given shareholder or director is not personally liable for any of the debts of the company, other than for the unpaid value of his or her investment in that company.
For example, let’s say that there existed a company that had $10 million in debts and no assets. A director of that company holds one share and has $5 million in personal assets including a yacht and a few million dollars in spare cash under his sofa. If the company were to be wound up, the director / shareholder would only be legally liable for any unpaid portion of the amount he invested in the company (which could be as little as $1) and not his yacht or cash. The legal protection offered to the above shareholder and director to prevent company creditors from touching his personal assets is referred to as the corporate veil.
Not surprisingly, the corporate veil can easily be manipulated at the expense of legitimate creditors. One instance of this is companies engaging in ‘phoenixing’ behaviour. Phoenixing involves a company being deliberately wound up to avoid the payment of debts. In its place, a new company is founded which performs substantially the same services with a clean slate. That new company, in a sense, ‘rises from the ashes’ of the wound-up company. It would be reasonable to say that the phenomenon of company phoenixing (using $2 companies in particular) is one of the most infamous abuses of the corporate veil ever devised.
There are very limited circumstances where the corporate veil can be pierced. The two most likely scenarios are breaches of directors’ duties and insolvent trading. However, neither scenario is particularly helpful in the context of building defects. Firstly, it is highly unlikely that a court would accept that a director of a company which engaged in defective building work is in breach of his or her directors’ duties. Secondly, even if a director is found to have engaged in insolvent trading, creditors still need to prove their loss and damage and then stand together with all the other creditors to recover that loss and damage.
Given that phoenixing is rife in the construction industry, it appears to be a belated response. As we reported in March this year, there have been previous attempts by the Commonwealth Government to discourage such behaviour legislatively.
However, it may be premature to celebrate if you are a long suffering owners corporation or lot owner whose building is riddled with defects. Even if the Tax Office gets its hands on those directors, it will be for the purpose of either putting them in jail or to reclaim unpaid tax debts and superannuation. That is, after the Tax Office, the employees and contractors have taken their cut, there may be no meat left on the metaphorical carcass to pick, nor does the Tax Office care. Therefore, this crackdown, as noble as it sounds, will not assist those owners corporations which suffer from building defects.
Authors: Christopher Kerin & James Qian