Lack of rules and data about phoenix activity compounds the problem: Research

Government agencies should continue to devote resources to tackling phoenix activity, according to research from the University of Melbourne Law School that has attempted to quantify just how widespread the practice is.

Phoenix activity occurs when a company is liquidated and rises again in a way that avoids paying debts owed to creditors.

While not all phoenix activity is illegal, the latest report from the Phoenix Research Team, made up of researchers from both Melbourne and Monash University, highlights the difficulties in accurately estimating the cost to the Australian economy of phoenix operators.

Part of the reason why there are gaps and inconsistencies in the available data is because there is no specific offence for phoenix activity under Australian law.

 According to the researchers this means “there is not, nor can there be, any accurate quantification of the incidence, cost or enforcement of illegal phoenix activity in Australia”.

But the researchers said the data that is available shows phoenix activity is causing “considerable difficulties for creditors, regulators and competitors”.

“This justifies the commitment of government time and resources to attempt to minimise its impacts,” the team said.

What the data shows

The research paper collates what data is available from a number of government agencies to attempt to create a picture of Australian phoenix activity.

For the 2013-14 financial year, 9822 Australian companies entered into a form of external administration, according to data from the Australian Securities and Investments Commission.

This led the researchers to conclude no more than 9822 companies in that timeframe could have entered liquidation as a means of carrying of illegal phoenix activity.

Of this group, the industry with the most firms entering external administration, but not necessarily involved in illegal phoenix activity, was “business and personal services” with 3124 administrations.

This was followed by 1802 administrations in the construction industry and 819 companies entering external administration in the accommodation and food services sector.

However, the researchers note a “substantial number” of companies remain dormant without entering external administration and some of these firms could become “a haven” for illegal phoenix activity.

“The Phoenix Research Team believes that they outnumber liquidated companies 10 to one,” the researchers said.

While the researchers said the Australian Tax Office does not generally provide statistics about the prevalence of illegal phoenix activity, in its most recent annual report, the ATO said 6223 companies were identified in the top five risk industries “for the potential to conduct illegal phoenix activity”.

External administration reports can also give some indication of suspected misconduct, although this misconduct is not necessarily linked to phoenix activity.

Between 2011 and 2014, misconduct by company directors was alleged in 28,787 reports, totalling 52,644 possible breaches.

The ATO has previously estimated illegal phoenix activity could be costing the Australian economy as much as $3.2 billion a year in lost tax revenue, as well as money owed to creditors and employees.

According to the researchers, the ATO has also previously indicated it believes large numbers of phoenix companies operate in the micro market – firms with under $2 million in annual turnover – as well as in the SME market of businesses with between $2 million and $250 million in turnover.

As of August 2014, ATO data provided to the researchers indicates 19,714 candidate and confirmed phoenix groups could be operating in Australia, which is made up of 335,837 individual business entities.

These groups are mostly likely to come from the financial assets investing industry, following by the auxiliary finance and investment services industry.

How to protect your business from phoenix activity

Patrick Coghlan, commercial director at CreditorWatch told SmartCompany there are key steps a small business should do to protect itself against losing money to phoenix operators.

“Running a credit report is something you should be doing for any new customer you are dealing with,” Coghlan says.

Coghlan says this is particularly the case if the dealings with a particular customer represent a sizeable chunk of your business’ credit limit.

“If you can shoulder it, that’s fine, but if not you should really be doing your due diligence,” he says. 

Once a credit report has been done, Coghlan recommends small business owners carefully consider the directors of the company and check to see if they have any cross directorships that may connect them with a failed company.

“Look at the age of the company and its registration date, especially if it is less than 12 months old. The younger a company, the more likely it is to default or go under.”

Coghlan says if the company has been operating for some time, it may also be possible to get trade references from within the industry. In some cases, accounts receivable personnel may also be able to speak to their counterparts at other firms if there are any concerns.

Other warning signs may be previous histories of defaults or court judgements against the company, Coghlan says.