Clipping the phoenix's wings

By Karen O'Flynn.

Key Points:
The Tax Office has employed a new tactic against phoenix companies. Companies with dubious commercial histories may be wound up even though they're trading profitably.

The Australian Tax Office is using an innovative legal weapon against phoenix companies. This tactic may prevent the transfer of assets out of a company, by having it wound up while still solvent.

It's possible that the same device could be used by other creditors, such as statutory authorities, banks or trade creditors.

A big history

Casualife Furniture International's advertising boasted of its "big history" as a "family company" that had been supplying customers "for almost 20 years".

In fact, Casualife was the latest in a series of companies through which members of the Guss family had conducted their furniture business. The business pattern could have been taken out of a textbook on phoenix companies: a company would run up tax debts but, before it could pay those debts, the business would be transferred to another company. The new company would run up tax debts, and …

The ATO apparently lost patience with the Gusses. In 2001, the latest company in the chain (Casualife) had run up tax debts. This time, the ATO decided to get in first. It applied to have Casualife wound up while it was still a going concern.

Despite its tax debts, Casualife was apparently trading profitably. That meant that the ATO couldn't apply for winding up on the grounds of insolvency. So it decided to make legal history by using a different section of the Corporations Act. That section allows a company to be wound up if it is "just and equitable". With a few exceptions, the "just and equitable" ground has tended to be used to resolve disputes between shareholders (typically, one shareholder will claim to be so badly treated by other shareholders that the only solution is to wind up the company).

The ATO argued that it would be "just and equitable" to wind up the solvent Casualife because:

• the ATO lacked confidence in the conduct and management of the company and the furniture business conducted by the company;
• fairness required that the company be wound up; and
• it would be conductive to commercial morality and in the public interest to wind-up the company:
  (i) so that the affairs of the company could be wound-up and brought under the control of a liquidator; and
  (ii) so that further commercial immorality could be prevented.

Commercial immorality

The court described the Gusses' approach to tax as being almost like a game played with the Tax Office. That gamesmanship didn't stop once the ATO launched its case. A few weeks after the ATO began legal proceedings, Casualife paid its tax bill. It then claimed that it should not be wound up, because:

• the ATO was no longer a creditor;
• the company was solvent (and had a number of employees); and
• there was no reason to doubt that the company would meet its tax obligations in future.

Arguments in the case finished in March 2003. In May this year, the court decided that Casualife should be wound up:

"[T]he Deputy Commissioner's lack of confidence in the conduct and management of the defendants is justified having regard to the history of the furniture business conducted by the Guss family. The history discloses a disdain for the obligation to pay tax and commercial morality in the conduct of a business. The Deputy Commissioner's lack of confidence in the defendants' likely observance of their taxation obligations is well justified in the circumstances. For that reason and also because it would be fair to do so, it is appropriate to order winding up. If the defendant companies were not wound up they would continue operating in the public domain under the same Guss control who would, I find, continue to engage by these entities in the same type of impugned conduct. I am also of the view that it is in the public interest and conducive to commercial morality that the companies be wound up, both to prevent the perpetration of further commercial immorality and for the benefit of having the companies under the control of a liquidator."

Implications

This is a groundbreaking case. Potentially, it is the greatest blow that phoenix companies have ever suffered.

There is no doubt that Casualife was an extreme case (which probably explains why the ATO chose it to test this new remedy). Nevertheless, it can be expected that the ATO has a number of phoenix companies on its records which would be almost equally susceptible to a "just and equitable" winding up application. It will be interesting to see if this is the start of a series of similar cases.

The decision has implications for other creditors, too.

Government authorities (revenue, workers compensation, etc) would have detailed records on phoenix companies that go back many years, and so would be in a similar position to the ATO. Trade unions and banks would also be in a position to identify phoenix companies.

Trade creditors would be less likely to have the detailed historical records necessary to show a repeated pattern of phoenix activity. However, this decision merely opens the doors to "just and equitable" applications; it doesn't set any boundaries or limits, so it is quite possible that even less blatant activities than Casualife's may result in a court's ordering a winding up.

Even if trade creditors aren't in a position to initiate a "just and equitable" application, they will enjoy some benefits from the ATO's new power. Putting a liquidator into a company before it has its assets stripped would increase the chance of there being a pool of money available to pay all creditors.

For further information, please contact Karen O'Flynn.