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Illegal phoenix activity has recently come under intense scrutiny from ASIC, with directors being exposed to expanded liabilities and harsh penalties.

What is Illegal Phoenix Activity?

From time to time, businesses fail purely out of bad luck, despite being responsibly managed. After liquidation, directors are within their rights to continue in business using another corporate entity. What is not acceptable, however, is acting against the interests of the failing company, including using or moving its assets – e.g. goodwill, branding, phone and website, as well as cash or physical assets – to help ‘breathe life’ into a new company, leaving the failed company unable to satisfy the debts owed to employees, creditors and the tax office.

Illegal phoenix activity commonly involves the following characteristics:

• A company is unable to pay its debts or otherwise satisfy its obligations;

• A new company commences, usually within 12 months, with the same or similar management and business;

• Some or all of the assets from the failing company transfer to the new company and unsecured creditors are denied access to the assets;

• The new company employs staff that had previously been terminated from the failed company.

The role of ASIC

ASIC may take administrative action to wind up abandoned companies and it has a surveillance campaign and funding to investigate illegal phoenix activity. Where phoenix activity is detected, ASIC may take action against parties involved, including legal, accounting or other advisors involved in facilitating the illegal activities.

Consequences for Directors

In small to medium enterprises, it is common to find directors with little understanding of the obligations imposed by the law vis-à-vis “their” company. As usual, ignorance of the law is no excuse. The company is a distinctly separate legal entity from the director, and the director owes duties to act in its interest, distinct from his/her own interests. Where the company is ‘flirting’ with insolvency, the interests of creditors cannot be disregarded. If directors disadvantage a failing company to benefit a new company or themselves they may be disqualified from managing corporations for an extended period of time.

Consequences for Advisors

Advisors who, with knowledge of the relevant facts, advise on or recommend a transaction which contravenes the Corporations Act 2001 may be held to have aided and abetted the transaction, thereby breaching their statutory duties.

There are lawful and effective ways to restructure, however, many advisors do not have the expertise to step a client (and themselves) through this ‘mine-field’ unscathed. We do.

For further information about solvency issues, structuring for asset protection, or director duties, please contact:

Ben Warren – Director

M: 0402 003 364
E: bwarren@ellemwarren.com.au

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There are two main reasons why most business owners are advised, quite rightly, to trade with a company structure:

1. The flat company tax rate; and
2. The separation of trading risks from the owners and directors personally.

For many years, there have been some limited exceptions to the separation of corporate liability from director’s personal liability and we have another article on this topic. In a negligence case, this separation of liability was summarised at a Supreme Court level in the following terms:

“[i]t will not ordinarily be the case that directors, even of “small one man companies”, will assume personal responsibility to a customer with whom they transact business on behalf of the company. The ordinary expectation … is that the company, not the individual, assumes responsibility for the consequences of not effecting the transaction with reasonable care.”

This separation has been a corner-stone of Australian corporate life for decades.

QCAT: Directors of Small Builders

However, according to a QCAT decision of Member Aaron Suthers made recently, and relying on some New Zealand cases , directors of smaller building companies can and frequently will be exposed to personal liability for negligence. Member Suthers pointed to the following factors:

• The director, Mr Wagner was primarily involved in negotiating the terms of the build contract with the owners and prepared the contract;

• The owners signed the contract without first obtaining legal advice;

• The “Builder” in the contract was the building company but the director signed it “without clarifying that he did so in his capacity as a director”;

• The director organised the house plans;

• The director was directly responsible for some of the building work.

According to Member Suthers, this was sufficient to cause for Mr Wagner to assume personal “responsibility to the [owners] to take reasonable care to avoid causing them loss through defective building work.” In our respectful view, Member Suthers has misapplied the relevant principles in this case. We hope the decision is appealed. Otherwise, it sets a disturbing precedent, where the ‘duty of care’ owed by a company contracting to perform building work can too easily be imposed also on its director(s) personally.

Previously, personal liability for negligence while agent or employee for a company was limited to well-established circumstances where the individual clearly owed a personal duty of care: e.g. negligent driving; negligent advice from a professional advisor.

Legal Minefield

Operating as a small or medium builder is difficult enough. There are industry specific licensing and insurance requirements and industry specific ‘watch dog’ regulators , industry specific ATO payment reporting obligations , consumer-friendly legislation in the domestic building context , and recent changes to the notorious Building and Construction Payments legislation.

For assistance with any aspect of the legal ‘mine field’ affecting the construction industry, please contact:

Ben Warren – Director

M: 0402 003 364
E: bwarren@ellemwarren.com.au

Richard Ellem – Director

M: 0403 464 875
E: rellem@ellemwarren.com.au

© December 2014

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With housing affordability at historic lows, high-density residential and mixed-use developments are an increasingly common investment vehicle for home buyers, and individual and corporate investors alike.

With the complexity of laws governing the ‘community titles schemes’, it is important that buyers understand their rights and obligations.

In particular, working out who should pay for maintenance or repairs is a common source of dispute, and may fall on the body corporate or an individual owner.

As the body corporate is comprised of all current lot owners, this is essentially a question of whether costs are borne by one owner or all the owners.

Body Corporate Duty: Maintenance and Repairs

Among other obligations, the body corporate is responsible for the administration of common property. This includes a duty to keep common property in ‘good condition’.

What is ‘Common Property’?

Land and facilities, which are part of the scheme but not part of any individual lot is referred to as ‘common property’. Common property is owned by all the lot owners together.

Facilities like gardens, lawns, walkways, parking areas, and pools are normally common property. In the case of subdivided buildings, such as apartment complexes, the body corporate is also responsible for external walls, railings, windows, and roofing membranes (waterproofing).

As the body corporate is only responsible for maintaining common property, determining whether something is part of the common property or an individual lot determines who is responsible for maintenance or repairs.

This is not always obvious. It can be an involved process and usually requires examination of the scheme plan held on record by the Titles Registry.

Nature of the Obligation

Bodies corporate must maintain common property in ‘good condition’ or, for structural elements (foundations, load-bearing walls, and roofs), in ‘structurally sound condition’. This is not optional: a body corporate does not have discretion to ‘opt out’ of its obligations.

Although the term ‘maintain’ is used, courts consider this to include repairs and, in some circumstances, replacement of damaged property.

There are situations where a failure to perform necessary repairs to common property results in damage to individual lots. Common examples include water damage caused by leaking roofs or insufficient drainage. Depending on the circumstances, bodies corporate may be accountable for damage to individual lots, which would likely exceed the cost of initial repairs.

Water, Electricity and Other Services

Water and electricity supplies, telephone services and drainage are considered part of the common property. Responsibility to maintain or replace damaged infrastructure would normally fall to the body corporate.

However, it is important to note some utilities installed for the occupier’s sole benefit do not form part of the common property; the body corporate will not be responsible for infrastructure that:
• supplies a utility service to only one lot;
• is within the boundaries of a lot; and
• is not within a boundary structure for the lot.

Common examples include hot water systems or air conditioning units installed by the owner. If this is the case, the owner of that lot is liable for its maintenance and repair.

Shared Obligations

Under a community titles scheme, lot owners are in an unusual situation where the body corporate may be obliged to organise and remit payment for repairs, but with each lot owner liable to foot a proportion of the repair cost.

Calculation of payment will be determined by reference to the interest schedule lot entitlement, which determines a lot owner’s share of amount levied by the body corporate. By comparison, any long-term replacements or renovations like painting or carpeting are financed by the Sinking Fund.

It should be noted that individual lot owners also have an obligation to contact the body corporate upon becoming aware of the need for repairs.

Failure to Act: Enforcing Obligations

If a body corporate repeatedly fails to look after common property or owners’ interests and assets, owners can enforce the obligation, if necessary, with assistance of the Office of the Commissioner.

If the matter proceeds to litigation, bodies corporate may be liable to lot owners for any expenditure incurred as a result of the body corporate ignoring its statutory duty to maintain the common property. Lot owners may also be able to obtain damages resulting from economic loss, costs of repair and legal costs, under common law.

Conclusion

It is vital that bodies corporate are aware, and understand the gravity, of their statutory obligations to repair and maintain common property. Damage caused as a result of a failure to fulfil these obligations will incur serious liability.

Bodies corporate should employ strict strategies to avoid preventable liability, particularly by regular distribution of information to all lot owners and investors, including details such as the following:
• Identification of the difference between common property and individual lots;
• Body corporate obligations; and
• Lot owners’ responsibilities.
It is also important to obtain a copy of the registered plan from the Department of Natural Resources and Mines to properly understand the boundaries of common property and individual lots within the community title scheme.

For further information about community titles schemes, and the obligations of bodies corporate and lot owners, please contact:

Ben Warren – Director

M: 0402 003364
E: bwarren@ellemwarren.com.au

Richard Ellem – Director

M: 0403 464 875
E: rellem@ellemwarren.com.au

© October 2014

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On 10 April 2014, The Treasury released an Exposure Draft of legislation which proposes further changes to the rules governing payment of share dividends.
Under the proposed amendments, the payment of dividends would be exempted from the share capital reduction rules in the Corporations Act 2001, increasing the flexibility of companies to pay dividends.

Current Requirements
Section 254T of the Act controls the circumstances in which dividends may be paid by a company, and has been the subject of reform on several occasions in recent years. It originally provided that dividends could only be paid out of profits (‘profits test’). The current ‘net assets test’ came into effect in June 2010.
In its current form, the legislation provides that dividends may only be paid where:

1. Assets of the company exceed its liabilities and, immediately before the dividend is declared, the excess amount is sufficient for the payment of the dividend;
2. Payment of the dividend is ‘fair and reasonable’ to company shareholders as a whole; and
3. Payment does not materially prejudice the company’s ability to pay its creditors, particularly where payment of the dividend would cause the company to become insolvent.

Practical Difficulties with ‘Net Assets’
In November 2011, The Treasury released a Discussion Paper considering the effectiveness of then recently-implemented ‘net assets test’. It identifies a number of prevailing concerns with the current approach.
Most significantly, it identifies the ‘assets greater than liabilities’ requirement as being problematic for businesses, often proving to be both an inaccurate measure of solvency and placing an unreasonable compliance burden on smaller companies.

Overview of Proposed Amendments

Amendments proposed in the draft Bill would adopt key recommendations of the 2011 Treasury Discussion Paper, including replacement of the existing ‘net assets test’ with a ‘solvency test’. The new test provides that directors of a company may pay a dividend if they reasonably believe the company will remain solvent if a dividend is paid. The proposed test would also discard the requirement for company directors to consider whether payment of a dividend is ‘fair and reasonable’ to shareholders. Overall, the test is simpler, although a director must still exercise caution when considering solvency issues.

Position Clarified – Paying Dividends from Capital

The draft Bill would also clarify whether payment of dividends otherwise than out of profits is a capital reduction which requires shareholder approval in accordance with Chapter 2J of the Corporations Act 2001.

Though it is debateable whether the legislation raises significant questions in this respect, the proposed amendments resolve any potential ambiguity by inserting a new section 254TA which expressly provides for the reduction of share capital by payment of a dividend, in most circumstances without the need for shareholder approval.

Tax Implications for Investors

According to the explanatory material accompanying the Exposure Draft, the proposed amendments are not intended to affect tax implications for investors. Share capital reduction by way of dividend payments to shareholders will generally be classified as a return of share capital to the shareholder rather than a ‘dividend’ and therefore would be taxed under capital gains provisions.

Seek professional advice from accounting professionals for advice on this topic.

Conclusion

The consultation period concluded on 16 May 2014, with Treasury receiving a total of 19 submissions.

By and large, those making submissions are in favour of the simplified solvency test proposed for s 245T dividend provisions, including a number of major industry and interest groups, notably the Australian Institute of Company Directors (AICD), Governance Institute of Australia (GIA) and Australian Shareholder’s Association (ASA). It appears there is limited support for the proposed s 254TA, particularly among financial services industry sector groups.

If the proposed amendments become law, companies will be empowered pay dividends more freely, providing added flexibility in their dealings.

In light of this, company directors may want to consider reviewing dividend payment provisions of their constitutions and/or shareholder agreements to take full advantage of diminished restrictions.

For further information about directors’ duties, corporate governance, corporate restructuring, or similar topics, please contact:

Richard Ellem – Director

M:          0403 464 875

E:           rellem@ellemwarren.com.au

Ben Warren – Director

M:          0402 003 364

E:           bwarren@ellemwarren.com.au