Crypto winter is here – what does it mean for insolvency practitioners?

The global market in crypto assets is currently experiencing a “crypto winter”, losing approximately US$2 trillion in value since the peak rally in 2021.[1] The price of Bitcoin has retreated approximately 70% from its November 2021 high of nearly US$69,000. In this stormy environment crypto insolvencies are on the rise.

However the rapidly evolving nature of the crypto industry and the complex nature of crypto assets and transactions present unique challenges for insolvency practitioners (IPs) seeking to resolve or restructure crypto firms.

In this note we explore the current crypto winter, and some of the specific issues that arise in respect of insolvencies of crypto firms. In particular, we address:

  • what is causing financial distress to crypto firms, and why we can expect more insolvencies in this space;
  • why crypto assets are relevant in insolvency processes;
  • the challenges in securing and recovering crypto assets; and
  • issues with realising crypto assets.

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Dousing the phoenix – an initial decision on Australia’s creditor defeating dispositions regime

The first case has been decided under Australia’s statutory powers to set aside “creditor defeating dispositions”. 

In IntelliComms Pty Ltd (in liq) [2022] VSC 228 Associate Justice Gardiner of the Victorian Supreme Court considered a transaction involving a business sale agreement entered into minutes before Intellicomms Pty Ltd (Intellicomms) passed a resolution to enter into voluntary liquidation. The sale, to an entity controlled by the sister of Intellicomms’ sole director, was for approximately $20,000 (significantly less than the amount a creditor was willing to pay to acquire the business).

Associate Justice Gardiner described the transaction as featuring “all the hallmarks of a classic phoenix transaction”, and made orders setting the business sale agreement aside as a “creditor-defeating disposition” pursuant to section sections 588FDB(1) and 588FE(6B) of the Corporations Act 2001 (Cth) (Corporations Act).[1]

In this article we provide a recap on the creditor defeating dispositions regime, a summary of this initial decision and some comments on potential implications going forwards.

Creditor defeating dispositions and “illegal phoenixing”

The creditor defeating disposition provisions were introduced into the Corporations Act by way of the Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2019 (Cth) (the Phoenixing Act).

So called ‘illegal phoenixing’ was one of the key focusses of this legislative reform. The practice of has been described by ASIC as occurring when: [2]

…a new company, for little or no value, continues the business of an existing company that has been liquidated or otherwise abandoned to avoid paying outstanding debts, which can include taxes, creditors and employee entitlements.

Addressing Illegal phoenixing was one of the key objectives of insolvency law reform introduced by the Turnbull Government.[3] In 2014, the Government established the ‘Phoenix Taskforce’ to detect, deter and disrupt illegal phoenixing,[4] a practice the government estimated to be costing the economy up to $3.2 billion per year.[5] Illegal phoenixing was also a key focus of the Senate’s 2015 inquiry into insolvency in the construction industry.[6]

What is a creditor defeating disposition

A creditor defeating disposition is a new category of voidable transaction under the Corporations Act, that can potentially be set aside upon the liquidation of a company.

A creditor defeating disposition is defined in section 588FDB(1), which provides:

  1. a disposition of property of a company is a creditor defeating disposition if:
    1. the consideration payable to the company for the disposition was less than the lesser of the following at the time the relevant agreement (as defined in section 9) for the disposition was made or, if there was no such agreement, at the time of the disposition:
      1. the market value of the property;
      2. the best price that was reasonably obtainable for the property, having regard to the circumstances existing at that time; and
    2. the disposition had the effect of:
      1. preventing the property from becoming available for the benefit of the company’s creditors in the winding-up of the company; or
      2. hindering, or significantly delaying, the process of making the property available for the benefit of the company’s creditors in the winding-up of the company.

The concept is further expanded under section 588FDB(2) and (3).

Section 588FE(6B) provides where a creditor defeating disposition is voidable if:

    1. it is a creditor-defeating disposition of property of the company; and
    2. at least one of the following applies:
      1. the transaction was entered into, or an act was done for the purposes of giving effect to it, when the company was insolvent, during the 12 months ending on the relation-back day or both after that day and on or before the day when the winding up began;
      2. the company became insolvent because of the transaction or an act done for the purposes of giving effect to the transaction during the 12 months ending on the relation-back day or both after that day and on or before the day when the winding up began;
      3. less than 12 months after the transaction or an act done for the purposes of giving effect to the transaction, the start of an external administration (as defined in Schedule 2) of the company occurs as a direct or indirect result of the transaction or act; and
    3. the transaction, or the act done for the purpose of giving effect to it, was not entered into, or done:
      1. under a compromise or arrangement approved by a Court under section 411; or
      2. under a deed of company arrangement executed by the company; or
      3. by an administrator of the company; or
      4. by a restructuring practitioner for the company; or
      5. under a restructuring plan made by the company; or
      6. by a liquidator of the company; or
      7. by a provisional liquidator of the company.

Where a Court is satisfied that a transaction is voidable under section 588FE, it can make a variety of orders under section 588FF (generally with the intent of setting the transaction aside), subject to the “good faith” and other defences in section 588FG.

However, unlike other voidable transactions, in the case of creditor defeating dispositions, the Australian Securities and Investment Commission (ASIC) may also make an order setting aside a creditor defeating disposition (without the involvement of the Court) under section 588FGAA.

The Phoenixing Act also contains prohibitions (and related offences) in respect of:

  • an officer of a company engaging in conduct that results in the company making a creditor-defeating disposition;[7] and
  • a person engaging in conduct of procuring, inciting, inducing or encouraging the making of a creditor-defeating disposition.[8]

Despite the potentially broad application of the creditor defeating disposition provisions,[9] the reforms largely flew under the radar upon the Phoenixing Act receiving royal assent on 17 February 2020, and have not seen any judicial examination until this decision.

Background to the decision

Intellicomms operated a business providing digital translation services under the trading name “Ezispeak”[10]. One of its key suppliers and creditors was QPC, a shareholder of Intellicomms which also provided the company with the software it used to provide translation services.[11]

In 2021, QPC and Intellicomms were discussing avenues to reduce Intellicomms’ debts to QPC, including the issue of further shares to QPC. However negotiations broke down, and QPC served a statutory demand on 17 August 2021, claiming $923,310.18 for unpaid invoices.[12]

On 8 September 2021, one day before the statutory demand for this undisputed debt owed to QPC was to expire, Intellicomms called a shareholder meeting for the purpose of passing a resolution that the company be wound up. QPC was given only 2 days’ notice of the vote, but voted in favour of the resolution. Intellicomms was accordingly placed into creditors’ voluntary liquidation.

It subsequently came to light that Intellicomms had entered into a business sale agreement only minutes before this meeting. Without informing QPC, Intellicomms’ assets were assigned to Tecnologie Fluenti Pty Ltd (TF) – an entity controlled by the sister of Intellicomms’ sole director – for a net purchase price of approximately $20,000.[13]

Liquidator’s challenge

Upon learning of the sale agreement QPC indicated to the liquidators it would be willing to participate in any sale process for the assets of Intellicom (on the assumption that the business sale agreement was set aside). QPC wrote to the liquidators stating that, subject to contract, board approval and identification of assets available to purchase, QPRC’s indicative purchase price for Intellicoms was between $500,000 and $1,000,000.[14]

QPC agreed to fund the liquidators to make an application to set aside the business sale agreement as a creditor defeating disposition. The application was made by the liquidators for the Court to set aside the transaction pursuant to section 588FE, rather than an order made by ASIC under section 588FGAA.

Timing, solvency and effect of disposition

The business sale agreement was entered into the date before Intellicoms entered into voluntary liquidation, and therefore the disposition clearly occurred within the timeframes required for under section 588FE(6B), and the proceeding was commenced within the 3 year timeframe required under section 588FF(3).

Furthermore, it was admitted by TF that the business sale agreement:

  • prevented the property from becoming available for the benefit of Intellicom’s creditors (for the purposes of section 588FDB(1)(b); and
  • was entered into when Intellicom was insolvent (for the purposes of section 588FE(6B)(b)).

Accordingly, the key question in the case was whether the requirements of section 588FDB(1)(a) were satisfied.

Was the disposition for less than market value or the best price reasonably obtainable?

As noted above, section 588FDB(1)(a) requires that (for a transaction to be a creditor defeating disposition) the consideration received by the company in respect of the disposal of the company’s property be less than its market value or the best price reasonably obtainable.

The Explanatory Memorandum to the Phoenixing Act described the market value as the price that would be paid in a hypothetical transaction between a knowledgeable and willing, but not anxious seller and a knowledgeable and willing, but not anxious buyer, who transact at arm’s length).

The test is applied at the time of the relevant agreement for the disposition to occur.[15]

TF contended that to satisfy this test, Intellicomms’ liquidators must demonstrate the actual monetary value of:

  • the best price reasonably obtainable for Intellicomms assets; and
  • the actual market value of those assets,

and then prove that each of these values was higher than the consideration paid by TF.[16]

This argument was not accepted. Gardiner AsJ opined that all the liquidators were required to establish was that, on the balance of probabilities, the consideration payable under the business sale agreement was less than both the ‘market value’ and ‘best price reasonably obtainable’ limbs of section 588FDB.[17]

Was the value insufficient?

After considering a significant volume of valuation evidence, his Honour found that, on the balance of probabilities, the consideration payable under the business sale agreement for Intellicomms’ assets was less than both the market value of the assigned assets and the best price that was reasonably obtainable for the assets, having regard to the circumstances in existence when the sale agreement was signed.[18]

In coming to this conclusion, Gardiner AsJ noted:

  • the lack of explanation as to why it was necessary to urgently sell the business, rather than leave the process of sale to the liquidators;
  • the lack of explanation as to why the regime of Part 5.3A of the Corporations Act was not explored, and why administrators were not appointed to conduct an orderly sale process;
  • that the sole director and shareholder of Intellicomms had commissioned multiple valuations in respect of Intellicomms’ business, with each successive valuer being provided with increasingly pessimistic inputs for the purpose of arriving at a valuation which would minimise the consideration payable by TF under the business sale agreement by TF;[19]
  • the lack of any attempt to put the sale to an open market, despite awareness of QPC’s interest in purchasing the business from late 2020 onwards;[20] and
  • that while QPC never submitted a formal offer for Intellicomms, the fact that QPC was willing to expend significant resources to fund the litigation and that TF was also willing to defend its rights under the agreement suggested a value significantly higher than the $22,925 paid for an assignment of Intellicomms’ assets under the sale agreement.[21]

QPC’s motivations

TF also contended that QPC was motivated by the fact that one of its subsidiary businesses was in competition with Intellicomms.[22] However the Court accepted that as a substantial creditor, QPC was fully entitled to try and recover their loss by “whatever means are legally available”, including by seeking to purchase the assigned assets through a legitimate sale process run by the liquidators, should the sale agreement be declared void.[23]

Given (i) the consideration paid was insufficient, (ii) TF conceded that Intellicomms was insolvent at the time that the sale agreement was entered into (minutes before the shareholders placed the company into creditors voluntary liquidation),[24] and (iii) the proceedings were commenced within the three year time period prescribed by section,[25] the Court made orders declaring the sale agreement to be void under section 588FE(6B) as a creditor defeating disposition pursuant to 588FDB.

Comment

Given Gardiner AsJ described the transaction as “a blatant example of phoenixing”,[26] it is unsurprising that it was set aside. The case provides a useful first step in exploring what constitutes a ‘creditor defeating disposition’, however professionals in this space will likely need to await further jurisprudence concerning ‘edge cases’ to gain a better understanding of the true scope of transactions to which 588FDB may apply.

It remains unclear how much the new creditor defeating disposition provisions expand the scope of transactions that can be potentially set aside (as opposed to streamlining the evidence and process for doing so). It is notable that the transaction considered by the Court in this case appears likely to have be voidable in any event under section 588FE(3) as an “uncommercial transaction” (within the meaning of section 588FB of the Corporations Act). No application was made to set aside the transaction on that basis in this case, and therefore this was not explored in the judgment. However, it appears that, having regard to the benefits and detriments to Intellicomms and other parties, the business sale agreement was not a transaction that a reasonable person in Intellicom’s circumstances would have entered into.

It is also interesting that the parties sought to set aside the business sale agreement by way of a court application by the liquidators, rather than requesting that ASIC make orders to that effect.[27] The power given to ASIC to make orders to set aside creditor defeating dispositions without a court decision potentially provides liquidators a more streamlined and cost effective pathway to challenge these transactions.

Given this was a “blatant example” of a phoenixing transaction, it would be interesting to understand whether the liquidators considered applying to ASIC for an administrative order, and if so whether ASIC declined to do so in this case. It may be that the liquidators considered that TF would apply to Court to set aside any such ASIC order,[28] in which case the liquidators may have considered it preferable to simply make the application themselves.

The case may indicate that liquidators will continue to make applications under section 588FDB to set aside creditor defeating dispositions going forwards, as it is difficult to imagine a much clearer example of the sort of case where an ASIC administrative order would be appropriate.

The judgment also notes that Intellicomms’ director had “planned the sequence of events carefully in close consultations with her business management consultants”.[29] As noted above, the Phoenixing Act introduced offences for both directors and advisors involved in the causing the company to undertake a creditor-defeating disposition’.[30] Whilst these provisions were not discussed in this case, the facts of the case are suggestive of a situation where ASIC might consider taking action under those provisions. Whether this occurs in relation to this situation remains to be seen.

Endnotes

[1] Intellicomms Pty Ltd (In Liq) (ACN 153 181 367) [2022] VSC 228, 1 [5] (‘Intellicomms’).

[2] ‘Illegal phoenix activity’ Australian Securities & Investments Commission (Webpage, 2022) <https://asic.gov.au/for-business/small-business/closing-a-small-business/illegal-phoenix-activity/>.

[3] The Hon Kelly O’Dwyer, ‘A comprehensive package of reforms to address illegal phoenixing’, Treasury Portfolio Ministers (Media Release, 12 September 2017) <https://ministers.treasury.gov.au/ministers/kelly-odwyer-2016/media-releases/comprehensive-package-reforms-address-illegal-phoenixing>.

[4] ‘Phoenix Taskforce’, Australian Taxation Office(Webpage, 2022) <https://www.ato.gov.au/general/the-fight-against-tax-crime/our-focus/illegal-phoenix-activity/phoenix-taskforce/#Ourwork>.

[5] Explanatory Memorandum, Treasury Laws Amendment (Combating Illegal Phoenixing) Bill 2019, [1.4] (‘Explanatory Memorandum’). See also. The Hon Kelly O’Dwyer, ’A comprehensive package of reforms to address illegal phoenixing’, Treasury Portfolio Ministers (Media Release, 12 September 2017) <https://ministers.treasury.gov.au/ministers/kelly-odwyer-2016/media-releases/comprehensive-package-reforms-address-illegal-phoenixing>.

[6] Ibid, [1.4].

[7] Corporations Act 2001 (Cth) section 588GAB.

[8] Corporations Act 2001 (Cth) section 588GAC.

[9] For further commentary on the Phoenixing Act, see the Australian chapter of the 2021 Global Restructuring Review, accessible here.

[10] Intellicomms (n 1) [2].

[11] Ibid 25 [78].

[12] Ibid 26 [82]-[83].

[13] Ibid 22 [67].

[14] Ibid 28 [90].

[15] Ibid 75 [243]; Corporations Act 2001 (Cth) section 588FDB(1)(a).

[16] Ibid 73 [234].

[17] Ibid 73 [235].

[18] Ibid 75 [242].

[19] Ibid 7, [1].

[20] Ibid 34, [113]; 72 [232].

[21] Ibid 75, [240]-[244].

[22] Ibid 65, [210].

[23] Ibid 75 [241].

[24] Ibid 5, [11].

[25] Ibid 72, [233].

[26] Ibid 76, [244].

[27] A liquidator is entitled to make such a request under section 588FGAA(3).

[28] Under section 588FGAE.

[29] Intellicomms (n 1) 6 [16].

[30] 588GAC(1),(2).

Key contacts

Paul Apáthy
Paul Apáthy
Partner, Sydney
+61 2 9225 5097
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Angus Dick
Solicitor, Sydney
+61 2 9322 4226

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On 2 August 2021, the Treasury released a consultation paper seeking feedback on changes to improve creditors’ schemes of arrangement in Australia. The submissions process has now closed.

The TMA submissions dated 17 September 2021 (the TMA Submissions) provided an considered and in-depth response to the Consultation Paper, reviewing the current use of creditors’ schemes of arrangement in Australia, considering the lessons from similar international reforms and recommending a number of reforms that should (and should not) be undertaken in Australia.

The TMA Submissions are available here.

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