Sarah Carlton examines the business practice of launching a phoenix company after insolvency.
It’s a sad fact of life that businesses can and do fail. Sometimes the failure is deliberate, but often there is nothing sinister – the company may have been wounded fatally by a lost contract, a significant hike in a rent or rates, or has been unable to adapt to changing market conditions.
There are numerous examples of companies that have been wound-up in recent years – including Kinetics Group, Ploughcroft Building Services and Tubs & Tiles – but some businesses never really go away.
‘Phoenixing’ describes the practice of carrying on the same business or trading successively through a series of companies that, in turn, become insolvent – the idea being that a new business rises from the ashes of the old one. Each time this happens, the business of the insolvent company, though not its debts, is transferred to a new, but similar, phoenix company. The business of the liquidated company, often using a pre-pack administration process, is sold as a going concern, orchestrated by an appointed insolvency practitioner. The insolvent company then ceases to trade.
A controversial practice
Phoenixing can harbour negative connotations, mainly because of the actions of directors who have forced their companies into insolvency only to then purchase back company assets through the new company, leaving behind any liabilities in the insolvent business. The process often involves financial loss being suffered by the creditors of the failed company – a practice that can give phoenix companies a rather bad reputation.
Sometimes directors do set out to commit insolvency fraud and so will deliberately reform a business using a phoenix company to avoid paying creditors. The bad news for creditors and suppliers is that they will have no contractual claim against the new company for debts incurred by the old, defunct, company.
The governing law of England and Wales allows shareholders, directors and employees of insolvent companies to set up new companies to carry on a similar business, as long as the individuals involved aren’t personally bankrupt or disqualified from acting in the management of a limited company, and the trading name of the new company is not the same or similar to that of the insolvent one.
Under entrenched company law, a limited liability company is a legal entity separate to that of its shareholders and directors. The responsibility for debts incurred remain that of the company, except in limited circumstances.
However, a director can be made personally liable – either jointly or severally with the company – for all the relevant debts of the new company if they contravene the Insolvency Act 1986 by acting as a director of a company with a prohibited name – a name similar enough to suggest an association with the previous company, for example. In this case, the director may be liable to a fine or, potentially, imprisonment.
If the company in question is insolvent, the appointed insolvency practitioner’s function is to investigate the practices of the company and distribute any assets found to the creditors of the business. Predominantly, the underlying assets of the insolvent company are required to be sold at market value and not at an undervalue. Creditors of the business should have an interest in such investigations and should speak to and assist the insolvency practitioner where possible.
Company directors owe numerous duties to their company and the key duties are codified in the Companies Act 2006. These include promoting the success of the company, exercising independent judgement, exercising reasonable care, skill and judgement, and avoiding conflicts of interests. Where a company is threatened with or starts to undergo insolvency proceedings, directors not only owe duties to the company, but also to any creditors it may have, and a number of provisions of the Insolvency Act 1986 will apply in this case.
There are strict regulations placed on the directors of an insolvent company and any appointed insolvency practitioner, regarding the use of a phoenix company to carry on the business of an insolvent company. The intention of the regulations is to protect the interests of unsecured creditors and to prevent company directors from escaping their obligations.
Intent to defraud
It is a criminal offence under the Insolvency Act to knowingly carry on business with intent to defraud creditors. If this is proven, an insolvency practitioner may decide the director is liable to make a contribution to the company’s assets on winding up.
Directors who don’t conduct their business in line with required legal obligations may face disqualification from acting as a company director. The Company Directors Disqualification Act 1986 prohibits directors, whose conduct led to the insolvency of a company, from taking on similar roles elsewhere for a prescribed length of time.
Remember, it is legal for a phoenix company to be formed from the insolvency of a prior company. However, any director who has been subject to a disqualification or bankruptcy order cannot act as a director of the newly formed company. Any concerns about bad business practice in should be reported to the Insolvency Service.
Sarah Carlton is an Associate at Fox Williams