Phoenix companies – what are they and are they legal?

Phoenix Companies - what are they and are they legal?

Phoenix Companies – what are they and are they legal?

The phoenix is an immortal colourful bird associated with Greek mythology with supernatural powers to come back to life. It is often said to have “risen from the ashes”.

Today, a phoenix company is used to describe a business that has purchased, or had transferred to it, the assets of an insolvent company. When the insolvent company ceases to trade, the phoenix company continues to operate in the same way as the insolvent entity, using its former assets, but without its debts. These two entities often have common directors. After the asset transfer the insolvent company may enter formal insolvency proceedings, such as liquidation or administration, or simply be dissolved.

Are Phoenix Companies Legal?

Yes, they can be, but only if the strict rules and regulations governing them are complied with. The legislation that governs this is Section 216 of the Insolvency Act 1986 (“the Act”). If this is not adhered to the individuals involved in the management of the phoenix company may be subject to criminal and/or civil sanctions and liabilities.

What the Law Says?

When a company is placed into insolvent liquidation, s216 of the Act prohibits its current directors and shadow directors (or anyone who has been appointed or acting as such in the 12 months before the liquidation) from their “involvement” in another company or business with the same or similar name as the company in liquidation for five years, starting on the day that the company went into insolvent liquidation. This may include existing companies/trading entities as well as those that have been recently incorporated and/ or commenced. What is involvement?

For the purposes of Section 216 of the Act, a person would be considered to be involved in a phoenix company if they were:

• a director of a company known by a prohibited name;

• in any way concerned with or taking part in the formation, promotion or management of such a company; or

• in any way concerned with or taking part in the carrying on of a business (which includes unincorporated businesses, unregistered companies, sole traders and partnerships) with a prohibited name.

What is a prohibited name?

A prohibited name is one by which the insolvent company was known at any time in the 12 months before it was placed into insolvent liquidation or, one so similar to that name so as to suggest an association with that company. This does not only apply to a company’s registered name but also to any trading names and/ or abbreviations associated with it.

Who decides if a name is prohibited?

Ultimately this would be a matter for the Court. However, in most cases, such clarification is not required. It is a matter of common sense and whether a lay person would associate the two trading entities by their names. It is of note that any Court asked to consider this would also take into account the nature of the businesses, trading styles and other factors.

Exceptions

Alison Beard

• the directors and/or shadow directors make a successful application to court for permission to be involved in an entity using the prohibited name; and

• the company with the prohibited name has been operating (and not dormant) for at least 12 months prior to the insolvent company going into liquidation.

Before any of these exceptions are relied upon it is strongly advised that the individuals involved ensure that they receive legal advice before a breach of s216 of the Act takes place.

What if s216 of the Act is breached?

There are three statutory exceptions when an individual will not be deemed to have breached s216 of the Act which are: • when the directors and/or shadow directors who have been involved in the insolvent company give the prescribed notice to the creditors to the insolvent company, before a breach has occurred, that they are, or are to be, involved in a company that is acquiring the whole or substantially the whole of the insolvent company’s business from either the liquidator (or administrator) appointed to the insolvent company;

If a person acts in breach of s216 they may be subject to both criminal and/or civil sanctions.

Phoenix Companies (continued from page 17)

• Under criminal law, the individual is liable to imprisonment or a fine, or both if convicted.

• Under civil law the individual could be prosecuted for disqualification as a company director.

• Under civil law the individual is automatically jointly and severally liable with the new business/company, and anyone else acting in breach of s216 of the Act in relation to the same, for the “relevant debts” of the new company, even if it is a limited company or partnership.

What constitutes the “relevant debts” will be fact dependant, but they will be those debts and liabilities incurred by the new company, during the period that it is known by the prohibited name.

Accordingly, a creditor of a new company using a prohibited name can bring a civil action directly against those individuals involved in its management. They do not need to pursue the company itself, although, if it is not in an insolvency process, it may be worth bringing an action against multiple defendants.

Conclusion

Although a phoenix company can be beneficial for its directors and its creditors it is often not done correctly leaving creditors aggrieved, whilst the individual involved are not aware of the personal liability they may be exposed to.

If you are a creditor of what you believe is a phoenix company, particularly one that has subsequently been placed into an insolvency process, you may wish to seek advice on the options available to you and the potential parties that you can pursue for the recovery your debt.