Phoenix companies rising from the ashes

Sarah Carlton is an associate at Fox Williams LLP Sarah Carlton is an associate at Fox Williams LLP

It’s a sad fact of life that businesses can and do fail and the fallout can impact upon many – owners, shareholders, employees, customers and suppliers alike, writes Sarah Carlton.

Often there is nothing underhand about the failure – the company is wounded fatally by a lost contract, a massive hike in a rent or rates, or has been unable to adapt to changing market conditions.

But occasionally firms are set up to fail through the deliberate actions of their management with a view to defrauding creditors. In certain situations, directors of the failed company turn to what is known as a ‘phoenix’ company.

Here they carry on the same business or trade successively through a series of companies which in turn become insolvent - the idea being that a new business rises from the ashes of an old one.

Each time this happens, the business of the insolvent company (but not its debts), is transferred to a new, but similar, phoenix company, usually through what is known as pre-pack administration.

A pre-pack administration involves the business of the liquidated company being sold as a ‘going concern’ through a process orchestrated by an appointed insolvency practitioner. The insolvent company then ceases to trade and might enter into formal insolvency proceedings or be dissolved.

Actions of directors
Phoenixing often harbours negative connotations, mainly because of the actions of directors who force their companies into insolvency to then purchase back company assets through the new company, leaving behind any liabilities in the insolvent company.

It’s worth noting that 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 (deliberately) at an undervalue. Creditors should take an interest in such investigations and speak to and assist the insolvency practitioner where possible.

New companies
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. However this is only if 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 company. Setting up as a new entity is legal if the process has been managed properly.

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. It is a criminal offence under the Insolvency Act to knowingly carry on business with an intention to defraud creditors.

If this is proven an insolvency practitioner may make the decision that the director is liable to make a contribution to the company’s assets on winding up.

Directors who don’t conduct business in line with their legal obligations face potential disqualification from acting as a company director.

Remember - it is legal for a phoenix company to be formed from the insolvency of a prior company. However, any director that is subject to a disqualification order or a bankruptcy order cannot act as a director of the newly formed company. 

Sarah Carlton is an associate at Fox Williams LLP

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