It’s a situation that can cause misery for creditors caught up in the crossfire, and an issue which has not escaped the government’s attention.

Phoenix companies have been the subject of significant press coverage in recent times. Much of this attention is justifiable, and has tended to focus on those companies that have abused the system and ridden roughshod over the interests of creditors.

Indeed, draft legislation was published in June to counter avoidance or evasion of tax liabilities. Ministers have spoken of wanting to bring an end to this type of “phoenixing”, which can see supplier payments left behind by companies, only for the business to start again with a clean slate.

The average observer may find it hard to understand why British law allows a new business to be set up in a similar way to a previously failed company. However, in most cases, it is perfectly lawful for a new company to be set up by the director of a limited company.

Current Law

The rationale behind the law in the UK is to enable such activity to protect and promote entrepreneurship. It is also important to point out that many company failures are not a consequence of misconduct on the part of a director. It could be argued that ensuring continued employment for staff under TUPE is an added benefit of the law. This not only protects their livelihoods but also reduces redundancy pay-outs and may increase the amount of money available for distribution to unsecured creditors.

For that reason, a director of a failed company can become a director of a new business unless they are subject to a disqualification order or undertaking, are personally bankrupt, or are subject to a bankruptcy restrictions order or undertaking.

What is a Phoenix Company?

A phoenix company is a new business that carries on the same work as an insolvent one that has come before it. Those familiar with the term, “phoenix from the flames” will understand that the term relates to a new business arising from the ashes of the insolvent one.

The insolvent company ceases to trade and will be liquidated or purchased out of a formal insolvency process, such as administration.  Existing contracts may be transferred to the new business. Essentially, the insolvent company’s business, but not its debt, is transferred to a new, similar ‘phoenix’ company.  A phoenix company can only come about should the original business be deemed to have failed.

For phoenix companies to not be challenged by creditors, the assets of “oldco” must be sold to the “newco” at a fair and reasonable market price, with independent valuations obtained and records kept.  This circumvents allegations that the directors have simply walked away from the insolvent company’s debts.

The new company may have had to provide a deposit or bond to HMRC if it required VAT registration, or face credit restrictions imposed on it by other clients.

Re-Use of a Company’s Name

Despite the law allowing for a new business to trade, it is important to note that insolvency law restricts who can reuse the company’s registered name and trading names. This is covered by S216 of the Insolvency Act 1986.

The improper use of an insolvent company’s name is a breach of the Act, and directors can face jail or personal liability for company debts should they be found guilty of this.

A prohibited name may include:

-the liquidated company’s registered name at any time in the 12 months before liquidation

-any other name that the liquidated company, or part of it, was known by at any time during that 12 months. This may include, but is not restricted to, any trading names, including registered trademarks or brand names whether owned by the liquidated company or others

-any similar name that suggests an association with the liquidated company

This ban applies unless one of the following exceptions are met

-Where the other company or business had already been using the name for a period of 12 months before the liquidation.

-Where permission has been granted by the courts. The application for permission must have been made within 7 days of the liquidation, which will automatically grant temporary permission for six weeks.

– Where the business or assets of the liquidated company were sold to the new company or business by a licensed insolvency practitioner (the liquidator). This exception requires a notice in a prescribed form to be sent to all the creditors of the liquidated company and to be put in The London Gazette within 28 days of the acquisition.

Pre-Pack Administrations

In a pre-pack sale, a company’s assets are sold before an administrator is appointed. The company can then start up again under a new name, but often it is the same directors who have purchased the assets, while creditors are left with unpaid invoices.

There are strict regulations surrounding pre pack sales which are intended to protect the interests of unsecured creditors and prevent company directors from escaping their obligations.

Insolvency practitioners must make a detailed SIP 16 Statement, which provides an in-depth explanation of how a decision to opt for a pre-packaged sale was arrived at, and the alternatives that were considered. This covers everything from valuations to marketing. The insolvency practitioner’s report is placed under scrutiny, not only by the creditors but also by their own regulatory body.

Maximising creditor returns is the theme running through SIP 16. Some pre-pack sales have even been successfully challenged in court in the past.

Should you Deal with a Phoenix Company?

A phoenix company may be able to continue to do business with many of its old suppliers and customers. Ultimately, only a company owner can answer this question. It is the choice for any supplier to decide whether they should deal with a phoenix company or allow it credit for its goods or services.

Most phoenix companies are perfectly legitimate businesses but, as with all new customers, it is wise to do some research on the new company. It may be prudent to investigate the reasons for the previous failure. A Companies House search will enable a supplier to find out whether the directors have been involved in any other previous liquidations. Most suppliers will also undertake a credit check before deciding how much credit to provide a new customer. If creditors wish to deal with the phoenix, it may well be expected that prices will be increased to recoup losses from the first time around.