Typically, the assets of the old business are purchased by a party connected to the previous company. The clear advantage is that the newly formed company may continue to trade in a similar manner to the old company, and this means that customers and clients may not be affected.
Are phoenix companies illegal?
There are many misunderstandings and negative connotations associated with such companies and they can be very controversial in the sense that creditors of the old company who remain unpaid are often understandably very unhappy to see a new company start up using a similar name to the old one and which may even have some of the assets of the old company but not the liabilities.
It is important to note that the formation of a new company in this matter is entirely legal. However, in order to remain legal, there are a number of rules that must be complied with. Such rules ensure that the relevant revenue compliance and tax legislation is adhered to, and it is important that individuals and companies are aware of the main company law relating to phoenix companies.
The Insolvency Act 1986
The most commonly referred to statute when discussing phoenix companies is the 1986 Insolvency Act (“the Insolvency Act”). Section 216 states that a name will not be accepted where it is the same as or similar to the name of the original company in the twelve months immediately before it went into liquidation.
This prohibition applies to directors or those who have been director in the twelve months preceding liquidation of the previous company using such a name for a period of 5 years from liquidation.
An example is where the courts looked at whether or not a name for a new company was too similar to the name of the original company was in Ricketts v Ad Valorem Factors Ltd  where an individual was Director of Air Component Company Limited from the beginning of January in 1998. This company suffered liquidation a month later. This individual then became director of Air Equipment Company Limited the following month, and it was held that “there was no doubt” that the names were similar enough to breach the requirements of Section 216 of the Insolvency Act.
There are exceptions to Section 216, including when the business is sold, if permission is sought from the court or if the director had previously used the name for a continuous 12 month period. Under Section 217 of the Insolvency Act, directors are personally responsible and therefore liable for any incurred debts as a result of a breach of section 216 (as above), or otherwise.
The Company Directors Disqualification Act 1986
In addition to the provisions of the Insolvency Act, The Company Directors Disqualification Act 1986 states that a director who has already been disqualified cannot act as director for a specified time period. For example, the original company may have been subject to certain investigations or been closed as a result of a misconduct charge, and in such cases, one or all of the directors may have been disqualified.
If this is the case, they may not start a new company even if they comply with the Insolvency Act and all other applicable legislation.
Phoenix company fraud
As previously mentioned, phoenix companies are often considered to be undesirable by nature. One reason for this is that, unfortunately, certain arrangements which do not follow applicable legislation result in fraud occurring. The most common type of fraud occurs when directors do not correctly value the assets that are being sold to the new company. By doing this, they ensure that little or no funds are available to the creditors of the original company becomes insolvent, and therefore the creditors are unable to claim back the money that they are owed, and the new company acquires all of the assets.
Ultimately, this usually means that the old company has no more debts and the new company, which is sometimes made up of the same directors, trades as if it were the old company without the liabilities. Such fraud will fall foul of the rules relating to valuations as dictated by the rules of insolvency, and should be reported to the Financial Ombudsman Service and Financial Services Authority.
The issue of phoenix companies and the increase in fraudulent activities relating to certain phoenix company arrangements led to much discussion and ultimately new legislation was proposed. This pre-pack legislation intended to increase regulation with regard to administration, but was initially delayed and subsequently dropped, as it was decided that the proposals were not beneficial to small businesses.
Need legal advice?
If you need advice on the legalities of starting a new business if your old one has genuinely become insolvent or if you are a creditor and suspect that the directors or shareholders of a company which owes you money are seeking to manipulate a situation to their advantage, get in touch with us for further advice. The earlier you act the better your legal position is likely to be.
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