The Phoenix Problem
Before the introduction of the phoenix rule, there were a number of situations where some directors deliberately operated a business with no intention to pay the debts. The business (“company A”) would then be closed by liquidation but then carried on under a new company (“company B”) with the same or similar name. Creditors would not necessarily even know about the liquidation until after they had supplied credit to the new company B thereby losing out unfairly and perhaps multiple times.
Accordingly rules were introduced restricting directors from re-using the business name, to provide some creditor protection.
However, at the other end of the stick, in a liquidation situation, often it is the directors who will be best placed to invest into the liquidation, so the result for creditors is better, and if the directors are investing, then they would usually want the right to use the business name to protect the goodwill value.
The Phoenix Rules are therefore a balance in protecting these respective interests. In this article, Spencer Laymond sets out the rule and its three exceptions.
The Phoenix Rule
Section 216 of the Insolvency Act 1986 applies as follows:
- to a person who was a director or shadow director of a company at any time in the period 12 months before its liquidation, for a period of 5 years after the liquidation;
- to a name (same or similar) which the liquidating company was known at any time in that period of 12 months.
It is important to understand the importance of the restriction as a director or shadow director can face civil and criminal sanctions including being asked to contribute towards the debts of the insolvent company, penalties and imprisonment.
The Phoenix Exceptions
There are three exceptions to the phoenix rule, as follows:
Telling creditors, and in the right way
Telling creditors in the right way is not an informal email or zoom call. It is not a quick or minor formality. There is a very specific form, known as “Form 22.4” which must be completed by the director or shadow director.
The form must be:
- Published in the Gazette; and
- Given within 28 days of completion of the purchase from liquidation to all creditors of the insolvent company.
Whilst it can be possible to issue the notice before an insolvency procedure, given the consequences of getting the notice wrong, great care is required when considering the rules relating to this exception. See rule 22.4 of the Insolvency (England and Wales) Rules 2016.
Obtaining the permission of the court
A director or shadow director may ask the court for permission to use the same or similar business name as a company in liquidation.
Permission may be granted by the court if two main standards can be shown:
- The new business acquiring the old business name, was not acquired at an undervalue; and
- Creditors of the new company are not being misled into thinking they are dealing with the old company.
There is a balance to strike to show there has been no misconduct. The application to court will need to include pertinent information including: the background to the insolvency; what caused the insolvency; the impact to creditors past and present; whether and how creditors have been notified; why the business name needs to be reused; the terms of the acquisition of the business name from the liquidator; the role of the director or shadow director in the new company; and other relevant information.
The court application must also be sent to the Secretary of State for Business, Energy & Industrial Strategy. The Secretary of State has a right to ask the liquidator to report on the liquidation and attend and advise the court on the application.
There is a timing issue for directors to be aware of. Provided a court application is made within seven business days of the liquidation, there is a period of grace, so the director may carry on using the restricted business name until the earlier of a period of six weeks following liquidation or the determination of the application. If the court application is heard more than six weeks following liquidation, then the restriction on using the business name will apply until court permission is given. However, court permission cannot be given retrospectively. In light of delays caused due to the coronavirus, particular care will be needed to adhere to the timescales.
Prior use of the business name
If a company has actively operated under a business name, which would be a restricted business name, for at least 12 months before a liquidation, then the director or shadow director may continue to use that other business name. However, this exception will be based on the facts. A director could not incorporate a new company with a similar name to an existing company, and then keep this new company dormant for 12 months as a work around scheme for liquidating the existing company.
Further guidance
The Insolvency Service is the UK Government’s agency that helps to deliver economic confidence by supporting those in financial distress, tackling financial wrongdoing and maximising creditor returns. The Insolvency Service has published guidance on Phoenix companies and the Insolvency Service’s role.
Summary
There can be a fine line between deliberate and intended actions. Someone who is out to deliberately asset strip a company, perpetuate a fraud on creditors has a very different mindset and intent, contrasted with a director of a business which has hit a difficult period and has no choice but to liquidate. The Phoenix Rule can apply to both types of director, and notwithstanding the coronavirus problems, at the time of writing, there has been no relaxation announced to the application of this rule.
If you are looking to reuse a company name as a result of a business liquidation and would like some guidance around the subject, then please get in touch.
