What are Phoenix Companies and are they Legal?
A phoenix company gets its name from the mythical bird of fire that rises from the ashes, and in essence, that’s exactly what a phoenix company does. A phoenix company is formed when the assets of an insolvent company are purchased by the company’s directors during administration. After closing the old company, they then start a new business which continues to operate in exactly the same way using these assets.
The result is that the business can resume trading as a new corporate entity with a completely clean slate.
Phoenix Company Law
In itself, the principle of starting a new company after insolvent failure lays at the heart of insolvency law. What is not acceptable is defrauding creditors and the term ‘Phoenixing’ refers to what used to occur in the bad old days. Specifically, a director racking up debts; selling off the company assets to a newly formed company often with the same name; and same directors with assets sold at an under-value so as to benefit the directors and defraud creditors.
As you can imagine these rules have been tightened up in every area stated above so that creditors are no placed at a disadvantage and insolvent directors have additional responsibilities. So, ‘Phoenxing’ per se’ is no longer practically possible. It is also a derogatory term often used by HMRC who have the right to ask for a security bond or even a personal liability notice for the director if they suspect ‘Phoenxing’ has taken place.
So in short ‘Phoenixing’ is not allowed but starting up again is.
Pre-Packs are the Correct Method to Avoid Phoenix Company Legislation
Although the formation of a new company formed from an insolvent company may seem like a raw deal for the company’s creditors, it can provide the best outcome for creditors as long as the directors pay a fair price for the assets. This valuation of the assets must be independent and provided by a Royal Institute Chartered Surveying agent. It should not be forgotten either that hundreds of thousands of jobs are rescued each year due to this process.
What are the Rules around Phoenix Companies?
The majority of UK companies do not fail due to any wrongdoing on the part of the company directors. There is a whole host of factors that can impact on the performance of a business without it being the directors’ fault. Therefore, UK law allows company owners and directors to set up a new business and carry on trading in much the same way as they were, as long as the individuals involved are not personally bankrupt and have not been disqualified from acting as directors. If everyone who ran into insolvent debt problems was banned from ever starting again you would wipe out some of the best-known brands today.
However, there are rules which restrict the use of the same or a similar name as a company that has entered liquidation. These restrictions mean that anyone who has been involved in the formation, promotion or management of the liquidated company cannot use the same name for five years, although there are some exceptions. As you can imagine using the same or similar sounding name or trading name lies at the heart of ‘Phoenixing’ as it was. You will be unsurprised therefore to learn it is a criminal offence to break this rule under section 216 of the Insolvency Act 1986 – so it is a serious offence.
Putting aside these comments provided the rules are followed there are ways the old director can remain on the ‘new company’ but this must be managed by someone with insolvency law experience.
Common methods of Starting another Business After Insolvency
In the majority of cases, an insolvent company uses a company administration order, which includes a pre-packaged sale of the assets and goodwill of the company. This is known as a pre-pack because the sale of the assets has been pre-arranged with the company’s directors.
A newly formed company can also be created out of a creditors’ voluntary liquidation – a liquidation which is instigated by the company directors. In this case, the new company buys some of the assets and goodwill of the company from the company’s liquidators. This effectively allows the new company to start from scratch.
The benefit is that the value of any assets and goodwill is usually worth more to the incumbent directors than being sold on the open market or at auction. Of course, the value paid will need to be proven that it was a reasonable fair price and marketing of the assets was carried out.
When is starting up again prohibited?
There are some companies that fail as a result of the misconduct of the company’s directors. In this case, it is the job of the Insolvency Service to investigate the suspected misconduct and to take action against any directors who have acted against the public interest.
If the Insolvency Service finds evidence of unfit conduct on behalf of the directors, the Secretary of State has the power to seek a director’s disqualification. If there is sufficient evidence to satisfy the court that misconduct has taken place, the director will be disqualified from acting in the formation, promotion and management of a limited company for a period of up to 15 years. In this case, an incumbent director would not be allowed to sit as a director on any new company for the disqualification period.
Targeted Anti Avoidance Rules Combat Misuse of Entrepreneurs Relief
New ‘anti-phoenix’ rules from HMRC apply to liquidated companies which fulfill certain conditions suggesting they have been wound up to avoid income tax. The five conditions required to qualify as an offender are:
- Shareholders must hold a minimum of 5% equity and voting interest before the liquidation begins
- The distributing company must be currently or in the 2 years prior to liquidation a ‘close company’, meaning it has five or fewer participants
- The recipient shareholders are seen to be involved in a similar business, within a two year period of shutting down the original company.
- The ‘reasonable’ evidence suggests that the liquidation was prompted by a chance to pay reduced income tax.
Want more information about setting up a phoenix company out of a pre-pack administration?
It’s a fact of life that not all legitimate businesses succeed at the first time of asking. In fact, one in three businesses closes within three years. In this case, a new company allows a business to start again from scratch, and for the profitable elements of the business to survive for both the suppliers’ and the employees’ benefit. There is the question of making sure that the same mistakes are not made again going forward.
For more information about setting up a phoenix company out of a pre-pack administration or creditors’ voluntary liquidation, please get in touch with our expert team today on 08000 746 757 or hit the Orange button on the bottom right-hand side for live support.