Phoenix Companies and prohibited names – directors beware

The use of a company name which is the same or similar to the name of an insolvent company is fraught with complications. Joseph Miller explains.

Were you at any stage involved in a company which went into liquidation or administration? Are you now involved in another business with the same or a similar name? If so, you could inadvertently have fallen foul of the criminal and civil liability under Section 216 of the Insolvency Act 1986. Joseph Miller explains the pitfalls of this complicated and often overlooked area of insolvency law.

If your answer to both the questions above is a “yes” or if one of your companies is on the path to insolvency, you should read on. The law surrounding the use of prohibited names in these situations is complex and technical, so even those directors who are aware of the restrictions could easily find themselves in breach.

Furthermore, the Insolvency Service are taking a increasingly proactive approach to seeking out and investigating any potential breaches, so actions under this legislation are becoming more common.

What is a “pre-pack”?

It is a fact of life that many businesses will end up in insolvent liquidation or administration. Whether it is bad execution, a bad idea or in many cases just bad luck, even the most successful businesspeople can find themselves with an insolvent company on their record.

In the current climate of “rescue”, a common outcome when a fundamentally workable business goes under, is the use of a “pre-pack”. This is an arrangement made with the insolvency practitioner to buy back the business and assets of the insolvent company, whilst leaving the liabilities behind. Although the insolvency practitioner is obliged to get the best price he can for the business, in the vast majority of cases, the business ends up being sold back to the original directors in a new company, known as a “phoenix company”.

Pre-pack arrangements can seem simple, and indeed they often are. Assets are always sold on a “no warranty” basis and usually at a knock-down price reflecting the distressed nature of the sale. Equally, the buyers will have had some involvement in running the business they are acquiring, so should know what they are, and more importantly are not, getting. Furthermore, these transactions often need to be concluded in a very short timeframe, possibly even as little as one day. All of these factors mean that buyers can be tempted to proceed without the benefit of legal advice. This article deals with one of the reasons why this is not a good idea.

Prohibited names and section 216

The legal framework surrounding insolvency proceedings makes the use of phoenix companies a relatively simple, affordable and accessible solution. However, one particular aspect of the legislation which seems to contradict this aim, is section 216 of the Insolvency Act.

In summary, section 216 provides that a director or shadow director of a company in liquidation is prohibited for a period of 5 years from having any involvement in another business which uses the same or a similar name to the company in liquidation. The restriction applies not only to the registered name of the company, but also to any trade name used. Whilst it only applies to liquidations and not administrations, administrations usually end up turning into liquidations, so the position needs to be considered in both contexts.

Anyone who breaches these restrictions is exposed to both criminal liability (imprisonment and/or fine) and also personal liability for the debts of the phoenix company. Clearly, these are not restrictions to be taken lightly.

What are the exceptions to section 216?

On the face of it, section 216 seems to scupper any prospect of a director resurrecting his business through a phoenix company. Changing the trading name is usually not an option, as the buyer needs to preserve the ability to pick up where the old company left off. Directors are therefore left having to rely on one of the following 3 exceptions specified in the Insolvency Rules:

• Sale of business – where the business is being bought from an insolvency practitioner, the directors are permitted to use a prohibited name so long as they notify all the creditors of the insolvent company and publish the appropriate notice in the Gazette. However, this exception is difficult to properly comply with (particularly where there is to be no break in trade) and even a theoretical failure to comply will invalidate the process entirely.
• Court approval – it is possible to apply to court to request permission to use a prohibited name. The problems with this approach surround costs and timing. Applications need to be made within 7 days of liquidation and costs can be disproportionate, particularly where the business involved is not of great value, as is often the case.
• Previous trade – the restriction does not apply to a director of a company which has already been actively trading under the relevant name for a period of 12 months prior to the liquidation of the insolvent company. This is designed to prevent other bona fide group companies from being caught by the restriction, without opening a loophole for a devious director who would incorporate the phoenix company a few months in advance of knowing insolvency was unavoidable. However, this is by no means a perfect solution. Any group companies which are less than 12 months old will be caught by the restriction, so advice needs to be taken on section 216 even where no pre-pack is involved.

In practice, most directors will seek to rely on the first exception, as this seems to be the only reasonable solution. For a relatively modest fee, lawyers can be engaged to handle the process which can be completed swiftly. However, unless this is approached before the sale has been concluded, directors can find themselves in a position where they have “missed the boat” and are stuck either changing the name entirely or having to remove themselves from the business.

Increased Enforcement

Historically, breaches of section 216 would tend to go unnoticed. The phoenix company would trade on and remain solvent and there would be no cause for the Insolvency Service to investigate whether a breach of section 216 may have occurred. Directors would have counted themselves extremely unlucky to be prosecuted for what may have been a technical breach of section 216 where they have otherwise conducted themselves properly.

However, in recent years I have noticed a marked increase in communications from the Insolvency Service regarding potential breaches of section 216. I have also observed them taking a far more detailed approach to investigating the circumstances of any potential breach and a less relaxed approach to breaches which were only technical in nature. It is therefore very likely than any breach of section 216 will come to light and, if it does so, that the Insolvency Service will pursue it.

Summary

In summary, the rules surrounding phoenix companies are complex and the ramifications of breach can be severe. In any circumstance where you are a director or shadow director of a company which is going into liquidation or administration, you need to take legal advice from the outset. Do not wait until the liquidation as gone through or it could be too late to protect yourself.

Keystone Law has experts who specialise in all aspects of the insolvency and pre-pack process. In particular, we can advise on ways of ensuring that you comply with section 216, allowing you to continue to trade under an otherwise prohibited name. If any of the above does or may apply to you, please feel free to contact us for advice.