UK: Liability Of Directors Of Phoenix Companies

Last Updated: 30 September 2009
Article by Francis Kean and Roderic McLauchlan

In the current economic climate, it is not uncommon for distressed businesses to be restructured through insolvency; the idea being to emerge in a leaner and more robust form albeit trading under a similar name. It is therefore timely to recall that this "phoenix" phenomenon brings special liability risks for directors of such companies.

Section 216 of the Insolvency Act (IA) 1986 (the Act) and the supplementary Insolvency Rules (IR) (the Rules) address so-called "Phoenix" companies. This is where the business activities of an insolvent company are continued by the directors using the vehicle of a new company, often trading under the same or a similar name, and using the old company's assets and exploiting its goodwill.

Criminal liability

Such situations can lead to heightened exposures for directors of such companies. Under s216 IA, entitled "Restriction on Re-use of Company Names", it is a criminal offence for a director of an insolvent company, without the leave of the court, to reuse that company's name (or a similar name) for another company in which he is a director, within five years of the insolvency. The prohibition extends to any person who has been a director of the insolvent company in the period of 12 months ending on the day before the date of liquidation - s216(1) IA. A director in breach of s216 and who does not fall within one of the exemptions is exposed to criminal liability, and risks imprisonment and/or a fine1.

Civil liability

In addition, s217 IA 1986 imposes civil liability for a breach of s216, and holds an offending director personally liable for all the relevant debts of the prohibited named company, if at any time he is involved with the management of that company2. Furthermore, the court has no discretion to discharge or limit the liability, and there is no right of contribution between the person liable and the company. In effect, s217 imposes strict liability on directors who have breached the provisions of s216. It is, for example, no defence for the director to maintain that the breach of s216 was "innocent", i.e. committed without intent to damage the interests of the company's creditors. Nor indeed is it any defence for the directors to argue that the creation of the new company was in the creditors' best interests even if in fact that was the case.

Limited exceptions

There are only three exceptions to the s216 prohibition. The first arises where a director applies to the court within seven days from the date on which the first company goes into liquidation for permission to use that company's name.3 The second exception relates to a situation in which the successor company has already been trading by the prohibited name for a period of 12 months at the point when the insolvent company goes into liquidation4

The third exception derives from IR 4.228. In order for this exception to apply, the successor company must acquire the whole or substantially the whole of the business of the insolvent company under arrangements made by an insolvency practitioner acting as its liquidator, administrator or receiver. Under this procedure, the successor company must give notice in prescribed form to all the company's creditors within 28 days of completion of the transaction. In addition, the rule requires that notice be published in the Official Gazette. Significantly, if this procedure is not followed, there does not appear to be any provision in the insolvency rules for retrospective permission to be conferred. The only option available to the directors in these circumstances appears to be to apply to the court under s216(3) IA for leave to continue using the prohibited name. If, however, the new company becomes insolvent in the meantime, the director may still face civil claims.

Implications

The vice at which ss216 and 217 IA was aimed was the Phoenix Company Syndrome under which directors would intentionally collapse one company and create another in order to defraud creditors. It should be noted that the combined effect of ss216 and 217 goes beyond this and, in effect, creates a strict liability regime where there has been non-compliance. The courts have made it clear that there is no requirement for there to have been prejudice to the creditors resulting from the conduct in question. In, for example, Ricketts v Ad Valorem Factors Ltd [2003] EWCA Civ 1706; [2004] 1 All E.R. 894 where the successor company was trading under a similar name to that of the failed company, the issue was whether the successor company's name was a prohibited name for the purposes of s216. In this case there was no transfer of assets as an undervalue from the failed to the successor company. There was no evidence that the companies were used to incur debts and avoid payments nor was there any evidence that creditors of the failed company had been misled by the similarity of the two names. Despite all this, the court found that s 216 had been breached and, accordingly, the director was liable for all the debts of the successor company.

Conclusion

The "anti-phoenix" provisions of the IA are widely drafted, with plenty of room for interpretation by the courts. In the current economic situation, company directors and advisers should take heed of the provisions contained within s216 and s217 IA 1986, and take care in their application of the limited exceptions provided for in the Insolvency Rules. The growing number of cases which are coming before the courts illustrates the increasing awareness of the provisions, their consequences (both criminal and civil), and the readiness of creditors and liquidators to utilise them.

Given the current economic climate, it is more important than ever that company directors are aware of the effect of the anti-phoenix provisions contained in ss216 and 217 of IA 1986. Given the strict liability nature of these provisions, directors who are in breach (and especially those with access to D&O liability insurance) will make very tempting targets for liquidators. The fact that there is little, if any, defence to a claim under s217 places it in a different category from the more typical wrongful trading and/or misfeasance claim, the outcome of which, from a liquidator's standpoint, can often be much more uncertain. As more and more companies are buffeted by poor economic conditions, directors who are genuinely interested in maintaining their business in a new company need to be aware of the risks associated with ss216 and 217. Otherwise, they risk being burned by the phoenix.

Footnotes

1 s216(4) IA 1986

2 s217(1)(a) IA 1986 (N.B. A person is held to be involved in the management of a company if he is a director of the company, or if he is concerned, directly or indirectly, or takes part, in the management of the company)

3 IR 4.229

4 IR 4.230

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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