Phoenix Companies and Phoenixing: Are they legal?

Phoenix companies are a surprisingly common outcome of corporate insolvencies in the UK. Yet they are poorly understood and looked upon with suspicion if not outright hostility. On the surface, the idea of a company’s directors being able to shed their old debt and continue on under a different name does seem inherently dishonest and a way to cheat creditors. However, phoenix companies serve an important economic function, albeit one that can be abused.

In this article, we will look at what exactly a phoenix company is, and what the term covers. Does this differ from phoenixing? And what process do these phoenix companies undergo? We'll also cover what the basic process is, why it is legal and the rules surrounding it.

 What is phoenixing?

Phoenixing is the illegal practice of deliberately abusing the process of pre-pack administration to run up debts that you do not intend to pay (often to purchase assets), declaring insolvency and then using a phoenix company to continue doing business minus any debts. 

Phoenixing effectively equates to fraud as directors take out lines of credit they never intend to pay. It is quite common for those who abuse this system to be serial phoenixers and have an extensive history of such dishonest behaviour. In recent years, strict laws have been introduced to curtail phoenixing.

Why are phoenix companies legal?

Phoenix companies often fall foul of the court of public opinion but perform an important economic function. The truth is that the vast majority of companies do not fail because of director malpractice or ineptitude. Often a business will no longer be viable but sometimes the cause of insolvency can simply be bad luck, such as a key debtor or supplier going insolvent.

In these cases an otherwise perfectly viable business will have to cease trading and the wider economic ripples caused by an insolvency will be felt. By using the process of a pre-pack administration jobs will be saved, taxes continue and often the creditors of the old business continue to generate revenue from the phoenix company. 

Whilst on the surface it does seem like the creditors are being cheated the practice of phoenix companies serves the economic greater good. There are strict rules around the practice and often overlooked factors are:

• Jobs being saved not only keeps people in work but also reduces the burden on the benefit system whilst people search for new work
• The directors may have had to personally guarantee debts at the old company and may face personal financial pressure that risks these debts not being paid
• The new company may have had to provide a deposit or bond to HMRC if it requires VAT registration
• The previous insolvent company will show on the Director's history and they may struggle to find new avenues of credit
• If creditors of the insolvent company do business with the phoenix company, it is accepted practice to increase prices to help recoup loss
• Bankrupt directors or those found guilty of malpractice are not allowed to use the pre-pack administration process

 What is the process of creating a phoenix company?

The creation of phoenix companies is now a highly regulated process and must take place under the guidance of a licensed insolvency practitioner. Those who do not follow this process are at risk of investigation and prosecution.

The process is:

1. The insolvent company is put into liquidation or administration
2. A licensed insolvency practitioner is consulted to manage the insolvency and pre-pack administration. The insolvency practitioner manages the process to ensure creditors are not disadvantaged; they will arrange for the company and assets to be independently valued and will appropriately market the pre-pack sale for offers more beneficial to the creditors
3. The directors of the insolvent company will purchase its assets; either directly from the insolvency practitioner or a third party will purchase them and then sell them on to the directors
4. The directors will create a new company and use the purchased assets to start business operations
5. The directors must ensure that the new company complies with all legal requirements e.g. registering with Companies House and obtaining all necessary licenses and permits
6. It is a legal requirement that all creditors of the insolvent company are kept up to date throughout these proceedings

When can a phoenix company process be followed?

In addition to a tightly regulated process, there are strict rules around when a phoenix company can be started. These exist to counter the process of phoenixing and protect creditors. Some key examples are:

• A phoenix company can only be started when the insolvent company can’t be saved
• Accurate records must be kept throughout the process
• A phoenix company can’t be started if there is found to be director misconduct at the previous company; such as the deliberate running up of debts, acting not in the best interests of creditors or being found to have broken the law in some way
• The previous company’s assets must be sold at a fair price and their sale must be advertised and marketed to seek a better outcome for the creditors
• Bankrupt or disqualified directors may not use the process
• The new company may not use the same name as the previous one, or a name so similar as to imply a connection with the previous company, without the leave of the courts (in accordance with Section 216 of the Insolvency Act 1986)

In addition to these rules, HMRC may investigate phoenix companies in search of ‘reasonable’ evidence that the previous company was wound up to pay reduced, or avoid paying, income tax.

Punishments for those found to have abused the system can face severe punishments. These include up to two years in jail, fines, disqualification and being made liable for any debts accrued under the new company. Should a director be found guilty of malpractice in the lead-up to the previous company’s insolvency then they will be prosecuted for that in addition.

How to protect against phoenixing

It is important to include a director search and due diligence in your risk management processes. Red Flag Alert allows you to view a person’s current and historic directorships and full reports on each company. 

 Should a person have an extensive history of insolvent businesses with a new similar company being incorporated soon after then they may be a serial phoenixer and an increased credit risk.  

If you find that you are dealing with a legitimate phoenix company then you should include finding out why the previous company failed in your due diligence process. Whilst in most instances there will be no cause for concern, you may find warning signs as to how the director/s run the company or the general viability of the business.

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