Just like the mythical bird that rises from the ashes, a phoenix company rises from the ashes of an old, failed company.
It has become commonplace for directors of failed companies to simply burn the old company and set up a new company with a similar name, trading in the same business as if nothing had happened. This is a phoenix company.
Directors typically use a similar name because they see some value to the trading name of the old failed business.
There are strict rules that apply to phoenix companies. There is a general prohibition on directors from being involved in phoenix companies. However, like all good laws, there are exceptions.
Understandably, if a director does this, it can be a source of contention for creditors of the failed company. As far as they are concerned, the director is still trading, using the old company assets and staff and is trading as if nothing happened. Meanwhile, they are owed money for goods or services provided. They naturally get frustrated.
Implementing the restructure of a company into a phoenix is just as much a legal exercise as it is an accounting and public relations one.
Why incorporate a phoenix company?
Phoenix companies are usually created due to the company being in financial difficulty or a dispute with creditors or a claimant.
A new company is formed and, largely, the old company is transferred into the new one (selected staff, assets, business etc). However, the old company’s debts are not.
However, usually directors ensure that ‘key’ suppliers are looked after, as are secured creditors (such as the bank). In fact, a proper restructure will not be possible without obtaining consent of secured creditors, as this is usually a requirement under security documents.
This doesn’t seem fair?
To creditors, it is not fair. In fact, there is a general prohibition on directors of a failed company becoming directors of phoenix companies.
If the assets have been transferred from the old company to the new for less than market value, then there are numerous remedies and recourses for creditors of the old company. These include:
- Suing the director or persons acting on the director’s instructions; for
- Breach of director’s duties; or
- Fraud.
- Actions recovering unlawful distributions.
- Transactions at an undervalue, as set out in s 297 of the Companies Act.
There is no duty on owners of a company to keep a business running. The common law position is also that directors cannot be prevented from working for a company in the same line of business as the company for which they formerly worked. The starting point is that a director of a failed company is prohibited from:
- Being the director of the phoenix company;
- Taking part directly or indirectly in promotion, formation or management of the phoenix company; and
- Being directly or indirectly be concerned in or take part in the carrying on of the business of a phoenix company.
As mentioned above, assets themselves can be transferred for market value. This should be done using the method which generates the most value, but only once this transfer has been approved by the shareholders (see s 129 of the Companies Act 1993).
Directors need to ensure that in any transfer they comply with the many duties of directors, for example, use of company information and rules around self-interested transactions.
How to become a director of the phoenix company
There are three statutory exceptions in the Companies Act which allow directors to become directors of the new phoenix company, despite having been a director of the previous company. They include the exception for a person named in a successor company notice, exception for a temporary period while application for exemption is made and exception in relation to non-dormant phoenix company known by pre-liquidation name of failed company for at least 12 months before liquidation.
The first statutory exception can happen in a situation where the phoenix company has bought the old business from the failed company’s liquidator or receiver, and the director has notified all creditors in a way that complies with the statutory requirements, via a successor company notice.
The second exception is only a temporary solution and lasts for up to 6 weeks after the commencement of the liquidation.
The third exception is applicable if the phoenix company has been trading for at least 12 months before the failed company’s liquidation, with the same or a similar name.
Risks to directors who participate in a phoenix company
There is the potential for directors to be accused of fraud if they allow the failed company to enter into contracts knowing that the company is about to stop trading and that the contracts being entered will not be performed. Directors also need to be mindful of voidable preference claims. The risk here is that transactions can be set aside under some circumstances, if a payment from the company has preferred one creditor over another and the creditor has received more than they would have under the liquidation.
If a director breaches the phoenix company rules, they can be liable upon conviction for up to 5 years’ imprisonment or a fine of up to $200,000, banishment from acting as the director of any company or being personally liable for the debts of the phoenix company.
Phoenix companies are often used because they maintain a connection with the previous company. There are however, risks that directors need to be aware of before engaging in this process.
No director of a failed company ought to contemplate a phoenix restructure without first obtaining expert legal (and accounting) advice.
More information
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Brent is the Director of Norling Law. He has a wealth of experience in the District Court, High Court, Court of Appeal and Supreme Court. Brent is passionate about negotiating favourable outcomes for his clients and able to implement this in his daily negotiations.