Phoenixing : Understanding the practice, legalities, and controversies
What is Phoenixing?
Phoenixing is a term which derives from the mythical phoenix bird that rises from its ashes. It refers to the practice where the directors close down a failing or insolvent company, and subsequently establish a new company to continue the same business, often under a similar name. This manoeuvre allows them to avoid paying the old company's debts while maintaining the essence of their operations.
Legalities surrounding phoenixing
In the UK, phoenixing is not illegal per se but it must be done within the framework of the law to avoid potential ramifications. The Insolvency Act 1986 governs the process of company insolvency, and within its remit, specific rules are designed to protect creditors' interests.
One such provision is Section 216, which restricts directors of an insolvent company from being involved in a new company with the same or a similar name unless court permission is granted, or specific exemptions are met. Breaching these restrictions can result in severe penalties, including personal liability for the new company's debts and possible disqualification from acting as a company director moving forward.
Controversies surrounding phoenixing
Phoenixing is controversial for several reasons. Critics argue that it allows unscrupulous directors to avoid their financial responsibilities, leaving creditors, employees, and suppliers out of pocket. This practice can undermine trust in the business ecosystem, as stakeholders may become wary of engaging with companies that have a history of phoenixing.
This practice can also be seen to distort competition. New companies arising from the ashes of their insolvent predecessors often have reduced debt burdens, enabling them to undercut competitors who stick to fair trading practices and pay their dues. This can lead to market imbalances and reduced economic fairness.
Consumer impact
Phoenixing can be detrimental to consumers for several reasons. When a company phoenixes without addressing its prior obligations, consumers may find themselves without recourse for warranties, returns, or refunds on previous purchases. The new company, despite operating under a familiar brand, is not legally obliged to honour the commitments of its predecessor.
Furthermore, phoenix companies may engage in aggressive cost-cutting measures to establish themselves quickly, potentially compromising product quality and customer service. This erosion of trust can lead to a less reliable market environment, ultimately affecting consumer confidence and satisfaction.
How to phoenix properly
To phoenix a company lawfully and ethically, directors should follow these key steps:
1. Seek Legal Advice: Consulting with legal and insolvency professionals ensures compliance with the relevant laws and regulations.
2. Transparent Communication: Directors should communicate openly with creditors, employees, and stakeholders about the insolvency and the formation of the new company.
3. Court Permission or Exemptions: If the new company name is similar to the old one, directors must obtain court permission or meet the exemptions under Part 22 of the Insolvency Rules 2016.
4. Proper Valuation and Sale of Assets: The old company’s assets should be independently valued and sold at fair market prices, ideally overseen by an insolvency practitioner.
5. Adherence to Tax Obligations: Ensuring all tax liabilities are settled and not simply transferred to the new entity is critical.
Record keeping by the Insolvency Service
It is imperative to note that the Insolvency Service holds company records for a minimum of six years from the date of the insolvency case's closure. These records are accessible to the public and include details of company directors, financial statements, and reports by insolvency practitioners. This transparency aims to deter fraudulent phoenixing by maintaining a historical account of directors' conduct.
Industries prone to phoenixing
Certain industries are more susceptible to phoenixing due to the nature of their operations and market conditions. The construction industry, for example, sees frequent occurrences of phoenixing due to its high risk and low-margin environment. Retail and hospitality sectors also exhibit notable instances, especially during economic downturns.
According to the UK Insolvency Service, there has been a notable shift in business insolvencies. In the period spanning 2023-2024, the number of compulsory liquidations and creditors' voluntary liquidations has increased to approximately 19,820. This rise underscores a growing trend in business failures, which may inadvertently present more opportunities for phoenixing activities.
In summary, while phoenixing can be a legitimate business strategy under certain conditions, it remains fraught with ethical and legal complexities. By adhering to strict legal guidelines and maintaining transparency, companies can phoenix responsibly, balancing the interests of all stakeholders and contributing to a fairer marketplace.
Contact Isadore Goldman today if you would like advice on the matters raised above, either as a director, creditor or other party involved.