Phoenix companies are controversial and as a result, there are strict rules in place governing the process of starting a new phoenix company via the purchase of the previous business out of an insolvency procedure by connected parties.
The deal can only be completed when the connected parties, such as directors, shareholders and/or employees of the failed company are able to show evidence that the interests of the company’s creditors as a whole will be maximised through the sale.
This article will give an overview to what phoenix companies are, and the various rules and regulations around them.
What is a Phoenix Company?
A Phoenix Company is a new company set up from the ashes of one that has become insolvent.
It is usually set up by the same directors, and with the same assets, including intellectual property. There is a lot of legislation around it so that unscrupulous directors cannot simple write off the debt from one insolvent company, and then start afresh without consequences.
What are the Rules Around Starting Phoenix Companies?
The main points with setting up phoenix companies is that any assets purchased should be done so at fair value. This means they must be independently valued and transparent record keeping maintained.
Should this not be done correctly, it is not unheard of for creditors to challenge phoenix companies in open court for assets sold at undervalue.
The other key factor is that a Phoenix company can only rise from the ashes of the old company, if the previous company is truly dead. The only person who can determine this is a licensed IP. His or her role is to oversee the process and to put creditor interests at the forefront of his or her actions to recoup as much money as possible for unsecured creditors.
Are Phoenix Companies Legal?
Where due process is followed, phoenix companies are perfectly legal.
For some people the term does still carry a negative connotation, however, since before the government tightened up its laws in this area the practice of ‘phoenixing’ was unused unscrupulously by some directors.
The Role of the Insolvency Practitioner (IP)
The IP must notify creditors of the sale of the business as soon as possible, but no later than 14 days after the sale date.He or she is also required to disclose all actions and decisions within a statement sent to creditors, which is usually sent out at the same time as the notification of the sale. Additionally, the IP investigates director conduct in the time leading up to the liquidation. This can stretch back as far as two years prior to the date of the insolvency.
The IP is also tasked with selling the company’s assets at the best possible price. A business asset sale aims to avoid subsequent allegations that the directors were able to start out again debt free. As the business is distressed and a quick sale is needed, business asset prices may be discounted. It is crucial that the sale of the previous business is viewed as a legitimate sale as some transactions have been successfully challenged in court by creditors.
Purchasing a Phoenix Company via a Pre-Pack Sale
Under UK law, business owners, directors and employees of insolvent companies can start a new phoenix company to carry on a similar trade as long as the people involved aren’t personally bankrupt or disqualified from managing a company. That said, starting a phoenix company isn’t straightforward and when a company goes into liquidation or is wound up, there are strict rules to follow that protect the interests of unsecured creditors and prevent company directors from reneging on their obligations. These rules include the following:
- When the directors and/or shareholders make the purchase, they may need to use personal funds, such as savings to buy the company if no other external investment is available
- If the new company needs to focus its operations, frequently, not all of the assets of the old company are purchased. Directors may not be able to afford to buy all of the assets at the same time and a deferred sale and purchase agreement may be negotiated
- If employee contracts are transferred to the new company, TUPE regulations come into play and the new company may need to seek professional advice before going down this route
- If the previous company has HMRC PAYE or VAT arrears, it is highly likely that the taxman will demand deposits from the Phoenix company to mitigate risk.
- In line with insolvency law, the trading name of the new company cannot be the same or even similar to the liquidated company’s registered name.
Under these stringent rules, it is possible for directors to wind up a company and start the same business again, retaining the most profitable parts of the business and offering some continuity for suppliers and employees.
In recent years HMRC has made a special effort to clamp down on directors who set up companies for the duration of a specific contract then shut it down to try to claim Entrepreneurs Relief.
This faciliates a means of taking profits out of a cash-rich company at the preferential rate of 10% rather than the dividend income rate of 32.5% or 38.1%
The Targeted Anti-Avoidance Rule or TAAR set up in 2016 are designed to counter exactly this. By setting up a similar company within two years of the sale, these rules mean your gains will be wiped out.