In these hard economic times, the number of company liquidations seems to be increasing. Even if a company is capable of being saved there may be good, legitimate reasons to allow it to be wound up but what problems might this cause for the directors?
A recent case provides a good example. The names have been changed for reasons of confidentiality.
A company was formed as part of the purchase or a sole trader’s business. The buyers, A and B, formed the company, bought X’s business in the name of the new company and issued shares to themselves and Mr X. All three were directors.
A and B fell out with X and tried to undo the deal. X was removed as a director and arrangements were made to restore the business to him and to get back A and B’s money. Mr X believed that he was owed more money and issued a winding up petition against the company. A and B fought it but after a number of adjournments the Judge suggested to them that as there were no assets in the company there was probably no harm in leaving it to be wound up. A and B accepted the advice and withdrew all opposition.
Sadly, before the winding up order other plans had been made and a couple of other companies incorporating the insolvent company’s name had been formed. A and B were directors of both.
Section 216 of the Insolvency Act 1986 is designed to stop “phoenixing”. This is a term for running a company into the ground, winding it up with huge debts and promptly forming a new company with the same or a similar name and carrying on without the burden of debt.
Put simply, if a person is appointed a director or acts as a shadow director of a company at any time within 12 months before the date of the liquidation of that company he cannot, for 5 years after the liquidation starts, be a director or a shadow director of another company with the same name or a name so similar as to suggest an association with the liquidating company. He cannot be involved in formation, promotion of such a company. He cannot be concerned in the carrying on of any business with such a name even if it is not through a limited company.
To do so is a criminal offence which can result in a fine, imprisonment or both. The director can be held personally responsible for the debts of the new company.There are three exceptions which are:
1. The new company has taken over all of the liquidated companies business under an arrangement with the liquidator and the liquidator gives notice to the creditors within 28 days of completing the arrangement.
2. The director applies to Court for permission to run the new company under a prohibited name not more than 7 days from the date when the old company went into liquidation and obtains that permission not later than 6 weeks after that date.
3. The new company has been running with the prohibited name for the whole of the year ending on the day when the liquidating company went into liquidation and has not been dormant at any time.
The reason for exception 1 is obvious. The liquidator might want to sell the company name and busines for the benefit of the creditors. Exception 2 is a temporary protection whilst court permission is obtained. Exception 3 allows for a company within a group going under without bringing the rest of the group to a standstill.
If none of the exceptions apply the only option is to apply to the Court for permission to operate the new company under a prohibited name. Notice of the application has to be served on the Official Receiver and on the Secretary of State for Trade and Industry who have the right to object and to bring any relevant circumstances to the attention of the Court.
The Court can ask for reports from the Official Receiver as to the circumstances in which the liquidating company went into liquidation. It will want to know whether the new company is solvent. It needs to be persuaded that the new company is not a phoenix operation.
As A and B discovered, if none of the exceptions apply the director cannot be a director or play any part in the running of the new company until the Court has given permission for them to do so.
Interim steps can be taken such as a temporary change of name for the new company or stepping down as director. Neither is ideal. The first involves damage to the goodwill attaching to the name. The second involves the risk that the remaining directors may not act as honourably as they might. There is also the possibility that the prohibited directors could be shown to be dictating to the remaining directors in which case they remain liable to prosecution and civil liability for the debts of the new company as shadow directors.
The lessons are simple. Firstly, if you are buying the business of an insolvent company from a liquidator make sure that the contract provides for the liquidator to give the appropriate notice to bring the matter within exception 1. Secondly, if you are the director of a company within a group which goes into liquidation and has a name similar to others within that group make the application quickly to fall within exception 2. The prohibition even applies to trading names so if “Z Ltd trading as ABC” goes into liquidation it is forbidden to form or be a director of ABC Ltd or to run “New Company Limited” with a trading name of ABC or Z. However, if New Company Limited has been running for a year or more before the liquidating company goes into liquidation there is no breach of section 216.
The last point is obvious. If you are involved in a company which seems to be insolvent or which is in the process of being placed into liquidation and you have an involvement in other companies with similar names or trading names you should take advice quickly.