The coronavirus crisis and the rise of phoenixism

As the wider effects of the coronavirus crisis continue to be felt, it seems inevitable that significant redundancies and insolvencies will arise as a consequence. Recent financial news has been increasingly bleak, a 20.4% drop in GDP was recorded in April and analysis from Red Flag Alert detailed over 500,000 companies already experiencing financial distress prior to lockdown.

Given the anticipated increase in insolvencies, many company directors will be considering their options in relation to the companies they are in control of and their potential next steps. As unemployment figures increase and the number of alternative job opportunities reduces, it seems safe to assume that an increasing number of directors may look to restart their business via a ‘newco’ or phoenix.

What are phoenix companies?

The term 'phoenix' company relates to the practice of carrying on the same business or trade through a successor company when the original entity is unable to pay its debts. The insolvent company ceases to trade and then typically enters into formal insolvency proceedings (the most well-known example of this being a ‘pre-pack’ administration).  

As the demise of a company is often as a result of circumstances outside the director’s control (which is particularly relevant during the current crisis) UK law specifically allows owners, directors and employees of insolvent companies to carry on a similar business.

Despite this, the practice of phoenixism has traditionally been dimly viewed by the wider public. As the assets of a company can be transferred and the debts left behind, many parties feel that this can permit deliberate attempts to manipulate the process. In recent years many top tier banks have refused to deal with phoenix companies as have various public bodies in terms of ongoing work.

However, if insolvencies increase as the country exits lockdown, as is expected, it seems reasonable to assume there may be a softening of this stance. Many directors will be forced to place companies into insolvency as result of circumstances outside of their control and starting again via a phoenix may be their only realistic option.

Matters to consider

That is not to say that the practice of phoenixism should be taken lightly. Any director who goes through this process will still have been party to a corporate failure and will need to carefully consider the financial position of the old company and practical matters for the new. There are a number of issues to be considered to ensure directors act properly in transferring the business and assets to a successor company and that the new company is a viable business. These include: 

The transfer of business and assets – It is imperative this is done at fair value. It is an offence to diminish assets (both tangible and intangible) of an insolvent company without adequate payment.  Use of a similar name or trading style – If a company is liquidated the phoenix company cannot have the same trading name, or a name so similar it suggests an association, without complying with certain regulations and legal exceptions (including court approved sanction).  Transfer of licences – Many specific licences such as a vehicle operator’s licence will not be transferrable to the new company and steps will need to be taken to ensure a new application is in place. Bonds – Depending on the level of HMRC liabilities and prior conduct the new company may have to provide a VAT bond before being registered by HMRC. Employee Rights – It is important to consider the implication of the Transfer of Undertakings (Protection of Employees) Regulations (commonly known as TUPE or TUPER) and that employees may transfer with full rights to any phoenix company.  Ransom Creditors – If suppliers and trade creditors have been left with a significant debt it is not uncommon for them to request payment in full or an increased pricing structure before agreeing to supply the phoenix company.  Viability of the Business – A thorough assessment of the business should be carried to ensure that it is viable.  This should include an assessment of the reasons behind the previous failure and consideration given to what is going to change.  Detailed trading and cashflow forecasts should be prepared to assess the level of working capital required to ensure the business can meet its ongoing liabilities.  This is particularly important as it is likely that suppliers will insist on pro-forma trading terms. 

Take professional advice

Given the complexities surrounding a phoenix company it is vital directors take steps to ensure that this is done legitimately. It is therefore recommended that any transfer of assets or business of an insolvent company is undertaken with advice from an insolvency practitioner.

You can arrange a consultation with Ian McCulloch, licensed insolvency practitioner and partner at Begbies Traynor, by calling 01772 202000 or 07854 031177.