The increasing use of pre-packaged administrations can lead to unexpected personal liability for directors if they do not comply with strict legal requirements. In this article, we look at how a director considering a pre-packaged administration can protect themselves from personal liability when they reuse a company name.
COVID-19 has had a significant financial impact on many businesses throughout the UK. With Government support measures ending and restructuring professionals seeing an increase in insolvencies, many directors of financially distressed companies may be contemplating the need for a pre-packaged administration through the use of a “phoenix company”.
There are, however, strict restrictions on the re-use of a company name and if not used in the correct and lawful way, directors are likely to find themselves committing an offence under the Insolvency Act 1986 which gives rise to both criminal and civil penalties.
This article explains the restriction on the re-use of a company name under the Insolvency Act, the penalties that can be imposed and the exceptions that may apply to enable a director to re-use a company name lawfully.
What is a phoenix company?
A phoenix company typically arises when a person trades a new company under the same or a similar name to an insolvent company. In doing so, the new company uses the insolvent company’s assets and management, but it leaves the insolvent company’s liabilities behind.
What is the restriction on using the name of an insolvent company and who does it apply to?
The restriction was implemented to prevent the unjust use of phoenix companies and to protect the public from being misled into dealing with a new business, thinking that they are still dealing with the insolvent company.
Anyone acting as a director or shadow director during the 12 months before an insolvent company is placed into insolvent liquidation is restricted from:
- being a director of any company known by a prohibited name;
- directly or indirectly concerned or taking part in the promotion, formation or management of such a company; or
- directly or indirectly concerned or taking part in the carrying on of a business that is carried on under a prohibited name.
The restriction lasts for five years from the date of insolvent liquidation, unless one of the exceptions applies.
What is meant by insolvent liquidation?
The restriction only applies to directors or shadow directors where the insolvent company is placed into insolvent liquidation, this includes compulsory liquidation or creditors’ voluntary liquidation. It does not apply to a company being placed into members’ voluntary liquidation, as this is a liquidation process where the company is solvent.
What is a prohibited name and how does it affect the insolvent company?
A name of a company is prohibited if it either is the same name, or a name so similar as to suggest an association with the insolvent company. This can include not only a company’s registered name, but also its trading names. Acronyms may also be caught by the restriction.
In assessing whether names are similar by association, the court is likely to take into account all the circumstances in which the names were, are, or likely to be used. This may include factors such as the locations of the businesses, the type of customers each company had, and those involved with management of the companies.
What are the consequences of breaching the restriction?
Breach of the restriction can lead to:
- criminal prosecution which may include imprisonment or a fine, or both; and
- civil liability which exposes a director or a shadow director to automatic personal liability of the debts of the new company for as long as the director continues to act in breach of the restriction.
Automatic personal liability of the debts of the new company also extends to those involved in the management of the company who act, or are willing to act, on instructions from the director or shadow directors of the insolvent company who they know are in breach of the restriction.
As liability for debts is automatic, a creditor of the new company can bring a direct action against the person(s) involved in the management of the company, it does not need to bring an action against the company itself.
- The offence applies to the person who has infringed the restriction, not the company.
- There is no statutory defence available. Unless the person acting in breach of the restriction has been granted leave to act by the court, or a statutory exception applies (discussed further below) they will be automatically liable.
- Following conviction, the court also has the power to make a director’s disqualification order under the Company Director Disqualification Act 1986.
Application for court permission
Where the restriction applies, the director or shadow director will need to obtain the court’s permission to re-use the company name, except where one of the three statutory exceptions apply.
Exceptions that allow continued use of the insolvent company’s name
There are three exceptions which, if applicable, allow the continued use of the company name without any criminal consequences or civil personal liability for debts of the new company.
First exception: giving notice to creditors
Where the restriction would ordinarily be triggered, it will not apply where:
- the whole or substantially the whole of the business of the insolvent company is sold to another entity in which a former director or shadow director plans to be involved, and
- if that person gives notice to all creditors of the insolvent company before the person acts in breach of the restriction; and
- in any event, the notice is given no later than 28 days after completion of the sale of the business.
In addition, the sale must take place under the arrangements of an insolvency practitioner, the notice must be published in proper format in the London Gazette.
What if the sale is by a company not yet in insolvent liquidation?
Where the sale is by a company in administration, it is likely that at this time the exit route out of the administration will be unknown. It might be dissolution, but it could well be liquidation if a dividend to creditors is anticipated. It is therefore possible that there will still be a liquidation and that the director may subsequently breach the restriction.
As a consequence of this highly possible scenario, the Insolvency Act allows the director, or shadow director, to give notice before the insolvent company enters liquidation. Therefore, in the circumstances where the sale is by a company in administration, directors should plan ahead and give notice upon completion of the sale or, at the very latest, within 28 days of completion of the sale, to avoid breaching the restriction at a later date.
Second exception: interim protection pending
If an application has been made to the court seeking permission to re-use the prohibited name on, or within seven days of, the company being placed into insolvent liquidation, the director may continue to act as if they have permission, pending court determination of the application, or for a maximum of six weeks (whichever is the earliest).
Third exception: company already known by prohibited name
The third excepted case arises where the company that has the prohibited name has been known by that prohibited name for at least 12 months before the insolvent company was placed into insolvent liquidation. The company must be a trading business and must not have been dormant at any time within the 12 month period.
This exception can be particularly helpful in circumstances where there is a group of companies, all known by similar names and that all have the same management, and one or more of those companies is subsequently placed into insolvent liquidation.
When to seek professional advice re-use of a company name
In certain circumstances, it is possible for a director to re-use a company name. However, there are strict regulations in place that must be followed to avoid the criminal and civil consequences of breaching the restriction. It is for this reason that professional advice should be sought when considering the re-use of a company name.