In basic terms the provisions (set out in Section 216 of the Insolvency Act 1986 and Chapter 22 of the Insolvency Rules 1986) apply when:
- The person concerned was a director of a company during the 12 months prior to its liquidation;
- The director post liquidation acts as a director (or is involved in the management) of a company with a similar name; and
- The exceptions do not apply (I’ll come on to these).
If a director breaches these rules they commit a criminal offence and are personally liable for the new company’s debts. The criminal offence could in theory result in a prison sentence of up to 2 years.
The implications of these rules can be avoided if the business is acquired by the director from the liquidator/administrator and the correct process is followed. This process can involve an application to court but more typically involves notification to creditors and advertisement in the London Gazette. In addition any companies that have been trading for 12 months with a similar name are excepted from the restrictions.
The key to this process is an understanding of the timescales – it should be done prior to breaching the rules and within a defined period following (or prior to) acquisition of the assets. Directors should always get legal advice on this to ensure they are not in breach of the provisions.
Why does this matter to a lender?
There are several ways this could impact on a lender:
- Personal Guarantees over phoenix company debts – this may have a reduced value if the phoenix fails and the director is personally liable for its entire debt. Bankruptcy could easily follow.
- Keyman – if ignored it could make resolving the issue difficult and sometimes impossible resulting in the director having to avoid any management role in the company.
- Responsibility – in theory any party aiding, abetting, counselling or procuring a criminal offence can be subject to the same sanction as the person committing the offence. I am not sure this has been tested and it may be an unlikely scenario but it is possible that a funder providing the means for a purchase and breach of the regulations could also be liable.
On the upside if a phoenix fails and the lender is left with a shortfall there could be an argument where there is a breach of these rules that the director will be personally liable. Swift recovery action in relation to this may give a lender another route to recovery if there are no other available claims under personal guarantees or performance warranties.
How big a risk is it?
The risk of personal liability to the director typically only really arises when the phoenix fails to pay its debts and the creditors start to pursue the director directly. In many circumstances creditors miss this opportunity as they are not aware of the provisions and it is a claim they make not a liquidator or administrator.
Whilst a criminal offence how serious it is to a trading business is not clear – during the 12 months to March 2013 BIS reported that it had dealt with and consensually rectified 163 breaches without the need to report them to the prosecuting authorities. Whether any other parties have reported matters to the prosecution unit is not clear.
Minimising the risk
Lenders should ensure that the directors of phoenix companies are seeking appropriate legal advice so as to avoid falling foul of these provisions. Whilst insolvency practitioners will highlight the rules to directors their importance is often not fully understood or ignored.
Where it appears breaches have occurred it may be prudent to involve a legal and restructuring specialist to rectify the breach or establish a strategy for dealing with the situation avoiding a collapse of the business.
Previously…
Next time…
