Worried About Your Company Becoming Insolvent?

Directors of a company on the brink of insolvency should take extra care in carrying out their duties to avoid the risk of liability for wrongful trading under the Insolvency Act 1986. 


In such circumstances it is advisable for directors to do the following:

• obtain professional advice from a solicitor and/or insolvency practitioner in relation to any major decision taken by the company and insist on such advice being documented;
  

• hold regular board meetings at which all directors should be present so that the entire board is aware of the company's financial status;

• circulate board minutes immediately after meetings as this will provide evidence of whether or not steps taken by the directors minimise the potential loss for the company's creditors for the purpose of avoiding liability for wrongful trading;

• draw up a list of all possible sources of funding for the company as this will be useful for the board in identifying the time at which the company no longer had any reasonable prospect of avoiding insolvent liquidation for the purpose of avoiding liability for wrongful trading.

• draw up a timetable for when financial milestones such as new funding levels for the company must be met. The timetable should be strictly adhered to and it should identify the time at which the company's failure to meet a milestone will mean that there is no reasonable prospect of the company avoiding insolvent liquidation.

It is also wise for director's to avoid:

• letting the company incur any new substantial liabilities until further funding has been secured, with the exception of circumstances where the board considers any such liabilities being essential and in the best interests of the Company;

• waiting for a winding up petition to alert the board to financial problems and directors should ensure that they have up to date financial information at all times, compliance with financial covenants in arrangements with lenders should also be closely monitored;

• ignoring events such as creditors putting pressure on the company, the company filing its accounts late or judgments being entered against the company as these could be evidence of insolvency which a reasonable director should have known about;

• delays in raising a problem with the rest of the board as it is important for the board to take immediate legal and financial advice as soon as a director is aware, or fears, that there is no reasonable prospect of the company avoiding insolvent liquidation;

• simply resigning to avoid the problem as directors must take every step to minimise potential loss to creditors and if they conclude that the company cannot continue to trade they must implement one of the insolvency procedures.

Directors and Phoenix Companies

Nowadays, it is common for distressed businesses to be restructured through insolvency. The idea is for it to emerge in a leaner, more robust form albeit trading under a similar name. But this "phoenix" phenomenon brings special liability risks for directors of such companies.


Section 216 of the Insolvency Act (IA) 1986 (the Act) and the supplementary Insolvency Rules (IR) (the Rules) address so-called "Phoenix" companies. This is where the business activities of an insolvent company are continued by the directors using the vehicle of a new company, often trading under the same or a similar name, and using the old company's assets and exploiting its goodwill.

Criminal liability

Such situations can lead to heightened exposures for company directors.


Under s216 IA, entitled "Restriction on Re-use of Company Names", it is a criminal offence for a director of an insolvent company, without the leave of the court, to reuse that company's name (or a similar name) for another company in which he is a director, within five years of the insolvency. 


The prohibition extends to any person who has been a director of the insolvent company in the period of 12 months ending on the day before the date of liquidation - s216(1) IA. 


A director in breach of s216 and who does not fall within one of the exemptions is exposed to criminal liability, and risks imprisonment and/or a fine.

Civil liability

In addition, s217 IA 1986 imposes civil liability for a breach of s216, and holds an offending director personally liable for all the relevant debts of the prohibited named company, if at any time he is involved with its management.


Furthermore, the court has no discretion to discharge or limit the liability, and there is no right of contribution between the person liable and the company. 


S217 imposes strict liability on directors who have breached the provisions of s216. It is, for example, no defence for the director to maintain that the breach of s216 was "innocent", i.e. committed without intent to damage the interests of the company's creditors. Nor indeed is it any defence for the directors to argue that the creation of the new company was in the creditors' best interests even if in fact that was the case.

Limited exceptions

There are only three exceptions to the s216 prohibition. 

• The first arises where a director applies to the court within seven days from the date on which the first company goes into liquidation for permission to use that company's name.
• The second exception relates to a situation in which the successor company has already been trading by the prohibited name for a period of 12 months at the point when the insolvent company goes into liquidation.
• The third exception derives from IR 4.228. In order for this exception to apply, the successor company must acquire the whole or substantially the whole of the business of the insolvent company under arrangements made by an insolvency practitioner acting as its liquidator, administrator or receiver. Under this procedure, the successor company must give notice in prescribed form to all the company's creditors within 28 days of completion of the transaction. In addition, the rule requires that notice be published in the Official Gazette. Significantly, if this procedure is not followed, there does not appear to be any provision in the insolvency rules for retrospective permission to be conferred. The only option available to the directors in these circumstances appears to be to apply to the court under s216(3) IA for leave to continue using the prohibited name. If, however, the new company becomes insolvent in the meantime, the director may still face civil claims.

Implications


The vice at which ss216 and 217 IA was aimed was the Phoenix Company Syndrome under which directors would intentionally collapse one company and create another in order to defraud creditors. It should be noted that the combined effect of ss216 and 217 goes beyond this and, in effect, creates a strict liability regime where there has been non-compliance. 


The courts have made it clear that there is no requirement for there to have been prejudice to the creditors resulting from the conduct in question. In, for example, Ricketts v Ad Valorem Factors Ltd EWCA Civ 1706; [2004] 1 All E.R. 894 where the successor company was trading under a similar name to that of the failed company, the issue was whether the successor company's name was a prohibited name for the purposes of s216. In this case there was no transfer of assets as an undervalue from the failed to the successor company. There was no evidence that the companies were used to incur debts and avoid payments nor was there any evidence that creditors of the failed company had been misled by the similarity of the two names. Despite all this, the court found that s 216 had been breached and, accordingly, the director was liable for all the debts of the successor company.


Conclusion


The "anti-phoenix" provisions of the IA are widely drafted, with plenty of room for interpretation by the courts. 


In the current economic situation, company directors and advisers should take heed of the provisions contained within s216 and s217 IA 1986, and take care in their application of the limited exceptions provided for in the Insolvency Rules. 


Given the current economic climate, it is more important than ever that company directors are aware of the effect of the anti-phoenix provisions contained in ss216 and 217 of IA 1986. Given the strict liability nature of these provisions, directors who are in breach (and especially those with access to liability insurance) will make very tempting targets for liquidators. The fact that there is little, if any, defence to a claim under s217 places it in a different category from the more typical wrongful trading and/or misfeasance claim, the outcome of which, from a liquidator's standpoint, can often be much more uncertain. As more and more companies are buffeted by poor economic conditions, directors who are genuinely interested in maintaining their business in a new company need to be aware of the risks associated with ss216 and 217. 


Otherwise, they risk being burned by the phoenix.

Landlords and Debt Relief Orders

Debt Relief Orders (DROs) are a new form of insolvency about which tenants are being advised by local CABs and authorised debt advisers. At first glance, social landlords may mistakenly believe that DROs may hinder their ability to recover rent arrears, however, the impact of DROs in this way, is somewhat limited.

What Is A Debt Relief Order?

A Debt Relief Order (DRO) is a form of insolvency which is an alternative to bankruptcy. They came into force in April 2009.

Who may apply for a DRO?

DROs are available to people who have very little surplus income (no more than £50 per month) and very few assets. Any assets owned by the debtor must be valued at no more than £300.

If the debtor owns a car, its value must be less than £1,000.

The level of debt owed must also be relatively low (no more than £15,000 in total).

The Insolvency Service website at www.insolvency.gov.uk/alternativestobankruptcy.htmprovides details about who may apply for a DRO.

What is the effect of a DRO?

Once a DRO has been made, there will be a moratorium period  usually lasting for a period of 12 months during which creditors cannot take enforcement action against the debtor without leave of the Court.

In addition, the debtor is prohibited from making payments towards any debts covered by the DRO.

Once the moratorium period has ended, any debts included in the DRO will be discharged.

Which debts can be included in a DRO?

Most debts can be included in a DRO including money judgments contained in an outright possession order or suspended possession order. Creditors, including landlords owed rent arrears, can raise objections to a debt being included in a DRO. The very limited grounds on which objections can be made are on the Insolvency Service website and can be accessed through the link above.

What is the effect of DRO's On Possession Orders?

The Insolvency Service does not seem to consider that DRO's have any effect on the validity or enforcement of possession orders.
Correspondence received from the Insolvency Service states that the principle in Harlow District Council –v- Norman John Hall [2006] EWCA Civ 156 applies to DROs.

Norman Hall was the secure tenant of a property owned by Harlow District Council.

By February 2004 Mr Hall fell into arrears with his rent and this led to a suspended possession order being made against him in February 2005.

A day after the suspended possession order was made a bankruptcy order was made against him.

After being made bankrupt, Mr Hall made an application to the Court seeking a discharge of the suspended possession order.

His application was dismissed.

Mr Hall then appealed to the Court of Appeal, who dismissed his appeal.

The Court of Appeal stated that a possession order was not a remedy for enforcing an outstanding debt for rent arrears, but was something that the landlord must obtain in order to recover possession of the tenant's property. A bankruptcy order did not therefore stop a landlord enforcing a possession order.

When DROs first came into force, it was not known if they would be treated in the same way as a bankruptcy order.

Recent indications from the Insolvency Service suggesting that they would be, are therefore helpful.

Landlords should note however, that any other methods of enforcement e.g. by way of an attachment of earnings order or a warrant of execution would not be permitted against a debtor who was the subject of a DRO, without leave of the Court. This is because these types of enforcement are used to enforce payment of the debt itself. The enforcement of a possession order essentially seeks to recover possession of the property.