Directors wanting to use the phoenix company provisions in the Companies Act 1993, to continue in a governance or a management role, need to apply to the court as a matter of urgency.
The High Court, in the first contested application of the rules, penalised the director for delay.
In Groves v TSSN Limited (in liquidation),1 the High Court refused to grant a director permission to continue as a director, but did allow him to continue taking part in the management of the company. For a copy of the case, click here.
The deciding factor was that the applicant, although he had been alerted to the phoenix company provisions, had continued as a director without seeking the Court’s permission. The Court considered that this failure reflected poorly on his fitness to be a director and refused the exemption.
The phoenix company rules
Sections 386A to 386F of the Companies Act prohibit a director from taking part in the management or governance of a “phoenix company” for five years after the liquidation – except with the express permission of the court and under appropriate supervision and controls.
A phoenix company is one that uses the same or similar legal or trading name of a company that went into insolvent liquidation. A name is “similar” if it suggests an association with the old company.
The Groves case confirms that the provisions are intended to address the risks that:
- the assets available in the liquidation of a failed company might be reduced by the sale of the business at less than market value to persons associated with the failed company, and
- creditors may extend credit to the new “phoenix” company without being fully informed of the risk.
The Court noted that there may be good commercial reasons, and value to the vendor of the business, in maintaining a continuity with the failed company. For example, it is not unusual, in the sale of a business, for the purchaser to be granted the right to use the business name, as part of the goodwill of the purchased business. Sometimes, too, the continued involvement of key personnel may contribute value to the business, which a purchaser will wish to retain. For that reason, the Court has the power to permit a director to remain involved in a phoenix company.
The liquidation of the old company will, as happened in Groves, often occur after the establishment of the new (phoenix) company. In such cases, the Act gives those directors already involved in the phoenix company a five working day window within which to apply to the Court for permission to continue.
The director is then deemed not to breach the prohibitions for the six weeks following the liquidation, which should be enough time to get at least an interim exemption from the Court.
In addition, certain arrangements are automatically exempted from the Act. These include:
- sales by receivers, liquidators and under deeds of company arrangement where a “successor company notice” is given2, and
- where the phoenix company has been trading and known by the same or similar name of the failed company for at least a year prior to the failed company’s liquidation.3
Factors the Court will consider in granting permission
Assuming that the director has applied for permission to continue within the timeframe set by the Act, the Court will consider:
- whether a fair market value of the failed business was obtained. This may require evidence of the valuation on which the sale price was based, or evidence that the sale price was established by a competitive sale process
- whether the creditors of the failed company were prejudiced by the sale to the phoenix company, and
- whether creditors of the new company are aware that it is a “phoenix” company.
Even if permission to act as a director is refused, the Court may allow the applicant to take part in the management of the phoenix company. This was the outcome in Groves, where the Court concluded that “the applicant’s experience and his contacts were important to the phoenix company’s business, and that there was a risk of damage to that business if he was unable to perform his management and executive role”.
Directors need to act promptly
The key lesson from the Groves decision is the need to seek the Court’s permission urgently when the phoenix company provisions are triggered. Being familiar with the law is obviously the first step in gaining that permission.
In Groves, the applicant waited several months before filing his application, by which time the exemption under section 386E no longer applied.
Directors should also be mindful of other situations in which the provisions will be triggered. For example, if a former director of the failed company, who had not initially been a director of the phoenix company, wished to become a director at a later point within the five year period prescribed, permission would be needed.
Where a director is in office in contravention of the rules, that director is at risk of conviction. It is an offence to continue to act as a director without permission from the Court (maximum penalty is five years prison or a fine not exceeding $200,000).