“RISING FROM THE ASHES” - PHOENIX COMPANIES

Posted by Jesvin Boparoy on September 23 2022 in News

Recently, there has been a rise of failed companies (particularly within the construction industry) where directors seek to restart their businesses again via a “new company” with a similar trading name, staff, assets, and overall business plan but without taking over the old company’s debts. 

If the director of a failed company has created a company with a similar name at any time, before or within five years after the commencement of liquidation, then that new company is known as a “phoenix” – basically rising from the ashes like the old mythical Phoenix bird. 

There are strict rules that apply to phoenix companies under sections 386A to 386F of the Companies Act 1993 which are slightly complicated, and perhaps not well understood. 

In short, except with the permission of the court or by way of legislative exceptions, a director of a failed company must not:

1. be a director of a phoenix company; or
2. directly or indirectly be concerned in or take part in the promotion, formation, or management of the phoenix company; or
3. directly or indirectly be concerned in or take part in the carrying on of a business that has the same name as the failed company’s pre-liquidation name or a similar name.

If he/she does, they can be liable for breaching the phoenix company rules which impose a conviction for up to five years imprisonment or a fine of up to $200,000, banishment from acting as the director of any company, or being personally liable for the debts of the phoenix company. 

The reason for the hefty penalties relate to Parliament’s intention to prevent directors from simply abandoning the old company’s debts and liabilities, and incorporating a new company to effectively carry on the same business and leverage off the goodwill of the old company name.  Often directors that do this have an intention to defraud their existing creditors.

Like any legislation, however, there are exceptions to the phoenix rules, and there will soon be more proposed legislative changes to identify phoenix activity quickly.

It is important to understand that there is no general prohibition on directors starting afresh even if it is with a similar business. Instead, the law (through the various phoenix exceptions) seeks simply to ensure that customers and suppliers are not misled or confused as to which entity they are dealing with, are aware of any former insolvency and any related sale of assets to a new company (whether it be for fair value). It is then up to those suppliers and customers to make an informed decision on whether they wish to continue to trade with the phoenix company.

Exceptions to the phoenix rules

Aside from a director getting a court exception to operate a phoenix company, there are three other statutory exceptions in sections 386D to 386F of the Companies Act 1993 which allow directors to create a phoenix company. 

Exception one:

Where the director purchases the old business from the failed company from a liquidator and notifies all creditors in a way that complies with the statutory exception in section 386D of the Companies Act 1993 via a “Successor’s Company Notice”.

The “Successor’s Company Notice” must be sent to all creditors within 20 working days after the acquisition of the business and specifically inform all creditors of:

1. The name and the registered number of the failed company
2. The circumstances in which the business has been acquired by the successor company
3. The name that the successor company has assumed for the purpose of carrying on business
4. Any change of name that the successor has made for the purpose of carrying on business
5. The director’s full name, the extent of involvement in the management of the failed company, and the duration of his or her directorship of the failed company.

Exception two:

Allows a temporary exception to the phoenix rules where the director has applied to the Court within five working days after the commencement of the liquidation of the failed company for an exemption to act. While the Court considers that application, the director is allowed to operate a phoenix company “temporarily”. The second exception is only a temporary solution and lasts for up to six weeks after the commencement of the liquidation.

Exception three

Where the phoenix company has been trading for at least 12 months before the failed company’s liquidation, with the same or a similar name.

Provided the director complies with the statutory exceptions, they will be afforded protection from personal liability.

Directors of a phoenix company should, however, be aware that operating a phoenix is not without risk, especially where it is typical for directors of failed companies to transfer assets to a new company at undervalue.  Transferring assets at undervalue can be voided by a Liquidator and are contrary to the insolvency law provisions which require a fair value to be obtained from the sale of assets. Legal and professional advice should be sought before taking on a directorship of a phoenix company.

Proposed Bill to track down phoenix activity

The Minister of Commerce and Consumer Affairs has recently announced that Parliament will be looking to introduce a finalised Bill in late 2022 containing amendments to the Companies Act 1993, which would help track down phoenix activity quickly.  

The proposed law changes will include the introduction of a “director identification number” which would help the public track a director or owner setting up companies under different names. It will also require all New Zealand registered companies to provide accurate information about their “beneficial owners”.  In theory, this will make it harder for directors to conduct phoenix activity. 

For further information about phoenix companies and how the proposed legislation may affect you, we suggest you contact:

Kalev Crossland | Partner | Kalev.Crossland@shieffangland.co.nz

Jesvin Boparoy | Senior Associate | Jesvin.Boparoy@shieffangland.co.nz