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Phoenix law and the Companies Act

Introduction

A “phoenix company” is a company which has emerged from the collapse of another through insolvency. The new company is set up to trade in the same or similar trading activities as the former, and is able to present the appearance of "business as usual" to its customers. In this instance the owners and managers decide to abandon a failed company and start a similar business with a new company. Phoenix companies, as the name suggests, rise from the ashes of failed companies with similar names and similar or the same directors.

The provisions under the 1993 Act

The phoenix law provisions are set out in sections 386A to 386F of the Companies Act 1993 (“the Act”). In summary these provisions prohibit a director of a failed company from being a director of, or involved in the promotion, formation or management of a company that has a similar name to that of the failed company. The new company is referred to as “a phoenix company” in that it arises out of the ashes of the old company by virtue of it having many of the same personnel, and usually the key assets, of the former company.

Likewise, a director of a failed company may not be involved in the carrying on of a business that has the same or similar name to that of the failed company. Under a specific criteria, the law allows a liquidator to sell a business to a related party of the old company.

Section 386D of the Act

The phoenix law prohibitions mentioned cease to apply if the parties adopt the “successor company procedure” established under the Act.

Under this procedure, the “phoenix” or successor company must acquire the whole, or substantially the whole, of the business of the former company from a liquidator or receiver of it, or under a deed of arrangement made under the Act. The creditors of the former company must be notified of the acquisition and of the relevant other details including the proposal that the former directors become directors, or involved in the management of the successor company.

Creditors may be placed in an awkward position when they ask for payment from the phoenix company only to be told that their debts are owed by the former company only. Creditors are more likely to be misled by the directors starting a company with a new name than one with the old name. Yet, the regime has no application where a new name is used.

Alternatively, the purpose of the regime may be to deny the director and shareholders advantages that there might be in using the company’s name, otherwise the phoenix company would not want to adopt a similar name. It is not apparent that any difficulty arises where the relevant director has paid full value for the goodwill associated with the name. The Courts have noted that any goodwill must be provided for in the acquisition of the former company’s assets by the phoenix company. Even where it is only the name that is common to the former company, the law may allow the liquidator of the former company to recover payment for its use. However, the nature of the new provisions provides an incentive to ensure that adequate value is paid for the use of the name.

At the same time the successor procedure may slow down the restructuring of businesses because of the need to ensure that the transferring company goes into liquidation, receivership or voluntary administration before a transfer of the assets occurs.

Example from case law

In Sojourner v Robb [2008] 1 NZLR 751 (CA) the relevant company had a successful engineering business making fibreglass and other products, including small boats, bus bodies, and shower enclosures for bathrooms. It extended into building large catamarans on commission which proved uneconomic and led to a dispute with the plaintiff.

The defendants responded by causing the company to cease to trade, and by transferring most of its assets to a new company with a very similar name. While realistic prices were paid for the tangible assets, nothing of substance was paid for the goodwill of the old business. The directors and staff moved to the new company, and business returned to normal. In the High Court, Judge Fogarty found that the defendants were in breach of their duties of loyalty to the company by failing to obtain value for the company’s goodwill, a figure estimated to be in the region of several hundred thousand dollars.

It appears that as part of the restructuring the directors paid off the general creditors of the company, but left nothing for the claims of the plaintiff. It is suggested here that directors, even after insolvency, can pay some creditors ahead of others if there is good reason to do so. It is doubtful whether this is consistent with the general duties, after insolvency, for directors to preferentially pay some creditors, nor to withhold payment deliberately to shut out a particular claimant.

The Court decided that directors must ensure that they do not profit from the transfer of assets to the phoenix company. Where the assets have a greater value to them, as associates of the phoenix company, than to the market, they would be accountable for that difference. That obligation applies as much to the sale of the company’s goodwill as to its other assets. Where directors want the new company to continue to use the old company’s name is a strong indication that there is some goodwill attached to the old company’s business. The Court of Appeal affirmed that the onus lies on the directors to show that a sufficient amount was paid. Given that on the facts of this case nothing was paid, the defendants were vulnerable to a sum being awarded against them.

Conclusion

Both directors and creditors of companies need to be aware of the phoenix law provisions. Directors need careful legal advice to ensure their companies are not engaging in illegitimate phoenix activity. In addition, creditors of companies should take legal advice, as the new provisions open up potential liability against those who may be involved in such activity.

Jerome is a Senior Solicitor in our Māori Legal Team and can be contacted on 07 958 7427.


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