What is a Phoenix Company and are They Legal?

What are the rules around the process of phoenixing?

What is a Phoenix Company?

A Phoenix company gets its name from the mythical bird of fire that rises from the ashes, and in essence, that’s exactly what a Phoenix company does. A Phoenix company is formed when the assets of an insolvent company are purchased by the company’s directors. After closing the old company, they start a new business that continues to operate in exactly the same way.

While creating a Phoenix Company can be a legitimate way to rescue a business and preserve jobs, the practice is sometimes abused. In some cases, directors may deliberately run a company into insolvency to shed debts, only to start a new company doing the same thing, leaving creditors out of pocket^[1]Trusted Source – .GOV- Phoenix companies and tax abuse.

Key characteristics of a Phoenix Company:

1. It is a new legal entity established to continue the business of a company that has entered insolvency.
2. It usually has a similar name, the same directors, and operates in the same industry as the failed company.
3. The assets of the insolvent company are purchased by the new company, often at a discounted price.
4. The new company is not liable for the debts of the old company, which are left behind in the insolvent entity.

Are Phoenix Companies Legal?

In the UK, Phoenix companies are legal if they are legitimately and transparently set up. The new directors can’t be on the bankruptcy register or have faced any kind of directorial disqualification.

When the liquidator puts an insolvent company’s assets on the market, the best offer often comes from the directors themselves, and as such, it’s perfectly legitimate for that sale to occur within the context of a pre-pack administration.

However, if a Phoenix Company is set up with the intention of defrauding creditors, it is considered illegal. This practice is known as “phoenixism” or “phoenix abuse.” The Insolvency Service, a government agency, has the power to investigate and prosecute directors who engage in such fraudulent activities.

What are the Rules Surrounding Phoenix Companies?

In the UK, phoenix companies are subject to a number of rules including:

• The previous company’s assets must be sold at a fair market price, and the creditor’s interests must be considered during the process.
• The Phoenix company must have a completely different name and trading name from the insolvent company unless with a specific court agreement. This helps to distinguish the new entity from the old and prevents confusion among customers and creditors.
• Compliance with the Insolvency Act 1986 and obtaining the advice of a licensed insolvency practitioner are essential for proper adherence to legal and regulatory requirements.

How is a Phoenix Company Purchased?

The process involves carefully selecting which assets of the insolvent company will be purchased. This decision is based on what is necessary and viable for the new company’s operations. It’s not uncommon for some assets to be left out of the purchase to streamline the new entity and focus on its core business.

The money gained from selling these assets is used to repay the creditors of the insolvent company. An important aspect of this transaction is the transfer of employee contracts. Under specific legislation, such as the Transfer of Undertakings Protection of Employment (TUPE) regulations, the employment contracts may be transferred to the new company, ensuring continuity and protection for the employees.

In cases where the full purchase of assets is not immediately affordable, a deferred sale and purchase agreement might be an option. This arrangement allows for the assets to be acquired over a period, making the purchase financially more manageable.

Targeted Anti-Avoidance Rules Combat Misuse of Entrepreneurs’ Relief

New ‘anti-phoenix’ rules from HMRC apply to liquidated companies that fulfil certain conditions, suggesting they have been wound up to avoid income tax.

The four conditions required to qualify as an offender are:

1. Shareholders must hold a minimum of 5% equity and voting interest before the liquidation begins
2. The distributing company must be currently or in the 2 years before liquidation a ‘close company’, meaning it has five or fewer participants
3. The recipient shareholders are seen to be involved in a similar business within a two-year period of shutting down the original company.
4. The ‘reasonable’ evidence suggests that the liquidation was prompted by a chance to pay reduced income tax.

How is Abusive Phoenix Activity Identified?

Here are the key indicators of abusive Phoenix activity:

1. Undervalued asset transfers to a new company
2. Pattern of insolvency under the same management
3. Overlapping directors, shareholders, or management
4. Non-payment of taxes and employee entitlements
5. Disadvantaged or unpaid creditors, similar business continues
6. Lacking transparency in asset transfers
7. Business operations continue unchanged after insolvency

Want more Information About Setting up a Phoenix Company Out of a Pre-pack Administration?

It’s a fact of life that not all legitimate businesses succeed at the first time of asking. In fact, one in three businesses closes within three years. In this case, a new company allows a business to start again from scratch, and for the profitable elements of the business to survive for both the suppliers’ and the employees’ benefit. There is the question of making sure that the same mistakes are not made again going forward.

For more information, please get in touch with our expert team today on 08000 746 757 or hit the button on the bottom right-hand side for live support.

Phoenix Company FAQs

References

The primary sources for this article are listed below, including the relevant laws and Acts which provide their legal basis.

You can learn more about our standards for producing accurate, unbiased content in our editorial policy here.

1. Trusted Source – .GOV- Phoenix companies and tax abuse