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The Race is on to Catch the Phoenix
We are all familiar with the Phoenix Bird from Greek and Egyptian mythology which is said to burn itself on an altar and rise again from its ashes young and beautiful. But in the world of credit, when a company does 'a phoenix' and rises again, it always comes at a high price to creditors. Phoenix companies have a bad reputation which is not surprising considering there have been numerous examples of directors deliberately running companies into the ground, buying the assets at a knockdown price, from a "friendly" liquidator, leaving the creditors of the original company with nothing. The directors have no obligation to pay back the original company's creditors; they can start again with a clean slate, and rise again just like the Phoenix Bird.
Analysing the phoenix concept, the author uses the example of the National Association of Paper Merchants that is trying to combat phoenix companies within its industry and illustrates the approach taken internationally on phoenix companies. The article explains how to protect business from dealing with phoenix companies, and gives seven key data elements to look for when spotting the next phoenix company.
The Enterprise Act 2002 was meant to prevent, 'phoenix company' syndrome where directors fold one company today, ditching its creditors, and starting a new company tomorrow, by operating a 'two hits and you're out system'. If a director has a second company put in compulsory liquidation, they face an automatic ban from being a director in future. However, the Act's effectiveness in preventing phoenix company syndrome is questionable.
In reality usually there are insufficient monies left after a liquidation to fund a proper investigation of the directors' conduct. The insolvency practitioner has very little incentive when their fees have been paid, and creditors often see funding an investigation as throwing good money after bad. Although the Act was intended to promote entrepreneurship and a corporate rescue culture, there have been cases where the Act has promoted the chance for business to start again by salvaging profit-making parts of a failed business. However, sceptics question whether companies that continue to fail leaving a trail of unpaid creditors should be allowed to rise repeatedly.
Rogue directors
With the legislation appearing too weak to prevent directors setting up a series of phoenix companies, it is up to those whom offer trade credit to protect their own business from rogue directors.
National Association of Paper Merchants
One industry sector that is getting tough on phoenix companies is The National Association of Paper Merchants (NAPM). The NAPM compiles a register of the details of failed printing companies. In its eyes a "failed company is a company that has entered into administration, receivership or liquidation due to being insolvent and where that fact is duly recorded as a matter of record within the public domain." The NAPM register is available to their members, so when they are setting up new customer accounts they can "crosscheck" the directors of that new account to see if it is potentially a "phoenix" company.
The NAPM states on its website that major merchants believe the failure rate of phoenix companies within the printing industry is unacceptably high. The former President of the NAPM, Martyn Eustace, says "This is a major initiative taken by the NAPM in an attempt to stem the flow of the huge amount of bad debt suffered by the paper merchant industry over the last five years and to root out the major culprits. Bad debts coupled with the ever increasing cost of credit insurance has become one of the major cost factors that merchants have had to grapple with in recent times. Merchants are frequently asked by their printer customers to do something about phoenix companies who generally damage the reputation of the printing industry and this initiative shows that the NAPM is serious about tackling this problem for the benefit of all."
If you wish to protect your business from serial phoenix organisations, it is important to verify the validity of a business you are trading with. Credit checks can be made using a commercial credit reference agency, agencies such as Experian, Graydon and D&B have developed sophisticated tools for monitoring directors activities, these include linking directors to previous failed companies and profiling the performance of other businesses in which they hold a company director appointment.
By credit checking your ledger using products and services provided by the leading agencies, phoenix organisations can be highlighted. In the majority of cases, it is likely your organisation would have previously traded with the failed company. Therefore, it is important to keep a record of customers that have gone bust; as it is likely they will re-approach you for credit from their "new" company.
"Lifeboat" companies
In some cases a "lifeboat" company is used for phoenix operations. A "lifeboat" company is one set up in the background as a dormant company, with the same directors whilst the existing company continues to trade. Should the existing company go into liquidation, for various reasons - usually serious losses, an insolvent situation, and/or starvation of cash - the owners simply transfer all trade and assets over to the other existing company "lifeboat" and continue to trade.
Looking at both sides of the coin
The issue of phoenix companies is not one that just effects UK organisations. For example, the Ministry of Economic Development in New Zealand considers both sides of the debate, where phoenix companies serve or are counter to the public interest.
The Ministry in New Zealand states that phoenix situations will promote the public interest where; the interests of creditors will be promoted through lower transaction costs and a higher sale price by using phoenix companies. For example, a higher sale price will be received, where existing directors/managers increase the company's value. Phoenix arrangements may also result in companies avoiding insolvency and its associated costs, creditors may prefer to have their security interests transferred across to the new company at a discounted value. In short as long as a true market value is received for the sale of the companies assets, the Ministry considers the use of phoenix companies as an effective way to meet creditors and debtors collective interests.
However, the Ministry considers phoenix operations to be counter to the public interest where a business is transferred at less than market value prior to insolvency, thereby reducing funds available to creditors. To do this, directors would need to obtain valuations made on a basis that suits the directors' interests rather than reflecting the market value of the business.
Kirsty McDonald of leading New Zealand law firm, Harkness Henry & Co, commented on the firm's website www.harkness.co.nz, "Existing laws probably do offer reasonable protection for creditors against phoenix companies and their masters, but the actual cost to creditors to enforce these are high."
Lack of investigation in the UK
Whereas in the UK this seems to remain a problem, the New Zealand government has reformed its insolvency laws to include criminal penalties if a director has acted inappropriately. Criminal penalties mean that creditors no longer have to pay to take action against the failed company, as the Crown will do this. However, in the UK, in my experience, the legislation is weak and the relevant authorities don't have the resources available to them, to investigate the number of phoenix operations occurring. Therefore, individual organisations must take steps to protect themselves.
By keeping a record of customers that have gone bust, the retained details will make it easier to identify a phoenix should they reapproach your business for a credit account. Phoenix companies can be successful. The use of phoenix arrangements to sell the business as a going concern can promote the interests of creditors (particularly employees, whom retain their jobs in the new company). Often by selling the business as a going concern a higher sale price is achieved and is an alternative to breaking-up and selling the business assets individually. However for those considering offering trade credit it is important to understand the reasons for the initial failure and the changes made to minimise the risk of re-occurrence.
How to spot a phoenix company
Seven key data elements to look for when spotting phoenix operations include:
1. The new company will often be newly incorporated. Look out for brand new company registration numbers. (The latest incorporated companies being issued a registration number in October 2005 start with a 0558**** pre-fix).
2. The company name will be similar to that of the failed company and in many cases the registered name is swapped with the failed company to give the impression of continuing trade.
3. The directors/owners will be the same and the information on company officers appointment forms will match in respect of home addresses and dates of birth.
4. The same business premises will often be used for the new trading entity or a location very near by, with many of the employees retained in the new venture.
5. The business activity will remain the same often with the same products and services, as will the types of products they order from your business.
6. The company share structure is often the same, typically with only a nominal £2 invested in share capital.
7. A new business bank account will be set-up often with the same bank and branch address for convenience.
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