Born again directors
Page 28
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you will prob
ably have experienced, or heard of, the following: Company X, a freight forwarder, (probably under-capitalised and insolvent from the day it com menced trading) acquires transport services from you on credit.
Payment is not forthcoming within the credit period. Rumours begin to be whispered about Company X's difficulties, culminating in a frenzied dash to recover money or return of goods before its collapse. The receiver or liquidator is appointed before the frenzied dash produces any benefit, a few weeks later Company X has been "born again". It is a new company acquired off the shelf, with similar or identical directors and/or shareholders, and a similar (sometimes identical) trading name..
It is not a crime in this country to be a director of a company that goes insolvent: likewise, it is not a crime if you set up a new business and begin trading again following insolvency. Neither is it a crime for any receiver or liquidator to sell the business or assets, of Company X to a new off-the-shelf phoenix company set up by the former directors of Company X. In practice, the phoenix company may well be the only interested buyer of the business/assets of Company X. That could tell you more about the state of our economy than criminality.
Distinction should be drawn between sales of businesses/assets occurring before as opposed to after appointment of receivers/liquidators. In recent years there has been a tendency for such sales to take place before the appointment of a receiver/liquidator.
However well dressed up or presented, pre-insolvency sales carry an unpleasant smell about them. Pre-insolvency sales may well be challengeable by a Liquidator, in which case the unsecured creditor's remedy is to exercise his voting power at the creditors meeting, and try and ensure that a liquidator is appointed who is most likely to investigate and if possible challenge it.
One of the main purposes of the 1986 Insolvency Act was to reduce the increasing abuses of the concept of limited liability by directors. In part it has succeeded, but phoenix companies rising from the ashes always have been and will continue to be a source of irritation to unsecured creditors.
The Insolvency Act 1986 did introduce one measure in relation to phoenix companies, namely Section 216. This restricts an individual who was a director of a company during the 12 months
preceding its entry into insolvent liquidation from being: (a) a Director of a company; or (b) in any way concerned or take part in the promotion formation or management of a company; or (c) in any way be concerned or take part in the carrying on of a business (otherwise than by a company) whose name is similar or identical to the name of the insolvent company—unless the individual in question obtains the permission of the Court.
Breach of Section 216 amounts to a criminal offence and renders the individual in question personally liable for certain debts of the phoenix company
Apart from Section 216, what remedies does the unsecured creditor have in these circumstances? The answer is many, but in practice they may be of limited value. Arguably, the first is the most effective. 1 Through your credit control techniques _L avoid being left as an unsecured creditor. This is stating the obvious but occasionally the obvious needs to be stated.
2If you are a supplier of goods, then incorporate a retention of title clause into your terms and conditions. This is one effective remedy for any unsecured creditor, as the effect is to elevate the unsecured creditor in the "pecking order" of priority in a receivership or liquidation. An undertaking should be sought from a receiver or a liquidator that he will not sell dispose or deal with the goods pending resolution of the retention of title (RoT) claim. Even if such an undertaking is not forthcoming and the goods are sold on to the phoenix company, the likelihood is that the phoenix company acquires those goods subject to the claims of RoT creditors. Consequently, the claim in relation to the goods can probably be advanced, in most cases, against the phoenix company, 0 At the outset of your trading relationship
with Company X, obtain security or, if practical, a personal guarantee from the director of company X: this may not recover you money but it gives you a chance of proceeding against a director and if necessary seeking a bankruptcy order against him.
A It may well be that the phoenix company `-± requires continued supplies and approaches you for them_ In such circumstances high morals or principles are often subordinated to commercial realities— given the present state of the economy — particularly if the loss in Company X can be mitigated by an increased profit margin in supplying the phoenix company..
5If all else fails, then the unsecured creditor is left with the somewhat watery option of complaining about the conduct of the director of Company X to the receiver/liquidator, in the hope that an adverse report is filed by the latter with the Disqualification Unit of the DTI. This may lead to proceedings being started against the director, disqualifying him from holding the position of a director, or being involved in the management of a limited liability company.
The present system whereby directors (whether formally appointed, de facto or shadow) of insolvent companies are subjected to a system of investigation, monitoring and sanction is probably the best "fudged compromise" that can be produced. One way to improve the system is to give it proper resources with a view to pursuing, and rendering harmless, those rogue or "born-again" directors.
The need for an effective form of policing, eg the DTI Disqualification Unit appears to become even greater.
For the present, minimise your risk or exposure and if you cannot or will not walk away from the occasional "hit", then perhaps corporate vigilantism is your answer. Self help does appear to be fast becoming the order of the day.
0 by Julian Horrocks
Julian Horrocks is head of the insolvency unit at commercial law firm Eversheds Hepworth & Chadwick.