Directors who dissolve companies to write off debts, only to start up near identical businesses shortly after, could be banned and fined under new regulations.
The government has moved to crackdown on so-called ‘phoenix companies’ as part of a raft of changes intended to protect employees and pension holders when companies are shut down.
The measures, which the government hopes to introduce next March, will give the Insolvency Service new powers to penalise and disqualify unscrupulous directors if it can be proven they have dissolved a company only to start a near-identical operation up again after wiping out its debts.
Under the proposals, company boardrooms will also be required to explain to shareholders how they can afford to pay dividends, clamping down on incidents of investors getting payouts when there is nothing left to cover wages or pension costs.
Struggling companies will also be given more time to find a solution to debt problems in a bid to cut down on the number being wound up.
The Phoenix Loophole
The rules on dissolving a company, last revised in the Companies Act 2006, are intended to cover instances where a limited company is no longer actively trading or the directors wish to cease trading. As long as the company is inactive and meets certain criteria, directors can apply for it to be struck off the company register.
This is supposed to be quite separate from insolvency law and the rules on liquidation, which govern what happens when a company has to close because of financial difficulties.
However, some directors use dissolution as a means of avoiding the tighter regulations around insolvency and liquidation. By letting a business lie dormant for three months they can have the company dissolved and, thanks to the protections of limited company law, are personally absolved of responsibility for any outstanding debts.
If a company is liquidated, the directors cannot take part in the running of a business with the same name for a period of five years. This does not apply with dissolution, which is why some directors use it as a loophole to wipe off debts and start up again within a period of a few short months.
While the proposals are welcome, there are the usual doubts over whether the government is prepared to go anywhere near far enough to tackle debt avoidance. Cracking down on phoenix companies which arise from dissolution will not stop directors using voluntary liquidation to wipe off debts, and then starting afresh under a different name.
It also doesn’t address concerns over pre-pack administration. We have seen the recent case where Sports Direct’s Mike Ashley has been able to buy up House of Fraser’s assets with no liability for outstanding payments owed to staff or to the company pension scheme.
Ultimately, while limited company law absolves directors of personal responsibility for company debt, you will always get unscrupulous individuals playing the system.