Phoenix Companies and Debt Evasion

In ancient Greek folklore a phoenix was a bird which cyclically regenerated or was otherwise reborn again. It’s a nice idea and most of you will be forgiven for thinking that the phenomenon could never happen. However, if we substitute for a “bird” a “limited company” then the concept is almost one of legal abuse. This is because a phoenix company, in Scotland at least, is one which has ceased to trade or may have been struck off the company register due to, for example, a failure to lodge accounts. There will have been no formal winding up process. The company will have “died” in the sense that it has either been struck off or simply left with no assets. However, it may well have a bundle of liabilities. It will be reborn in the sense that a new company will be formed, possibly with the same directors as the old one, trading from the same premises and often having a similar trading name as the old bird. However, it will not inherit its liabilities.

In Scotland politicians of all parties have decided that businesses which do not pay their non-domestic rates should be named and shamed. Recent news reports stated there is as much as £50 million outstanding in non-domestic rates annually. Of particular concern are “phoenix companies”. How can this happen you may well enquire? Simple really. Whilst many may think that business rates are like a property tax it is not the property owner who is liable to pay them. It is, in fact, the occupier of the restaurant premises who has the liability. A typical ruse is as follows: a property on which a restaurant is run is owned by limited company “A”. It leases the restaurant to company “B” whose directors or shareholders could be a couple of unsuspecting waiters of the restaurant. Company “B” ceases trading after having run up substantial debts including non-domestic rates as well as utility suppliers. Court action is taken against company ”B” .By the time the judgment comes to hand a new company, company “C” (the phoenix) is incorporated with perhaps different waiters and shareholders but operating as the restaurant but as a new limited company. Whilst some assets may have been transferred form company “B” to company “C” for little or no consideration, there will be no assets left in company “B”. It is unlikely that creditors will petition for company “B’s” liquidation due to their being an insufficiency of funds left in the company from which a liquidator can take their fees .Creditors will be most reluctant to liquidate the company due to these and other expenses and the likelihood of there being no significant financial return for doing so.

Councillors and MSPs have welcomed the naming and shaming initiative. In stating that there is no excuse for failing to pay rates the councils believe that naming and shaming will help in recovering these non-domestic rates. Whilst West Dunbartonshire council are the first authority to adopt the strategy other councils, including Glasgow, are considering the position. That’s no small wonder when one considers that some of the debts can be over £100,000.

But will the initiative have any effect? Glasgow City is reported to have said that naming and shaming will allow “consumers ... to make up their own minds about that kind of behavior”.

However, other politicians are more sanguine and are describing the practice as “tax avoidance” and that more effective measures should be adopted. Whilst there has been discussion on the topic one suggested solution is that councils should have the power to transfer the liability from the business operator and occupier to the business owner. However the Scottish government have rejected this.

One possible solution could be that Scotland adopt an official receiver. In England, The Official Receiver (OR) is a civil servant working on behalf of the Insolvency Service, but is also an officer of the court. If Scotland emulated this then such a person could be a public official (much like we have the Accountant in Bankruptcy who often administer Scottish personal bankruptcies) and who could take action against the occupying company. They could proceed with liquidation and then operate the various sanctions contained in the insolvency Act, such as director disqualification and challenging unfair preferences. The issue here will be, of course, who will fund an official receiver? Doubtless the petitioning creditor will have to bear some of the expense with the public purse the balance. However, if adopted, this could be a workable solution to an age old problem and help ensure that Scotland is a good place to do business by ensuring that unscrupulous persons do not take advantage of others by forming phoenix companies as a way of avoiding debt.

Stephen Cowan is Managing Director of Yuill + Kyle.

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