When a company becomes insolvent, there are regulations in place that restrict directors and shadow directors from becoming involved in another company or business with the same (or similar) name as the company which has been put into liquidation.
This is Section 216 (s.216), and is in place to prevent “phoenixism”, where companies liquidate and evade paying outstanding creditors in full, then carry on trading as before. Through this model, the insolvent company’s business can transfer to a new company, while leaving its debts behind.
When does s.216 apply?
S.216 operates for the duration of 5 years following the date of liquidation. The section prohibits any director or shadow director of the liquidated company in the 12 months preceding insolvency from:
- Being a director of any company known by a prohibited name
- In any way, whether directly or indirectly being concerned or taking part in her promotion, formation or management of such a company
- In any way, whether directly or indirectly, being concerned or taking part in the carrying on of a business that is carried on under a prohibited name.
What are the penalties?
Directors who have been found guilty of a s.216 offence can be liable to serve a prison sentence, or a community service order, as well as a fine. They may also be disqualified from acting as a director.
Under s.217, any directors who have breached s.216 can also be held personally liable for “relevant debts” of the new company, on a joint and several basis with the company itself. “Relevant debts” are any debts or liabilities, including damages claims, which were incurred by the new company whilst the breach was ongoing – ie. whilst it was known by the prohibited name and the director was involved in its management. Liability in this respect is restricted to the time that the new company was known by its prohibited name and is automatic – so any creditors of the new company can pursue the director as they would the company.
Application of these sections are strict and there is no room for judicial discretion as to liability. This means that there are harsh consequences even for honest or unwitting directors.
Exceptions
There are three exceptions to s.216 of the Insolvency Act.
The first is where the new company was using the name for a 12-month period prior to the onset of insolvency. It must have been active for the whole 12-month period – it cannot have been dormant. This is intended to provide protection to companies which deal in a group with the same or similar names, so that the liquidation of one member will not impact the right of the remaining companies to use their names.
The second exception aims to protect those using ‘pre-pack purchases’. Where the new company has purchased the “whole, or substantially the whole” of the first company’s business from the liquidator, it is not prevented from using the name. In order to rely on this exception, a notice must be sent to all creditors and put in the Gazette 28 days prior to liquidation.
Finally, the director seeking to use the name may request the permission of the courts. Permission must be sought in advance of the liquidation – the application must be made within 7 days of the liquidation. This would then allow the director a six-week grace period in which they can continue to act as a director for the new business.
The consequences of using a prohibited name under s.216 can be harsh even on honest directors, so it is always best to seek advice as early as possible so that the right steps can be taken to fall within the exemptions. If you think that you may have an issue as above, please contact Jonathan Chadwick as our Head of Insolvency and Restructuring, at jonathan.chadwick@glaisyers.com.
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