Wrongdoing in insolvency: part 4

This week we look at sections 216 and 217 under chapter X of the Insolvency Act 1986. These provisions are designed to deal with the problem caused by the so-called "Phoenix" syndrome, named after the legendary bird which emerges reborn from the flames. The problem arises in the following circumstances. Let us say that there is a company called XYZ Ltd. Those running the company establish a good name for the company, and a significant market. However, in no rush to acquire market share and goodwill, they expand too quickly, and acquire that goodwill partly through using tight profit margins. This builds up significant debt. What they then do is liquidate the company, transfer the assets to a new company, and get the new company to operate either under the name XYZ Ltd or something so similar to the same (whether by sight or sound) so as to effectively take over that goodwill. They then have all the benefit of the company they built up, but have conveniently left all the creditors to whistle for their money. Needless to say, this type of behaviour is frowned upon by creditors and the authorities alike.

However the problem is not necessarily confined to those people who are deliberately trying in some discreditable way to avoid paying creditors. Those involved in the company may have behaved perfectly properly, but still effectively appropriate the name. If they want the name, then it must have some value (even if it is value which is only relevant to them: if there is something which only one person really wants, there is still a price they will pay to avoid anyone else getting hold of it). There is also the issue that other people may be under a misapprehension that so far from this being a new corporate venture succeeding to one which has failed, they may think it is the same established business or linked to it.

Sections 216 and 217 only deal with the issue of the company name. Other issues, such as transfer of assets at undervalue, are dealt with in other sections of the Insolvency Act and such issues have been considered in earlier articles in this series. (See for example Office holders Powers part 12 and following articles).

The persons to whom section 216 applies are people who within the 12 month period ending on the day before the company went into liquidation were directors or shadow directors of the relevant company, referred to in the section as "the liquidating company". (for the definition of shadow director see Office holders Powers part 13). The liquidating company must be one which went into liquidation at a time when its assets were insufficient for the payment of its debts and other liabilities and the expenses of the winding up.

The restrictions within the section related to prohibited names as defined by section 216 (2) (although of course these restrictions only apply to the persons to whom this section applies as referred to in the previous paragraph: if someone else uses such a name then although there may still be certain consequences if for example it breaches any rights of the company in liquidation to the name, such as may arise in respect of trademarks or under the doctrine of passing off which protects goodwill in the name, those will only be protectable, if they are protectable at all, by the liquidator suing in the ordinary way on behalf of the company. Persons who are not shadow directors or directors at the relevant time are not covered by section 216, so that the statutory prohibition and specified consequences will not apply to them). A prohibited name is the name by which the liquidating company was known at any time in the 12 months ending the day before the company went into insolvent liquidation, or a name so similar to a name by which it was known in that period as to suggest an association with the liquidating company.

If the names are identical then there is obviously no difficulty. The question of similarity is a question of fact for the court to decide. The relevant test is whether it is probable that members of the public would associate the two companies with one another, whether because they would be likely to think that one was a successor company to the other or that they were linked as part of the same group. The public would not have to believe that they were the same company. In considering these matters all the facts and circumstances such as the nature of the companies and the type of the business will be considered. A similar name can be similar even though a different word is added to it. Thus in one case "MPJ Construction Ltd" and "MPJ Contractors limited" were regarded as sufficiently similar.

We will continue considering the provisions of this section next week.