Phoenix company

Phoenix company
See also
Funding agreement Corporate opportunity doctrine Hobby loss rule Fraudulent Conveyance Profits interest Capital rationing Turnkey business Litigation risk Nominee company

Phoenix company gets the name from the mythical bird of fire which rises from the ashes and that's exactly what a phoenix company does. It's a commercial entity which has formed when the assets of a failed company are purchased by the company's directors during administration. After closing the old company, they can start a new business which continues to operate in the same way using these assets. Customers can see the company “as usual”. The result is that the business can resume trading as a new corporate entity with a completely clean slate.

A typical Phoenix Company

The most common situation is when:

• A new company, which we call “NewCo”, begins trading as an identical business from the same location, with a similar trading name as another company, which we call “OldCo”.
• The assets of OldCo are transferred to NewCo and no consideration is paid for those assets.
• OldCo probably enters liquidation and leaves a number of creditors unpaid.

The situation as described is a bad thing for two main reasons. First of all, there is the financial loss suffered by the creditors of the OldCo when they don't get pay. Secondly, the situation is unfair for the competitors of the Phoenix Company – if a company is not paying the tax debts or trade creditors than its cost base is understated, usually in a big extent and a competitor can't match its pricing.

Legal or illegal

It is important to note that phoenix activity can be legal as well as illegal. Legal phoenix activity covers situations where the previous controllers start another similar business when their earlier entity fails in order to rescue its business. Phoenix activity can be entirely legal, when the worth of the insolvent company's assets is maintained and the employees keep their jobs and entitlements. It's describes this as a “legal phoenix activity, or business rescue”. However, the repeated resurrection of a business can become problematic even with the best of intentions if the returns to creditors and benefits to employees are minimal. It becomes illegal where the intention of the company's controllers is to use the company's failure as a way of avoiding paying Oldco's creditors (who may include the company's employees) that which they otherwise would have received had the company's assets been properly dealt with.

Australian Securities and Investments Commission approach to Phoenix Companies (ASIC)

ASIC has a special team dealing with Phoenix Companies. ASIC has taken a number of legal actions in last years against directors and their advisers and ASIC considers there has been a Phoenix Company. It's important to remember that there is no definition of a Phoenix company in the Corporations Law - ASIC has taken action under a variety of sections of the Corporations Act. In the last cases taken by ASIC, there is a common part that assets were transferred from one company to another for no consideration. That is, the NewCo started using the assets of the OldCo but did not pay for those assets.

Australian Taxes Office approach to Phoenix Companies (ATO)

The ATO also has a dedicated Phoenix Company team and has taken action against directors for what the ATO considers Phoenix Company situations. The aim of the ATO legal actions has been “payroll” companies. That is, where a company sets up a subsidiary that employs staff. That company will incur a large debt to the ATO for deducted PAYG (pay – as – you – go) deductions from staff wages. The holding company just quit the subsidiary and creates a new payroll company. The ATO attidute is to issue default judgement against the payroll company and to seek to have a liquidator appointed to the payroll company. The final goal is to have the liquidator repay a debt due from the Holding Company to the payroll company in liquidation. ("Defining and profiling phoenix activity" 2014)

United Kingdom

Company law in the UK has been formed to allow such activity to protect and promote entrepreneurship, by reducing risk and improving the chances of continued trading and business development. It is perfectly legal to form a new company from the remains of a failed company. Any director of a failed company can become a director of a new company unless he or she is:

• subject to a disqualification order or undertaking;
• personally adjudged bankrupt;
• subject to a bankruptcy restriction order or undertaking.

UK law allows company owners and directors to set up a new business and carry on trading in much the same way as they were, as long as the individuals involved are not personally bankrupt and have not been disqualified from acting as directors. If everyone who ran into insolvent debt problems was banned from ever starting again you would wipe out some of the best-known brands today. ("Carbon copy companies", 2014)

Examples of Phoenix company

• The most famous example of a Phoenix company is the rise of Apple Computers from the ashes of Apple Computer Inc. In the mid-1990s, Apple Computer Inc. was struggling to remain competitive in the computer industry and had to declare bankruptcy. The company was bought by a new company, Apple Computer Inc., and was then rebranded as Apple Inc. The new entity was able to keep the same product lines and customer base, while also introducing new products such as the iPhone and iPad.
• Another example of a Phoenix company is the British car manufacturer MG Rover, which was formed after the collapse of Rover Cars in 2005. The new company was able to purchase the assets and factories of the old company and continue producing vehicles under the MG Rover brand.
• The U.S. company General Electric is also a Phoenix company, having risen from the ashes of the failed conglomerate General Electric Company in the early 2000s. The company was able to purchase the assets of the old company, and was able to continue producing products such as appliances and light bulbs.

Advantages of Phoenix company

The advantages of a Phoenix company are:

• It can provide an opportunity for a business to continue trading, thus preserving jobs and business relationships.
• It allows a company to be re-established with a clean slate, free from any debts or obligations of the former company.
• It provides a chance to negotiate favourable terms with suppliers, as they are aware of the company's poor financial position.
• It can allow a company to retain its brand name, making it easier to re-establish itself in the market.
• It allows a company to remain operational while restructuring its operations.
• It can provide a chance to re-evaluate the business model and make improvements.
• It allows a company to take advantage of reducing costs by renegotiating rental agreements, taking advantage of new technology and investing in new markets.

Limitations of Phoenix company

A Phoenix company has the potential to provide a new life to an old business, but there are several limitations to be aware of. These include:

• Lack of credibility - as the company is new, it will take time for customers to trust it;
• Lack of resources - the new company may not have access to the same resources as its predecessor;
• Risk of being sued - the new company may be held liable for the debts and other obligations of the predecessor;
• Limited access to financing - the new company may not be able to obtain the same level of financing as the old company;
• High costs - setting up a new company can be expensive, and the new company may struggle to cover the costs of doing so;
• Inability to compete - the new company may have difficulty competing in the market against established companies.

Overall, these limitations must be considered when setting up a Phoenix company, and the potential benefits must be weighed against the risks.

Other approaches related to Phoenix company

A Phoenix company can also be formed through other approaches such as:

• Asset Purchase – This involves the company buying assets from the insolvent company to form a new business.
• Share Purchase – This involves purchasing the shares of the insolvent company in order to form a new company.
• Management Buyout – This involves the management of the insolvent company buying the company to form a new business.
• Administration – This involves the company entering administration and being sold to a third party to form a new company.

In summary, Phoenix companies can be formed through a variety of approaches, including asset purchase, share purchase, management buyout, and administration. Each approach has its own advantages and disadvantages, and it is important to understand these before deciding on the best approach for a particular situation.

References

• Anderson H., O’Connell A., Ramsay I., Welsh M., Withers H., (2015) Defining and profiling phoenix activity
• Blair-Loy M., Wharton S., Goodstein J., (2011), The Phoenix Companies: Mission and ValuesOrganization Studies, 32(3)
• Anderson H., Ramsay I., Welsh M., (2016) Illegal Phoenix Activity: quantifying its incidence and cost 24 Insolvency Law Journal, 95
• Anderson H., O’Connell A., Ramsay I., Welsh M., Withers H., (2015) The productivity commision, corporate insolvency and phoenix companies 33 Company & Securities Law Journal, 425

Author: Katarzyna Górna