Consider the following scenario:
Joe Lollipop Limited has been trading for a number of years from 5 Glebe Street, Glasgow. This is also the company’s registered office.
Fred Fish is the sole director of the company and he is aware that trading conditions are poor. His broad understanding of limited liability is that he is not personally liable for the company’s debts. However, he carries on trading regardless. He then has what he considers to be a great idea. He will incorporate a new company called Joe Lollipop (Glasgow) Limited with its registered office at the same address. But, prior to doing so, he ensures that Joe Lollipop Ltd orders a large number of goods on credit from existing suppliers. This is done prior to the incorporation of Joe Lollipop (Glasgow) Ltd. Once the goods arrive, he will ensure that they are transferred from Joe Lollipop Ltd to Joe Lollipop (Glasgow) Ltd.
Naturally, Joe Lollipop (Glasgow) Ltd has not paid any money for the goods to Joe Lollipop Ltd, nor is there any consideration paid for them. Indeed all of Joe Lollipop Ltd.’s assets are made over to the new company for no consideration. So, by the time the goods have arrived at Glebe Street, the new company has been incorporated and Fred simply starts selling them.
The suppliers are unaware that a new company has been incorporated. Indeed, as far as they are concerned, they have supplied their goods to Joe Lollipop Ltd. They decide to instruct their lawyers to take court action against Joe Lollipop Ltd for the sums due to them.
Court action is taken and is undefended. Decree (judgment) is extracted and sheriff officers (High Court enforcement officers) are instructed. When they report back to the lawyers they tell them that they attended well stocked premises in Glebe Street and interviewed Fred Fish a director of Joe Lollipop(Glasgow) Ltd who stated that Joe Lollipop Ltd ceased trading some time ago and that Joe Lollipop(Glasgow) Ltd are now trading from the premises.
The lawyers report this back to their client who is furious. How much did the new company pay for the assets? Surely Joe Lollipop Ltd was trading whilst involvement? They then instruct their lawyers to petition for Joe Lollipop’s liquidation in the sure and certain belief that a liquidator will utilize all the available remedies against Fred Fish who orchestrated this “fraud”.
The liquidators assess the situation and conclude very early on that Joe Lollipop (Glasgow) Ltd is a phoenix company and that it was likely that it was Fred Fish’s clear intention to move the assets from the old company to the new company for no consideration. Indeed, the liquidators say it is likely that all of the assets were transferred in this fashion for either no or totally inadequate consideration. As such, the full force of the insolvency legislation should apply with action being taken against Fred for fraudulent preferences, trading whilst insolvent, wrongful trading and potential disqualification procedure.
The creditor is happy that Fred will be “brought to book”, so to speak.
There is only one problem, and that is – who pays the liquidator? In Scotland, because there is no official receiver, the liquidator will want to ensure that the company which they are liquidating has sufficient assets which, when disposed of, will be sufficient to discharge the liquidator’s fees and disbursements. In the absence of there being such assets, the liquidator will have to look to the petitioning creditor to discharge these and they will amount to several thousands of pounds.
And this is where the creditor gets very frustrated and irate. The position is that Fred deliberately moved the assets from “old co” to “new co” precisely to leave “old co” with no assets. He knows that it will be unlikely that the creditor will petition for Joe Lollipop Ltd’s liquidation precisely because it has no assets and that the creditor will not fund the liquidation.
So, matters will probably just lie as they are with Joe Lollipop Ltd ultimately being struck off the company register.
Section 216 of the Insolvency Act 1986 makes it illegal for any person who was a director of a company at any point in the 12 months before that company went into liquidation to be involved in another company with the same or a similar name for a period of five years. These laws also apply to shadow directors. A shadow director is a person who acts in the role as a director although is not formally appointed.
The legislation was created to stop directors from liquidating insolvent companies and then starting up a company with the same or a similar name to stand in the place of the original liquidated company. This is, of course, what Fred has done. The legislation’s intention is to prevent “phoenixism” which allows companies to liquidate and evade paying outstanding creditors in full and then simply start a new company to carry on as before which, as we can see, is what has happened here.
However, Section 216 will only apply if the company is actually liquidated. Because Fred has deliberately shifted assets to the new company for no consideration and the creditor does not want to pay for the old company to be liquidated then section 216 simply cannot be operated.
Indeed all of the insolvency act’s remedies are in effect rendered inoperable simply because no liquidation has taken place.
The creditor could, of course, still pay for Joe Lollipop Ltd.’s liquidation. But remember, if they did this they will be an ordinary creditor and possibly only receive a small dividend. So from a “return on investment” perspective, it probably will not be worth it.
Alternatively, the creditor could report the matter to the police who may consider that a fraud has been committed. However, unless there has been serious loss of money the fraud squad may not proceed with such investigations with any degree of alacrity.
The Accountant in Bankruptcy (charged with Scottish judgment enforcement reform) is aware of the issue and raised the issue of introducing an official receiver in Scotland. But it will be probably be too expensive for this to be paid for from the public purse and this will, no doubt, be kicked into the long grass.
To enable creditors to protect themselves, as well as taking credit reports and putting their customers on “watch lists”, they should look out for unusual trading patterns. In the example given, Fred may well have asked for an unusually large order. A prudent creditor should be alive to this and be put on alert and possibly ask for payment to be made on order.
It will be a matter of prevention being better that the cure, simply because there may not be any cure!
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