The collapse of Maclean Computing Ltd, and the reported purchase of its assets by Maclean Technology Ltd, has led to some discussion on whether the new company may be a phoenix company (see here for the New Zealand definition). While many of the issues being discussed are moral rather than legal issues, here are my quick comments on some aspects of the phoenix rules generally:
Liability for debts
Under the phoenix rules (sections 386A-386F of the Companies Act 1993), a director of a phoenix company is not automatically liable for the debts of the original company. The director of a phoenix company will only be automatically liable (under the phoenix rules) for the relevant debts of the new company (i.e. the phoenix company). For example:
- Company A Ltd collapses and goes into liquidation owing $1m.
- Either before or within 5 years of the collapse, a director of Company A Ltd starts up a new company with a similar name, “Company A Technology Ltd”, and starts doing business out of the new company, apparently leaving unsecured creditors of the old company up the river.
- Company A Technology Ltd will likely be a phoenix company.
- The director will be personally liable for relevant debts (which has a particular meaning) of the Company A Technology Ltd (i.e. the phoenix company) if it fails.
- But the director will not be liable for the $1m of debts of Company A Ltd (i.e. the original, failed company).
So the phoenix rules effectively give directors of “failed companies” (note there is a particular definition of that term) what some may consider a free pass on debts of their first company (although they may be liable to fines – see below – and there are also numerous other company law liabilities that may arise and result in personal liability; these are very selective thoughts only). That is the nature of limited liability companies, which are essential for modern commerce. The new rules are aimed at creditors who may be deceived by the phoenix company, rather than creditors of the original company. So a director can rack up large debts in your first company, have that company fail, launch a phoenix, and not be personally liable (under the phoenix rules) for the first company’s debts. But if the phoenix company “fails”, or any second, third or later phoenix company, then the director will likely be liable for those companies’ relevant debts (which should itself act as a deterrent, because it undermines the protection of limited liability).
The very simple way to avoid the phoenix rules is to avoid using a similar name to the failed company.
Capturing the debts of the original company
It may still be possible to make a director of a phoenix company liable for at least some debts of the original company as follows:
- Put the original company into liquidation (if not already).
- Apply for and obtain a “pooling order” under s 271 of the Companies Act 1993, in respect of the original and phoenix companies. This is not easy, but if granted has the effect of allowing the debts of the original company to be treated as debts of the phoenix company.
- Then use the phoenix rules to make the director personally liable for the debts of the phoenix company, which, because of the pooling order, may include the obligation to pay the debts of the original company.
Note that pooling orders are not commonly obtained and have strict requirements, including that the two companies were “related” (as defined), hopelessly intermingled and effectively indistinguishable. This generally requires a period of overlap of existence between the two companies; a phoenix company formed after the collapse of the original company would be unlikely to qualify.
Penalties under the Companies Act
A person convicted of breaching the phoenix rules can face a fine of up to $200,000, or up to 5 years imprisonment. The fine gets paid to the Government, not go to creditors. These punishments will hopefully deter phoenix directors but will likely provide cold comfort to a stiffed creditor.
There can be other potential remedies for creditors either directly under the Companies Act or, more likely, via the liquidation / receivership process. Remember that the phoenix rules are not intended to protect creditors of the original company.
In any case, at the end of the day it is usually a case of what is economic to pursue.
To end on a positive note, prevention is always better than cure. A key step that creditors can take (if available) to improve their chances in the event of a debtor’s insolvency is to become a secured creditor over appropriate collateral supported by a registered security interest protecting their position.